PNC, §1A diff (2016 → 2017)

ITEM 1A - RISK FACTORS We are subject to a number of risks potentially impacting our business, financial condition, results of operations and cash flows. As a financial services organization, certain elements of risk are inherent in what we do and the business decisions we make. Thus, we encounter risk as part of the normal course of our business, and we design risk management processes to help manage these risks. Our success is dependent on our ability to identify, understand and manage the risks presented by our business activities so that we can appropriately balance revenue generation and profitability. We categorize the risks we face as credit risk, liquidity risk, capital management, market risk, operational risk and compliance risk. We discuss our principal risk management processes and, in appropriate places, related historical performance and other metrics in the Risk Management section included in Item 7 of this Report. The following are the key risk factors that affect us. Any one or more of these risk factors could have a material adverse impact on our business, financial condition, results of operations or cash flows, in addition to presenting other possible adverse consequences, including those described below. These risk factors and other risks we face are also discussed further in other sections of this Report. Our business and financial performance are vulnerable to the impact of adverse economic conditions. As a financial services company, our business and overall financial performance are affected to a significant extent by economic conditions. Adverse economic conditions generally result in reduced business activity, which may decrease the demand for our products and services, can impair the ability of borrowers to repay loans, and may lead to turmoil and volatility in financial markets. Such effects would likely have an adverse impact on financial institutions such as PNC, with the significance of the impact generally depending on the severity of the adverse economic conditions, increasing typically under recessionary conditions. Even when economic conditions are relatively good or stable, specific economic factors can negatively affect the performance of financial institutions, especially as these factors relate to particular industries or geographical regions. For example, shifting consumer behavior with respect to retail 14 The PNC Financial Services Group, Inc. - Form 10-K purchases over the internet rather than in physical stores has negatively impacted performance by some retailers, potentially decreasing demand for financial services in that sector and impairing the creditworthiness of some shopping malls and retail companies. Given the geographic scope of our business and operations, we are most exposed to issues within the United States economy and financial markets and, within the United States, most exposed to issues within our primary geographic footprint concentrated in the Mid-Atlantic, Midwest and Southeast. International economic conditions, however, can impact our business and financial performance both directly to the extent of our international business activities and, possibly more significantly, indirectly due to the possibility that poor economic conditions impacting other major economies around the world will have an impact on the United States. For example, the prospect of the United Kingdom’s impending exit from the European Union has led to uncertainty regarding the impact on the United Kingdom’s economy and capital markets as well as that of the remaining countries in the European Union. It is also possible that other countries might seek to exit the European Union in the future. The extent to which these uncertainties will affect the United States economy and capital markets is unclear. The recently enacted Tax Cuts and Jobs Act will impact PNC’s business and financial results, including likely resultant changes in customer behavior. In December 2017, Congress passed and the President signed the Tax Cuts and Jobs Act, representing the most significant change in U.S. federal tax law in decades. Although the direct impact of this legislation on PNC is likely to be positive, primarily as a result of a reduction in the corporate tax rate from 35% to 21%, there are specific aspects that will have a negative impact, including the disallowance of deductions for FDIC deposit insurance premiums and for a portion of our executive incentive compensation. In addition, we anticipate that business and retail customers will modify behavior going forward in response to changes in the tax law, some of which are likely to be favorable to PNC over time, but some changes in customer behavior could be detrimental to our business. For example, in addition to various potential positive impacts, new or modified limitations on the ability of individuals to deduct mortgage and home equity interest expense could adversely affect demand for our home lending products. As another example, there could be reduced demand for commercial borrowing, due to factors such as improved cash flow resulting from lower tax rates or funds repatriated from outside the U.S. or utilization of other financing options. It is not possible at present to determine the likely overall impact of the new tax law on PNC as a result of changes in economic activity and customer behavior, either in terms of magnitude or timing. The monetary policies of governmental agencies, including the Federal Reserve, have a significant impact on interest rates and overall financial market performance. Governmental monetary policies, including those of the Federal Reserve, have a significant impact on interest rates and overall financial market performance. These governmental policies can thus affect the activities and results of operations of banking companies such as PNC. An important function of the Federal Reserve is to regulate the national supply of bank credit and certain interest rates. The actions of the Federal Reserve influence the rates of interest that we charge on loans and that we pay on borrowings and interest-bearing deposits and can also affect the value of our on-balance sheet and off-balance sheet financial instruments. Both due to the impact on rates and by controlling access to direct funding from the Federal Reserve Banks, the Federal Reserve’s policies also significantly influence our cost of funding. We cannot predict the nature or timing of future changes in monetary policies or the precise effects that they may have on our activities and financial results. The very low interest rate environment that has prevailed since the financial crisis has had a negative impact on our ability to increase our net interest income. Although the Federal Reserve started increasing its benchmark interest rate in December 2015, ending approximately seven years of near zero rates, and has continued to do so through 2017, with expectations that it will continue to do so in 2018, there is no assurance that it will do so or that it will do so in a manner that will be consistent with market expectations. Should the Federal Reserve not continue raising rates, it could affect consumer and business behavior in ways that are adverse to us in addition to continuing to affect our net interest income. Even if the Federal Reserve continues to increase the interest rates it directly influences, there may be a prolonged period before interest rates return to more historically typical levels. Recent and pending changes in the membership of the Federal Reserve Board, including its Chair, may create additional uncertainty regarding the direction of policy by the Federal Reserve. After an extended period during which the Federal Reserve increased its balance sheet substantially above historical levels through the purchase of debt securities, the Federal Reserve has indicated an intention to start reducing its balance sheet from these elevated levels. It is unclear what impact this will have on the economy or on the markets for and values of financial assets, including assets of the types that we hold, purchase and sell. In addition, monetary policy actions by governmental authorities in the European Union or other countries could have an impact on global interest rates, which could affect rates in the United States as well as rates on instruments denominated in currencies other than the U.S. dollar, any of which could have one or more of the potential effects on us described above. While we have not experienced negative interest rates in the United States, and in recent periods the Federal Reserve has been gradually increasing rates, some central banks in Europe and Asia have cut interest rates below The PNC Financial Services Group, Inc. - Form 10-K 15 zero. If U.S. interest rates were to fall below zero, it could significantly affect our businesses and results of operation in ways that cannot easily be predicted. Other government legislation, regulation and policy potentially impacting the economy can have an adverse effect on our business and financial performance. Changes in law or governmental policy affecting the economy, business activity, or personal spending, investing or saving activities may cause consumers and businesses to alter behavior in ways that impact demand for our products and services. PNC may also adjust the types of transactions we seek to pursue under those circumstances. Uncertainty regarding future law or policy may have similar impacts. Concern regarding the ability of Congress and the President collectively to reach agreement on federal budgetary matters (including the debt ceiling), or prolonged stalemates leading to total or partial governmental shutdowns, also can have adverse economic consequences and create the risk of economic instability or market volatility with potential adverse consequences to our business and financial performance. As a regulated financial services firm, we are subject to numerous governmental regulations, and the financial services industry as a whole continues to be subject to significant regulatory reform initiatives in the United States and elsewhere. The PNC Financial Services Group, Inc. is a bank holding company (BHC) and a financial holding company and is subject to numerous governmental regulations involving both its business and organization. Our businesses are subject to regulation by multiple banking, consumer protection, securities and derivatives regulatory bodies. In recent years, we, together with the rest of the financial services industry, have faced intense regulation, with many new regulatory initiatives and vigorous oversight and enforcement on the part of numerous regulatory bodies. Legislatures and regulators have pursued a broad array of initiatives intended to promote the safety and soundness of financial institutions, financial market stability, the transparency and liquidity of financial markets, and consumer and investor protection. As a result, we have experienced significantly increased compliance costs and have needed to adjust our business practices to accommodate new requirements and limitations, impacting some of our revenue opportunities. Applicable laws and regulations restrict our ability to repurchase stock or to receive dividends from subsidiaries that operate in the banking and securities businesses and impose capital adequacy requirements. PNC’s ability to service its obligations and pay dividends to shareholders is largely dependent on the receipt of dividends and advances from its subsidiaries, primarily PNC Bank. The Federal Reserve requires a BHC to act as a source of financial and managerial strength for its subsidiary banks. The Federal Reserve could require PNC to commit resources to PNC Bank when doing so is not otherwise in the interests of PNC or its shareholders or creditors. Applicable laws and regulations also restrict permissible activities and investments and require compliance with provisions designed to protect loan, deposit, brokerage, fiduciary, mutual fund and other customers, and for the protection of customer information, among other things. We are also subject to laws and regulations designed to combat money laundering, terrorist financing, and transactions with persons, companies or foreign governments designated by U.S. authorities. The current presidential administration has indicated an intent to pursue the regulation of the financial services industry differently than under the previous administration. There is, however, significant uncertainty regarding the direction this administration will take and its ability to implement its policies and objectives. In addition, the ultimate impact on potential new regulatory initiatives and the enforcement of existing laws and regulations is not known. Even to the extent that the current administration takes a different approach to regulation of the financial services industry than had previously been the case, and even if that is overall favorable to us, we would still expect compliance with regulations to be a meaningful burden presenting significant risk. In addition, there could be an increase in state regulation of aspects of our business and in foreign regulation that impacts our operations. Different approaches to regulation by different jurisdictions could increase our compliance costs. There are currently pending numerous additional regulatory proposals, and other new initiatives are likely to be pursued in the future. The implementation of new regulatory requirements and limitations could further increase our compliance costs and the risks associated with non-compliance and could affect our ability to pursue or take full advantage of some desirable business opportunities. A failure to comply, or to have adequate policies and procedures designed to comply, with regulatory requirements and expectations could expose us to damages, fines and regulatory penalties and other regulatory actions or consequences, such as limitations on activities otherwise permissible for us or additional requirements for engaging in new activities, and could also injure our reputation with customers and others with whom we do business. See Supervision and Regulation in Item 1 of this Report for more information concerning the regulation of PNC and recent initiatives to reform financial institution regulation, including some of the matters discussed in this Risk Factor. Note 18 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report also discusses some of the regulation applicable to us. 16 The PNC Financial Services Group, Inc. - Form 10-K Current and likely future capital and liquidity standards will result in banks and bank holding companies needing to maintain more and higher quality capital and greater liquidity than has historically been the case. We are subject to regulatory capital and liquidity requirements established by the Federal Reserve and the OCC, and discuss these requirements and standards in the Supervision and Regulation section included in Item 1 of this Report and the Liquidity and Capital Management portion of the Risk Management section of Item 7 of this Report. The regulatory capital requirements applicable to banks and BHCs have undergone significant changes. For example, the final rules adopted by the U.S. banking agencies in July 2013 to implement the new international guidelines for determining regulatory capital established by the Basel Committee known as “Basel III,” as well as to implement certain provisions of Dodd-Frank, fundamentally altered the U.S. regulatory capital requirements for U.S. BHCs and banks. Significant parts of these rules are now effective for us, although as a result of the staggered effective dates of the rules, many provisions are being phased-in over a period of years, with the rules generally to be fully phased-in as of January 1, 2019. The Basel Committee recently finalized additional, significant changes to the international capital framework for banking organizations, including modifications that would: (i) significantly alter the international frameworks governing the market risk capital requirements for trading positions and the standardized risk weighting approach for credit risk, (ii) introduce a new standardized measure of operational risk to replace the current methodology under the advanced approaches, and (iii) establish a standardized approach floor for capital ratios calculated by banking organizations that use the advanced approaches for the risk weighting of assets. Moreover, the Basel Committee continues to consider other changes to the international regulatory capital framework to enhance the transparency and consistency of capital requirements among banks and jurisdictions, including, among others, the treatment of securitization positions. It is unclear how these or other initiatives by the Basel Committee may be implemented in the U.S. and, thus, we are unable to estimate what potential impact such initiatives may have on us. The liquidity standards applicable to large U.S. banking organizations also are expected to be supplemented in the coming years. For example, the Basel Committee, in October 2014, released the final framework for the NSFR standard, which is designed to ensure that banking organizations maintain a stable, long-term funding profile in relation to their asset composition and off-balance sheet activities. In May 2016, the U.S. banking agencies proposed rules to implement the NSFR but these rules have not yet been finalized. Thus, the potential impact of the NSFR on us remains unclear. The need to maintain more and higher quality capital, as well as greater liquidity, going forward than historically has been required could limit our business activities, including lending, and our ability to expand, either organically or through acquisitions. It could also result in us taking steps to increase our capital that may be dilutive to shareholders, being limited in our ability to pay dividends or otherwise return capital to shareholders, or selling or refraining from acquiring assets, for which the capital requirements appear inconsistent with the assets’ underlying risks. In addition, the new liquidity standards require us to maintain holdings of highly liquid short-term investments, thereby reducing our ability to invest in longer-term or less liquid assets, even if more desirable from a balance sheet or interest rate risk management perspective. In addition, PNC, as a BHC that is subject to the advanced approaches for regulatory capital purposes, is subject to a higher LCR requirement than other BHCs that have more than $50 billion in total assets but are not subject to the advanced approaches. Until the scope and terms of pending or future rulemakings relating to capital, liquidity or liability composition are known, the extent to which such rules may apply to us and the potential impact of such rules on us will remain uncertain. The planned discontinuance of the requirement that banks submit rates for the calculation of LIBOR presents risks to the financial instruments originated or held by PNC that use LIBOR as a reference rate. LIBOR is the reference rate for many transactions in which we lend and borrow money, issue, purchase and sell securities and enter into derivatives to manage our or our customers’ risk of these transactions. LIBOR has been the subject of recent national and international regulatory guidance and proposals for reform. The United Kingdom Financial Conduct Authority, which regulates the process for establishing LIBOR, announced in July 2017 that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. It is not possible to predict the effect of this announcement, including whether LIBOR will continue in place, and if so what changes will be made to it, what rates may replace LIBOR in use going forward, and how LIBOR will be determined for purposes of loans, securities and derivative instruments currently referencing it if it ceases to exist at some point. Any change in the availability or calculation of LIBOR may adversely affect the yield on loans or securities held by us, amounts paid on securities we have issued, or amounts received and paid on derivative instruments we have entered into, the value of such loans, securities, or derivative instruments, the trading market for LIBOR-based securities, the terms of new loans being made using different or modified reference rates, or our ability to effectively use derivative instruments to manage risk. Any of the reform proposals or the general increased regulatory scrutiny of LIBOR could increase the costs and risks of administering or otherwise participating in the setting of LIBOR and complying with any such regulations or requirements. Such factors may have the effect of discouraging market participants from continuing to administer or contribute to LIBOR or lead to the ultimate discontinuance or unavailability of quotes of LIBOR. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR. The PNC Financial Services Group, Inc. - Form 10-K 17 Our business and financial results are subject to risks associated with the creditworthiness of our customers and counterparties. Credit risk is inherent in the financial services business and results from, among other things, extending credit to customers, purchasing securities, and entering into financial derivative transactions and certain guarantee contracts. Credit risk is one of our most significant risks, particularly given the high percentage of our assets represented directly or indirectly by loans and securities and the importance of lending activity to our overall business. We manage credit risk by assessing and monitoring the creditworthiness of our customers and counterparties, by diversifying our loan portfolio and by investing primarily in high quality securities. A borrower’s ability to repay a loan can be adversely affected by several factors. Individual borrowers can be affected by, among other things, declines in income, job losses, health issues or family issues. Commercial borrowers can be affected by, among other things, poor business performance or catastrophe losses. A weak or deteriorating economy and changes in the domestic or global markets would typically adversely impact the ability of our borrowers to repay outstanding loans. We may also be exposed to credit risk if we fail to evaluate properly at origination the likely ability of a borrower to repay a loan or fail to identify declining creditworthiness of a borrower at a time when remedial actions may reduce our exposure. Any decrease in our borrowers’ ability to repay loans would result in higher levels of nonperforming loans, net charge-offs, provision for credit losses and valuation adjustments on loans held for sale. Financial services institutions are interrelated as a result of trading, clearing, lending, counterparty and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. Despite maintaining a diversified loan and securities portfolio, in the ordinary course of business, we may have concentrated credit exposure to a particular person or entity, industry, region or financial market. Loans secured by commercial and residential real estate represent a significant percentage of our overall credit portfolio, as well as of the assets underlying our investment securities. Events adversely affecting specific customers or counterparties, industries, regions or financial markets, including a decline in their creditworthiness or a worsening overall risk profile, could adversely affect us. Our credit risk may be exacerbated when collateral held by us to secure obligations to us cannot be realized upon or is liquidated at prices that are not sufficient to recover the full amount of the loan or derivative exposure due us. We reserve for credit losses on our loan and lease portfolio, as well as for unfunded loan commitments and letters of credit, through our Allowances for loan and lease losses and unfunded loan commitments and letters of credit, with changes in the allowances reflected in Net income through Provision for credit losses. An increase in credit risk would likely lead to an increase in Provision for credit losses with a resulting reduction in our Net income and would increase our allowances. Our business and financial performance is impacted significantly by market interest rates and movements in those rates. As a result of the high percentage of our assets and liabilities that are in the form of interest-bearing or interest-related instruments, changes in interest rates, in the shape of the yield curve, or in spreads between different market interest rates can have a material effect on our business, our profitability and the value of our financial assets and liabilities. For example: • Changes in interest rates or interest rate spreads can affect the difference between the interest that we earn on assets and the interest that we pay on liabilities, which impacts our overall net interest income and margin as well as our profitability. • Such changes can affect the ability of borrowers to meet obligations under variable or adjustable rate loans and other debt instruments, and can, in turn, affect our loss rates on those assets. • Such changes may decrease the demand for interest rate-based products and services, including loans and deposit accounts. • Such changes can also affect our ability to hedge various forms of market and interest rate risk and may decrease the effectiveness of those hedges in helping to manage such risks. • Movements in interest rates also affect mortgage prepayment speeds and could result in impairments of mortgage servicing assets or otherwise affect the profitability of such assets. • Increases in interest rates can lower the price we would receive on fixed-rate customer obligations if we were to sell them. We discuss the impact of governmental monetary policy on interest rates in “The monetary policies of governmental agencies, including the Federal Reserve, have a significant impact on interest rates and overall financial market performance” Risk Factor in this Item 1A. Our business and financial performance are vulnerable to the impact of changes in the values of financial assets. As a financial institution, a substantial majority of our assets and liabilities are financial in nature (items such as loans, securities, servicing rights, deposits and borrowings). Such assets and liabilities will fluctuate in value, often significantly, due to movements in the financial markets or market volatility as well as developments specific to the asset or liability in question. Credit-based assets and liabilities will fluctuate in 18 The PNC Financial Services Group, Inc. - Form 10-K value due to changes in the perceived creditworthiness of borrowers or other counterparties and also due to changes in market interest rates. In addition, changes in loan prepayment speeds, usually based on fluctuations in market interest rates, could adversely impact the value of our mortgage servicing rights. Additionally, the underlying value of assets under lease or securing an obligation may decrease due to supply and demand for the asset or the condition of the asset. This could cause the ability to collect fully on, or the value of, the secured obligation to decline. In many cases, we mark our assets and liabilities to market on our financial statements, either through our Net income and Retained earnings or through adjustments to Accumulated other comprehensive income on our balance sheet. We may need to record losses in the value of financial assets even where our expectation of realizing the face value of the underlying instrument has not changed. In addition, asset management revenue is primarily based on a percentage of the value of the assets being managed and thus is impacted by general changes in market valuations. Thus, although we are not directly impacted by changes in the value of such assets, decreases in the value of those assets would affect related noninterest income. Our asset and liability valuations and the determination of the amount of loss allowances and impairments taken on our assets are highly subjective. Inaccurate estimates could materially impact our results of operations or financial position. We must use estimates, assumptions and judgments when assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Changes in underlying factors or assumptions in any of the areas underlying our estimates could materially impact our future financial condition and results of operations. During periods of market disruption, it may be more difficult to value certain assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were historically traded in active markets with significant observable data that rapidly become illiquid due to market volatility, a loss in market confidence or other factors. In addition, we have certain assets and liabilities carried at fair value that are estimated using unobservable inputs that are significant to the fair value of the assets or liabilities. Further, rapidly changing and unprecedented market conditions in any particular market could materially impact the valuation of assets as reported within our consolidated financial statements. The determination of the amount of loss allowances and asset impairments varies by asset type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Management updates its evaluations regularly and reflects changes in allowances and impairments in operations as such evaluations are revised. Although we have policies and procedures in place to determine loss allowance and asset impairments, due to the subjective nature of this area, there can be no assurance that our management has accurately assessed the level of impairments taken and allowances reflected in our financial statements. Furthermore, additional impairments may need to be taken or allowances provided for in the future. Historical trends may not be indicative of future impairments or allowances. Our success depends on our ability to attract and retain customers for our products and services, which may be negatively impacted by a lack of consumer and business economic confidence as well as our actions, including our ability to anticipate and satisfy customer demands for products and services. As a financial institution, our performance is subject to risks associated with declines in customer demand for our products and services, including as a result of a loss of economic confidence or customer trust in us. Economic and market developments may affect consumer and business confidence levels. If customers lose confidence due to a weak or deteriorating economy or uncertainty surrounding the future of the economy, the demand for our products and services could suffer. We may also fail to attract or retain customers if we are unable to develop and market products and services that meet evolving customer needs or demands or if we are unable to deliver them effectively and securely to our customers, particularly to the extent that our competitors are better able to do so. News or other publicity that impairs our reputation, or the reputation of our industry generally, also could cause a loss of customers. Financial companies are highly vulnerable to reputational damage when they are found to have harmed customers, particularly retail customers, through conduct that is illegal or viewed as unfair, deceptive, manipulative or otherwise wrongful. The negative impact of such reputational damage on our business may be disproportionate to the actual harm caused customers. In addition, we could suffer reputational harm and a loss of customer trust as a result of conduct of others in which we have not engaged. If we fail to attract and retain customers, demand for our loans and other financial products and services could decrease and we could experience adverse changes in payment patterns. We could lose interest income from a decline in credit usage and noninterest income from a decline in product sales, investments and other transactions. Our customers could remove money from checking, savings or other types of deposit accounts in favor of other banks or other types of investment products. Deposits are a low cost source of funds for us. Therefore, losing deposits could increase our funding costs and reduce our net interest income. The PNC Financial Services Group, Inc. - Form 10-K 19 The United States is just starting to emerge from an extended period of very low interest rates. Very low interest rates decrease the attractiveness of alternatives to bank checking and savings accounts, which may lack deposit insurance and some of the convenience associated with more traditional banking products. As interest rates rise, and the spread between the rates we offer and those offered by alternatives to bank accounts widens, customers may be less willing to maintain balances in noninterest bearing or low interest bank accounts, which could result in a relatively higher cost of funds to us and negatively affect net interest income. This could also result in a loss of noninterest income. In our asset management business, investment performance is an important factor influencing the level of assets that we manage. Poor investment performance could impair revenue and growth as existing clients might withdraw funds in favor of better performing products. Additionally, the ability to attract funds from existing and new clients might diminish. Overall economic conditions may limit the amount that customers are able or willing to invest as well as the value of the assets they do invest. The failure or negative performance of products of other financial institutions could lead to a loss of confidence in similar products offered by us without regard to the performance of our products. Such a negative contagion could lead to withdrawals, redemptions and liquidity issues in such products and have a material adverse impact on our assets under management and asset management revenues and earnings. We operate in a highly competitive environment, in terms of the products and services we offer and the geographic markets in which we conduct business, as well as in our labor markets where we compete for talented employees. Competition could adversely impact our customer acquisition, growth and retention, as well as our credit spreads and product pricing, causing us to lose market share and deposits and revenues. We are subject to intense competition from various financial institutions as well as from non-bank entities that engage in many similar activities without being subject to bank regulatory supervision and restrictions. This competition is described in Item 1 of this Report under “Competition.” In all, the principal bases for competition are pricing (including the interest rates charged on loans or paid on interest-bearing deposits), product structure, the range of products and services offered and the quality of customer service (including convenience and responsiveness to customer needs and concerns). The ability to access and use technology is an increasingly important competitive factor in the financial services industry. Having the right technology is a critically important component to customer satisfaction as it affects our ability to deliver the products and services that customers desire and in a manner that they find convenient and attractive. Banks generally are facing the risk of increased competition from products and services offered by non-bank financial technology companies, particularly related to payment services and lending. Consolidation in our industry, including among smaller banks combining to form more competitive larger ones and between banks and non-bank entities offering financial products and services, could result in PNC facing more intense competition, particularly in impacted regions or with respect to particular products. Another increasingly competitive factor in the financial services industry is the competition to attract and retain talented employees across many of our business and support areas. This factor presents greater risk when we are expanding into new markets, developing new product lines, or need to significantly enhance staffing in certain areas. This competition leads to increased expenses in many business areas and can also cause us to not pursue certain business opportunities. Limitations on the manner in which regulated financial institutions can compensate their officers and employees, including those contained in pending rule proposals implementing requirements of the Dodd-Frank Act, may make it more difficult for regulated financial institutions, including PNC, to compete with unregulated financial institutions for talent. A failure to adequately address the competitive pressures we face could make it harder for us to attract and retain customers across our businesses. On the other hand, meeting these competitive pressures could require us to incur significant additional expense or to accept risk beyond what we would otherwise view as desirable under the circumstances. In addition, in our interest rate sensitive businesses, pressures to increase rates on deposits or decrease rates on loans could reduce our net interest margin with a resulting negative impact on our net interest income. We continually encounter technological change and need to keep pace with this change in order to maintain or enhance the competitiveness of our businesses. The financial services industry is undergoing rapid technological change with frequent introductions of new technology-driven products and services. Examples at the present time include expanded use of cloud computing, artificial intelligence and machine learning, virtual and augmented reality, biometric authentication, voice and natural language, and data protection enhancements, as well as increased on-line and mobile device interaction with customers. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. We have been investing in technology and connectivity in order to automate functions previously performed manually, to facilitate the ability of customers to engage in financial transactions, and otherwise to enhance the customer experience with respect to our products and services. On the retail side, this has included developments such as more sophisticated ATMs (including the ability to cash checks using exact change), cashless bank branches, and expanded access to banking transactions (including mobile deposits, instant availability of funds, and real time payment processing) through the internet, smart phones, tablets and other mobile devices. These efforts have 20 The PNC Financial Services Group, Inc. - Form 10-K all been in response to actual and anticipated customer behavior and expectations. Our continued success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that satisfy customer demands, including demands for faster and more secure payment services, and create efficiencies in our operations. A failure to maintain or enhance our competitive position with respect to technology, whether because we fail to anticipate customer expectations or because our technological developments fail to perform as desired or are not rolled out in a timely manner, may cause us to lose market share or incur additional expense. We depend on the effectiveness and integrity of our employees, systems and controls to manage operational risks. We are a large organization that offers a wide variety of products and services to a broad and diverse group of customers. We are dependent on our employees, systems and controls to assure that we properly enter into, record and manage processes, transactions and other relationships with customers, suppliers and other parties with whom we do business, as well as to assure that we identify and mitigate the risks that are inherent in these relationships. We necessarily rely on our employees or, in some cases, employees of third parties to perform these tasks and manage the resulting risks. As a result, we are vulnerable to human error, misconduct or malfeasance, leading potentially to operational breakdowns or other errors. In addition, when we change processes or procedures or introduce new products or services, we may fail to adequately identify or manage operational risks resulting from such changes. We have taken measures to manage and mitigate this risk, but our controls may not be adequate to prevent problems resulting from human involvement in our business, including risks associated with the design, operation and monitoring of automated systems. Errors by our employees or those of third parties, whether accidental, intentional or fraudulent, or other failures of our systems and controls, including systems and controls that are automated, could result in customer remediation costs, regulatory fines or penalties, litigation or enforcement actions, or limitations on our business activities. They also could result in damage to our reputation and to our ability to attract and retain customers, with the reputational impact likely greater to the extent that the mistakes or failures are pervasive, long-standing or affect a significant number of customers, particularly retail consumers. It is possible that the damage to our reputation may be disproportionate to the actual harm suffered by our customers or may be severe even if we fully remediate any harm suffered by our customers. It is not possible to prevent all errors of these types, and over the last several years, financial services organizations have been reported to have failed to adequately prevent, identify or respond to a broad range of operational risk matters with resulting consequences to the other organizations of the types described above. Recent examples include unauthorized account openings, assessment of inappropriate fees, and failure to report information timely to the government. We depend on technology, both internally and through third-parties, to conduct our business and could suffer a material adverse impact from interruptions in the effective operation of, or security breaches affecting, those systems. As a large financial company, we handle a substantial volume of customer and other financial transactions on a continuous basis. As a result, we rely heavily on information systems to conduct our business and to process, record and monitor our transactions and those of our customers. Over time, we have increased substantially in size, scope and complexity. We have also seen more customer usage of technological solutions for financial needs as well as higher expectations of customers and regulators regarding effective and safe systems operation. We expect these trends to continue for the foreseeable future. The need to ensure proper functioning and resiliency of these systems has become more challenging, and the costs involved in that effort are greater than ever. The risks to these systems result from a variety of factors, both internal and external. In some cases, these factors relate to the potential for bad acts on the part of hackers, criminals, foreign governments or their agents, employees and others, and to some extent will be beyond our ability to prevent. In other cases, our systems could fail to operate as needed, including failures to prevent access in an unauthorized manner, due to factors such as design or performance issues, human error, unexpected transaction volumes or inadequate measures to protect against unauthorized access or transmissions. We are also at risk for the impact of natural or other disasters, terrorism, international hostilities and the like on our systems or for the effect of outages or other failures involving power, communications, or payment, clearing and settlement systems operated by others. In addition, we face a variety of types of cyber attacks, some of which are discussed in more detail below. Cyber attacks often include efforts to disrupt our ability to provide services or to gain access to, or destroy, confidential or proprietary company and customer information. We rely on other companies for the provision of a broad range of products and services. Many of these products and services rely on information systems maintained by third parties or involve the use of such systems in connection with providing our products or services. In some cases, these other companies provide the infrastructure that supports communications, payment, clearing and settlement systems, or information processing and storage. These other companies are generally subject to many of the same risks we face with respect to our systems. To the extent we rely on these other companies, we could be adversely affected if they are impacted by system failures, cyber attacks or employee misconduct. All of these types of events, whether resulting from cyber attacks or other internal or external sources, expose customer and other confidential information to security risks. They also The PNC Financial Services Group, Inc. - Form 10-K 21 could disrupt our ability to use our accounting, deposit, loan and other systems and could cause errors in transactions or system functionality with customers, vendors or other parties. In addition, our customers often use their own devices, such as computers, smartphones and tablets, to do business with us and may provide their PNC customer information (including passwords) to a third party in connection with obtaining services from the third party. Although we take steps to provide safety and security for our customers’ transactions with us and their customer information to the extent they are utilizing their own devices or providing third parties access to their accounts, our ability to assure such safety and security is necessarily limited. We are faced with ongoing efforts by others to breach data security at financial institutions or with respect to financial transactions. Some of these involve efforts to enter our systems directly by going through or around our security protections. Others involve the use of schemes such as “phishing” to gain access to identifying customer information, often from customers themselves. Most corporate and commercial transactions are now handled electronically, and our retail customers increasingly use online access and mobile devices to bank with us. The ability to conduct business with us in this manner depends on the transmission of confidential information, which increases the risk of data security breaches. As our customers regularly use PNC-issued credit and debit cards to pay for transactions with retailers and other businesses, there is the risk of data security breaches at those other businesses covering PNC account information. When our customers use PNC-issued cards to make purchases from those businesses, card account information may be provided to the business. If the business’s systems that process or store card account information are subject to a data security breach, holders of our cards who have made purchases from that business may experience fraud on their card accounts. We may suffer losses associated with reimbursing our customers for such fraudulent transactions on customers’ card accounts, as well as for other costs related to data security compromise events, such as replacing cards associated with compromised card accounts. In addition, we provide card transaction processing services to some merchant customers under agreements we have with payment networks such as Visa and MasterCard. Under these agreements, we may be responsible for certain losses and penalties if one of our merchant customers suffers a data security breach. Over the last few years, several large companies disclosed that they had suffered substantial data security breaches compromising millions of user accounts and credentials. To date, our losses and costs related to these breaches have not been material, but other similar events in the future could be more significant to us. There have been other recent publicly announced cyber attacks that were not focused on gaining access to credit card or user credential information but instead sought access to a range of other types of confidential information including internal emails and other forms of customer financial information. Ransomware attacks have sought to deny access to data and possibly shut down systems and devices maintained by target companies. In a ransomware attack, system data is encrypted or access is otherwise denied, accompanied by a demand for ransom to restore access to the data. Other types of attacks in recent years have included distributed denial of service (DDoS) attacks, in which individuals or organizations flood commercial websites with extraordinarily high volumes of traffic with the goal of disrupting the ability of commercial enterprises to process transactions and possibly making their websites unavailable to customers for extended periods of time. We (as well as other financial services companies) have been subject to such attacks. To date, these types of attacks have not had a material financial impact on us, but attacks on others demonstrate the risks posed by new and evolving types of cyber attacks. We could suffer material financial and reputational losses in the future from any of these or other types of attacks. Methods used by others to attack information systems change frequently (with generally increasing sophistication), often are not recognized until launched against a target, may be supported by foreign governments or other well-financed entities, and may originate from less regulated and remote areas around the world. As a result, we may be unable to address these methods in advance of attacks, including our inability to implement adequate preventive measures. In addition to threats from people external to us, insider threats represent a significant risk to us. Insiders, having legitimate access to our systems and the information contained in them, have the easiest opportunity to make inappropriate use of the systems and information. Addressing that risk requires understanding not only how to protect us from unauthorized use and disclosure of data, but also how to engage behaviorial analytics to identify potential internal threats before any damage is done. We have policies, procedures and systems (including business continuity programs) designed to prevent or limit the effect of possible failures, interruptions or breaches in security of information systems. We design our business continuity and other information and technology risk management programs to manage our capabilities to provide services in the case of an event resulting in material disruptions of business activities affecting our employees, facilities, technology or suppliers. We regularly seek to test the effectiveness of and enhance these policies, procedures and systems. Nonetheless, we cannot guarantee the effectiveness of our policies, procedures and systems to protect us in any particular future situation. Our ability to mitigate the adverse consequences of such occurrences is in part dependent on the quality of our business continuity planning, our ability to understand threats to us from a holistic perspective, and our ability to anticipate the 22 The PNC Financial Services Group, Inc. - Form 10-K timing and nature of any such event that occurs. The adverse impact of natural and other disasters, terrorist activities, international hostilities and the like could be increased to the extent that there is a lack of preparedness on the part of national or regional governments, including emergency responders, or on the part of other organizations and businesses with which we deal, particularly those on which we depend, many of which we have little or no control over. In recent years, we have incurred significant expense towards improving the reliability of our systems and their security against external and internal threats. Even with our proactive and defensive measures in place, there remains the risk that one or more adverse events might occur. If one does occur, we might not be able to remediate the event or its consequences timely or adequately, particularly to the extent that it represents a novel or unusual threat. To the extent that the risk relates to products or services provided by others, we seek to engage in due diligence and monitoring to limit the risk, but here, as well, we cannot eliminate it. Should an adverse event affecting another company’s systems occur, we may not have indemnification or other protection from the other company sufficient to compensate us or otherwise protect us from the consequences. The occurrence of any failure, interruption or security breach of any of our information or communications systems, or the systems of other companies on which we rely, could result in a wide variety of adverse consequences to us. This risk is greater if the issue is widespread or results in financial losses to our customers. Possible adverse consequences include damage to our reputation or a loss of customer business. We also could face litigation or additional regulatory scrutiny, which in turn could lead to liability or other sanctions, including fines and penalties or reimbursement of customers adversely affected by a systems problem or security breach. Even if we do not suffer any material adverse consequences as a result of events affecting us directly, successful attacks or systems failures at other financial institutions could lead to a general loss of customer confidence in financial institutions, including us. Also, systems problems, including those resulting from third party attacks, whether at PNC or at our competitors, would likely broadly increase regulatory and customer concerns regarding the functioning, safety and security of such systems. In that case, we would expect to incur even higher levels of costs with respect to prevention and mitigation of these risks. There are risks resulting from the extensive use of models in our business. We rely on quantitative models to measure risks and to estimate certain financial values. Models may be used in such processes as determining the pricing of various products, grading loans and extending credit, measuring interest rate and other market risks, predicting or estimating losses, assessing capital adequacy, and calculating economic and regulatory capital levels, as well as to estimate the value of financial instruments and balance sheet items. Poorly designed or implemented models present the risk that our business decisions based on information incorporating model output will be adversely affected due to the inadequacy of that information. Also, information we provide to the public or to our regulators based on poorly designed or implemented models could be inaccurate or misleading. Some of the decisions that our regulators make, including those related to capital distributions to our shareholders, could be affected adversely due to their perception that the quality of the models used to generate the relevant information is insufficient. Our business and financial results could be impacted materially by adverse results in legal proceedings. Many aspects of our business involve substantial risk of legal liability. We have been named or threatened to be named as defendants in various lawsuits arising from our business activities (and in some cases from the activities of companies we have acquired). In addition, we are regularly the subject of governmental investigations and other forms of regulatory inquiry. We also are at risk when we have agreed to indemnify others for losses related to legal proceedings they face, including litigation and governmental investigations and inquiries, such as in connection with the sale of a business or assets by us. The results of these legal proceedings could lead to significant monetary damages or penalties, restrictions on the way in which we conduct our business, or reputational harm. Although we establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated, we do not have accruals for all legal proceedings where we face a risk of loss. In addition, due to the inherent subjectivity of the assessments and unpredictability of the outcome of legal proceedings, amounts accrued may not represent the ultimate loss to us from the legal proceedings in question. Thus, our ultimate losses may be higher, and possibly significantly so, than the amounts accrued for legal loss contingencies. We discuss further the unpredictability of legal proceedings and describe certain of our pending legal proceedings in Note 19 Legal Proceedings in the Notes To Consolidated Financial Statements in Item 8 of this Report. We grow our business in part by acquiring other financial services companies or assets from time to time, and these acquisitions present a number of risks and uncertainties related both to the acquisition transactions themselves and to the integration of the acquired businesses into PNC after closing. Acquisitions of other financial services companies, financial assets and related deposits and other liabilities present risks and uncertainties to us in addition to those presented by the nature of the business acquired. In general, acquisitions may be substantially more expensive or take longer to complete than anticipated (including unanticipated costs incurred in connection with the integration of the acquired company). Anticipated benefits (including The PNC Financial Services Group, Inc. - Form 10-K 23 anticipated cost savings and strategic gains, for example resulting from being able to offer product sets to a broader potential customer base) may be significantly harder or take longer to achieve than expected or may not be achieved in their entirety as a result of unexpected factors or events. Our ability to achieve anticipated results from acquisitions is often dependent also on the extent of credit losses in acquired loan portfolios and the extent of deposit attrition, which are, in part, related to the state of economic and financial markets. Also, litigation and governmental investigations that may be pending at the time of the acquisition or be filed or commenced thereafter, as a result of an acquisition or otherwise, could impact the timing or realization of anticipated benefits to us. Integration of an acquired company’s business and operations into PNC, including conversion of the acquired company’s different systems and procedures, may take longer or be more costly than originally anticipated or have unanticipated adverse results relating to the acquired company’s or our existing businesses. In some cases, acquisitions involve our entry into new businesses or new geographic or other markets, and these situations also present risks and uncertainties in instances where we may be inexperienced in these new areas. Our ability to analyze the risks presented by prospective acquisitions, as well as our ability to prepare in advance of closing for integration, depends, in part, on the information we can gather with respect to the target, which is more limited than the information we have regarding companies we already own. As a regulated financial institution, our ability to pursue or complete attractive acquisition opportunities could be negatively impacted by regulatory delays or other regulatory issues. In addition, our ability to make large acquisitions in the future may be negatively impacted by regulatory rules or future regulatory initiatives designed to limit systemic risk and the potential for a financial institution to become “too big to fail.” Our business and financial performance could be adversely affected, directly or indirectly, by disasters, natural or otherwise, by terrorist activities or by international hostilities. Neither the occurrence nor the potential impact of disasters (such as earthquakes, hurricanes, tornadoes, floods and other severe weather conditions, pandemics, dislocations, fires, explosions, and other catastrophic accidents or events), terrorist activities and international hostilities can be predicted. However, these occurrences could impact us directly (for example, by causing significant damage to our facilities or preventing us from conducting our business in the ordinary course), or indirectly as a result of their impact on our borrowers, depositors, other customers, suppliers or other counterparties. We could also suffer adverse consequences to the extent that disasters, terrorist activities or international hostilities affect the financial markets or the economy in general or in any particular region. These types of impacts could lead, for example, to an increase in delinquencies, bankruptcies or defaults that could result in our experiencing higher levels of nonperforming assets, net charge-offs and provisions for credit losses. Our ability to mitigate the adverse consequences of such occurrences is in part dependent on the quality of our resiliency planning, and our ability, if any, to anticipate the nature of any such event that occurs. The adverse impact of disasters or terrorist activities or international hostilities also could be increased to the extent that there is a lack of preparedness on the part of national or regional emergency responders or on the part of other organizations and businesses that we deal with, particularly those that we depend upon but have no control over. ITEM 1B