Earnings season for the first quarter kicked off with a deluge of bank earnings. The common theme so far has been a big uptick in reserves being set aside for future credit losses driven by COVID-19. 

PNC Financial Services (NYSE:PNC) reported earnings per share of $1.95, down 25% from a year ago and off 34% from the fourth quarter of 2019. PNC's Return on Assets fell to 0.89% from 1.33% in the fourth quarter, and Return on Equity fell from 11.5% to 7.5%. Let's take a deeper diver into the earnings report and see whether this bank is managing well in 2020.

Big jump in reserves for loan losses

Provisions for credit losses increased 384% on a year-over-year basis to $914 million, largely due to expected future losses from COVID-19 and the new Current Expected Credit Loss (CECL) accounting standard that became effective on Jan. 1, 2020. The incremental jump was $693 million, or 0.16% of assets and 0.27% of loans. They were applied roughly 55% to the commercial loan portfolio and 45% to the consumer portfolio.

Pillars and hundred dollar bills

Image source: Getty Images.

PNC CEO Bill Demchak said on the conference call that economic conditions had deteriorated since the quarter's end, and we could see further provisioning. In addition, he believes we are looking more at a U-shaped recovery, versus the V-shaped one when many of the CECL calculations were made. 

Good credits dealing with a cash flow crunch

Commercial loans increased during the quarter, driven primarily by companies pre-emptively taking down their lines of credit. PNC has received thousands of applications under the Paycheck Protection Program of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. About $2.5 billion of PNC's loan book is to retailers, and 60% of those are backed by collateral. Oil and gas exposure is about $4.6 billion, and restaurants and leisure are $1.2 billion.

So far, PNC is making decisions regarding loan modifications on a customer-by-customer basis, and most of them are agreements to defer interest or lower fees. On the conference call, Demchak said most of these modifications were "good credits" which are dealing with a "cash flow crunch." 

Mortgage forbearance and servicing

In the consumer book, most of the exposure is in the mortgage sector. PNC has completed 41,000 loan modifications related to COVID-19. These consist of loan extensions, deferrals, and forbearances. PNC will also have to write down its mortgage servicing portfolio somewhat, although at the end of 2019, PNC was valuing the servicing at 83 basis points of unpaid principal balance, which was probably conservative to begin with.

Note that PNC did attribute income to "increased mortgage servicing valuation net of hedges," which is surprising given that the other big banks wrote down their servicing portfolios. Since delinquencies and prepayment speeds are poised to accelerate, it would seem appropriate to write them down, but perhaps the positive P/L from the hedge position was larger than the loss on the MSR portfolio. 

Blackrock fee income declined as well

PNC generates a lot of fee income and it holds 35 million shares of global investment management firm BlackRock, which is included on the balance sheet as equity income. PNC also earns fee income from asset management and corporate treasury services. These businesses generate fee income without taking on credit risk.

In the first quarter, Other Income, which includes Blackrock, accounted for 32% of net income in the quarter. Last year, Blackrock accounted for 15% of net income. While fee income can help mitigate the effect of provisioning and credit losses, it is still sensitive to the overall banking environment and asset markets. 

PNC's provision for loan losses is about 1.5% of loans. This is toward the high side compared to some of the other big banks reporting last week. PNC's Basel III Tier 1 Capital Ratio dipped 10 basis points to 9.4%, compared to the end of 2019. PNC also maintained its dividend of $1.15 a share, which works out to be a 4.5% dividend yield. The dividend is well-covered at under 60% of earnings.

While we are in uncharted territory, economy-wise, PNC Financial seems to be in decent shape to weather the current financial storm.