Why did PNC's reported earnings drop so sharply in 1995?

Net income fell to $408.1 million from $883.9 million mainly because of $380.2 million in after-tax charges from the Midlantic merger and the balance sheet repositioning. These included $260 million of pretax special charges and $279.7 million of pretax net securities losses, partly offset by lower provisions. Excluding the after-tax charges, 1995 earnings were $788.3 million, or $2.29 per fully diluted share.

What is the outlook for net interest income and margin in 1996?

Management expects the fourth-quarter 1995 termination of $5.1 billion of pay-fixed swaps and $5.5 billion of interest rate caps to favorably affect net interest income and margin in 1996 compared with 1995. In January 1996 it also added two-year receive-fixed swaps, reducing the one-year gap asset sensitivity from 7.0% to 3.8%. The filing does not provide a specific margin target.

What are the expected benefits and risks of the Midlantic merger?

The merger is expected to produce substantial cost savings by eliminating overlapping operations and to enhance revenue by cross-selling to a new customer base, and it moved PNC into the second and third largest retail deposit market positions in Philadelphia and New Jersey. However, the filing states no assurance can be given on the level or timing of savings, which depend on conversion strategies, customer attrition and competitive responses. Midlantic Bank, N.A. is expected to be combined with PNC Bank, N.A. in the third quarter of 1996.

What material legal or regulatory risks does PNC disclose?

Key items include a consolidated securities class action from 1994 stock purchases, which management believes is defensible and not material; a Pennsylvania credit card fee class action against PNC National Bank whose outcome depends on a pending U.S. Supreme Court case and cannot yet be assessed; and possible SAIF recapitalization, including a significant one-time assessment on the roughly $5.3 billion of SAIF-insured deposits, whose effect management cannot predict. Management also notes that the Federal Reserve could restrict dividends and that the Midlantic-related New Jersey lawsuit was dismissed in March 1996 with no payment.

How much capital and liquidity does PNC have, and what constrains dividends?

At year-end 1995 the company and each bank were classified as well capitalized, with a total risk-based capital ratio of 11.56% and a leverage ratio of 6.37%, both down from 1994 largely due to acquisition-related intangibles. Liquid assets totaled $21.8 billion, of which $7.6 billion was pledged. Dividends from subsidiary banks are the main source of parent income, and about $650 million was available for upstreaming without regulatory approval. The company paid $1.40 per common share in 1995, though the board's stated intent to continue quarterly dividends depends on earnings and regulatory policy.

PNC 10-K FY1995 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 27, 1996. Cited figures are marked; the original filing is the authoritative source.

PNC Bank Corp.'s 1995 10-K reflects a year dominated by the December 31, 1995 merger with Midlantic Corporation, accounted for as a pooling of interests, which expanded the company into New Jersey and Pennsylvania and lifted total assets to $73.4 billion and deposits to $46.9 billion^a.

Reported 1995 net income fell 54% to $408.1 million^b, or $1.19 per fully diluted share, from $883.9 million, or $2.52, in 1994. Excluding $380.2 million of after-tax charges tied to the Midlantic merger and balance sheet repositioning, earnings would have been $788.3 million, or $2.29 per share. Return on average assets was 0.54% reported (1.05% excluding charges), and return on average common equity was 7.05% reported (13.67% excluding charges).

Management used the year to shrink the securities portfolio from $23.7 billion to $15.8 billion^c and reduce wholesale funding from 35.9% to 28.2% of total sources of funds, while terminating $15.1 billion notional of derivatives. These moves produced $279.7 million of net securities losses and $260 million of special merger charges, and they compressed net interest margin to 3.15% from 3.64%. Credit quality improved: nonperforming assets fell to $536 million from $757 million, the provision for credit losses dropped to $6 million, and management does not expect a provision in 1996 absent deterioration.

Management also expects the derivative terminations to improve net interest income in 1996 compared with 1995. For investors, the central questions are whether the Midlantic cost savings and revenue synergies materialize on schedule, whether net interest margin recovers, and how the pending SAIF recapitalization and the Pennsylvania credit card fee litigation resolve. Capital remained above well-capitalized thresholds at all subsidiary banks, with a Tier 1 risk-based ratio of 8.00%^d and a leverage ratio of 6.37%, both lower than in 1994.

02—Key points

Key Highlights

Midlantic merger completed December 31, 1995 (pooling of interests), issuing about 112 million shares and creating a $73.4 billion bank holding company, the 12th largest in the U.S. by total assets.
Reported 1995 net income of $408.1 million ($1.19 per fully diluted share) versus $883.9 million ($2.52) in 1994; excluding $380.2 million of after-tax merger and repositioning charges, earnings were $788.3 million ($2.29).
Net interest margin compressed to 3.15% from 3.64%, with net interest income down 13.5% to $2.19 billion, largely due to adverse effects of interest rate swaps and caps.
Balance sheet repositioning: securities cut by $7.8 billion to $15.8 billion (23.7% of earning assets vs. 33.9%), and wholesale funding reduced to 28.2% of funding sources from 35.9%.
Asset quality improved: nonperforming assets declined to $536 million (1.10% of loans and foreclosed assets) from $757 million, and the provision for credit losses fell to $6 million from $83.5 million.
Special charges of $260 million related to the Midlantic merger, including $89 million for duplicate facilities, $42 million for severance, and $80 million to terminate an interest rate cap; the company also booked $279.7 million in net securities losses.
Capital ratios declined but all subsidiary banks remained well capitalized: Tier 1 risk-based ratio 8.00% (9.36% in 1994), total risk-based 11.56%, leverage 6.37% (7.10%); no share repurchases were made after the merger due to pooling constraints.

03—Questions

Frequently Asked Questions

Why did PNC's reported earnings drop so sharply in 1995?
Net income fell to $408.1 million from $883.9 million mainly because of $380.2 million in after-tax charges from the Midlantic merger and the balance sheet repositioning. These included $260 million of pretax special charges and $279.7 million of pretax net securities losses, partly offset by lower provisions. Excluding the after-tax charges, 1995 earnings were $788.3 million, or $2.29 per fully diluted share.
What is the outlook for net interest income and margin in 1996?
Management expects the fourth-quarter 1995 termination of $5.1 billion of pay-fixed swaps and $5.5 billion of interest rate caps to favorably affect net interest income and margin in 1996 compared with 1995. In January 1996 it also added two-year receive-fixed swaps, reducing the one-year gap asset sensitivity from 7.0% to 3.8%. The filing does not provide a specific margin target.
What are the expected benefits and risks of the Midlantic merger?
The merger is expected to produce substantial cost savings by eliminating overlapping operations and to enhance revenue by cross-selling to a new customer base, and it moved PNC into the second and third largest retail deposit market positions in Philadelphia and New Jersey. However, the filing states no assurance can be given on the level or timing of savings, which depend on conversion strategies, customer attrition and competitive responses. Midlantic Bank, N.A. is expected to be combined with PNC Bank, N.A. in the third quarter of 1996.
What material legal or regulatory risks does PNC disclose?
Key items include a consolidated securities class action from 1994 stock purchases, which management believes is defensible and not material; a Pennsylvania credit card fee class action against PNC National Bank whose outcome depends on a pending U.S. Supreme Court case and cannot yet be assessed; and possible SAIF recapitalization, including a significant one-time assessment on the roughly $5.3 billion of SAIF-insured deposits, whose effect management cannot predict. Management also notes that the Federal Reserve could restrict dividends and that the Midlantic-related New Jersey lawsuit was dismissed in March 1996 with no payment.
How much capital and liquidity does PNC have, and what constrains dividends?
At year-end 1995 the company and each bank were classified as well capitalized, with a total risk-based capital ratio of 11.56% and a leverage ratio of 6.37%, both down from 1994 largely due to acquisition-related intangibles. Liquid assets totaled $21.8 billion, of which $7.6 billion was pledged. Dividends from subsidiary banks are the main source of parent income, and about $650 million was available for upstreaming without regulatory approval. The company paid $1.40 per common share in 1995, though the board's stated intent to continue quarterly dividends depends on earnings and regulatory policy.

04—Continue

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