PNC Financial: One Of The Best Regional Banks Money Can Buy

Introduction

I don’t really like regional banks.

Regional banks are horrible long-term wealth compounders due to the volatile nature of their businesses. They often depend on the simple lending business, which is driven by rate changes, and tend to suffer during recessions.

Selloffs are often so severe that they ruin long-term returns.

Looking at the chart below, we see that regional banks, as displayed by the SPDR S&P Regional Banking ETF (KRE), have returned 28.9% since pre-Great Financial Crisis levels. This isn’t the annual total return. It’s what investors would have made if they had invested every penny of dividends since then.

Excluding dividends, the KRE ETF is down 15% since its 2006 inception.

The Great Financial Crisis, the pandemic, and the current selloff have all prevented investors from generating wealth.

S&P 500 (SPY) investors have made 385% during this period.

Having said that, there are two things I need to mention:

1. Regional banks are great trading vehicles. I bought regional banks in 2020, and I’m constantly monitoring them for mid-term trading opportunities.
2. There are some terrific regional banks on the market that are, in fact, able to deliver strong returns.

One of them is The PNC Financial Services Group, Inc. (NYSE:PNC), a bank that has consistently returned high returns and income for its investors. The bank has lost roughly half of its value since early 2022, making it an attractive bank to keep an eye on.

After all, this is what its total return looks like:

For what it’s worth if it weren’t for the current crisis, PNC would have come close to outperforming the S&P 500.

However, it still managed to outperform the regional banking industry and financial sector, though. By a considerable margin, I should add!

Now, the bank yields more than 5% and trades at an attractive valuation.

It’s the reason I’m discussing it for the first time since 2019.

So, let’s get to it!

A Banking Powerhouse

PNC, headquartered in Pittsburgh, Pennsylvania, stands as a major diversified financial institution within the U.S.

The company’s extensive offerings include retail banking, residential mortgage services, corporate and institutional banking, and asset management, reaching a national scale.

USD in Million	2021	Weight	2022	Weight
Retail Banking	9,002	46.9 %	10,507	49.7 %
Corporate and Institutional Banking	8,309	43.3 %	8,800	41.7 %
Asset Management Group	1,463	7.6 %	1,544	7.3 %
Other	437	2.3 %	269	1.3 %

Click to enlarge

While the company is officially a regional bank, it’s more of a super-regional bank, generating more than half of its income from non-retail banking operations.

As the map below suggests, the bank’s robust retail branch network spans coast-to-coast, complemented by strategic international offices in Canada, China, Germany, and the United Kingdom.

Furthermore, on June 1, 2021, PNC completed the acquisition of BBVA USA Bancshares, Inc. for $11.5 billion in cash, marking a significant milestone.

The acquisition involved the merger of BBVA USA into PNC Bank on October 8, 2021.

This strategic move integrated approximately 2.6 million customers, 9,000 employees, and over 600 branches across seven states into PNC’s operations.

Prior to that, in the second quarter of 2020, PNC divested its entire 22.4% equity investment in BlackRock (BLK), resulting in net proceeds of $14.2 billion and an after-tax gain of $4.3 billion.

While some may make the case that it’s unfair to compare a company like PNC to the “average” regional bank, I believe it makes sense. Why not opt for a well-diversified regional bank with capabilities that others don’t have?

We don’t need to settle for lower-quality banks.

After all, the company isn’t just large and diversified, but it is also holding up very well in this economic environment.

A Strong Q2 2023 Performance

For example, in the second quarter, the company generated $1.5 billion in net income or $3.36 in diluted earnings per share.

Despite the challenging macroeconomic environment and competitive dynamics in the banking sector affecting revenue, the company emphasized the robustness of its franchise and balance sheet during the earnings call.

The focus remains on executing strategic priorities and momentum, particularly in the Southwest markets.

The company reported that loans amounted to $325 billion, which was consistent with the previous quarter, indicating stability. During the earnings call, the company emphasized that growth in consumer loans, such as residential mortgages, credit card balances, and auto loans, helped to offset the decline in commercial loans caused by weaker demand.

Consumer loans increased by $400 million from the first quarter, indicating a positive trajectory in consumer lending. This stability in loans is crucial for maintaining a steady revenue stream and suggests prudent lending practices, according to the company.

However, it’s noteworthy that commercial loans, amounting to $223 billion, saw a decline of $1 billion, primarily due to limited new production being outweighed by paydowns.

This decline highlights the economic dynamics and demand in the commercial sector, and it will be important for PNC to strategize on revitalizing commercial loan growth to support their overall revenue and business expansion.

In light of economic challenges, I would not be surprised if the company were to report more headwinds in this segment, not because of poor management but because elevated rates are such a drag on loan demand.

Looking at the chart below, we see that total C&I loan growth is now at 0% in the United States, an indication that a recession may be very close.

PNC also detailed the dynamics of its deposit portfolio. Total deposits, standing at $426 billion, experienced a 2% decline on both a spot and average basis, primarily attributed to the impacts of quantitative tightening and increased spending activity.

As one can imagine, there was a notable shift in deposit composition, with a movement from non-interest-bearing to interest-bearing accounts, especially in the commercial sector.

Commercial non-interest-bearing deposits represented 45% of total commercial deposits, down from 47% in the previous quarter, underlining a change in deposit mix caused by higher rates.

Furthermore, PNC’s capital position is strong, with an estimated CET1 ratio of 9.5%.

CET capital ratio increased 30 basis points in the quarter. So we’re at 9.5. We did well on the stress test, the most recent stress test where our stress capital buffer decreased. So we’re in an excess capital position. The part of that thinking was the increase in the dividend that we announced recently. – PNC 2Q23 Earnings Call.

The company also saw no notable increase in delinquencies, net charge-offs, and nonperforming loans. Just 2.7% of its total loans are commercial office loans. Non-office CRE loans are 8.5% of total loans.

It has an A- credit rating, one of the best in the banking industry.

PNC’s outlook for the third quarter of 2023 includes a decline of approximately 1% in average loans, a decrease of 3-4% in net interest income, and a 10-11% increase in non-interest income.

The bank anticipates stable total non-interest expense and third-quarter quarter net charge-offs to range between $200 million and $250 million.

The bank expects a mild recession to start in early 2024, as it sees a contraction in real GDP of less than 1%. These economic projections factor into the bank’s strategies for managing credit risk and making informed lending decisions throughout the year.

This is also seen in their full-year guidance, which was revised lower.

Having that said, there’s more to report.

Recent Comments & Shareholder Distributions

Last month, during the Barclays Annual Global Financial Services Conference, the company discussed the possibility of a soft landing for the economy, acknowledging a slight recession in their official forecast, expecting unemployment to hover around 5% by the end of next year.

PNC also discussed interest rates, suggesting they might have peaked with one potential upward move left. The company emphasized the need to remain vigilant due to global macro risks, indicating a cautious optimism about the rate trajectory.

I agree with all of this – except for unemployment. I believe that the Fed can do enough damage to the economy to potentially lower inflation if it keeps rates at current levels.

The problem I see is that it may have to do serious damage to the economy in order to get inflation down. Inflation has increased for two straight months. It also doesn’t help that energy prices are flying again after the horrific news from Israel.

Additionally, despite a shift in spending towards essential goods, credit card balances have seen growth.

The company also highlighted that a significant portion of retail clients with student loans have adequate payment coverage, reducing concerns about this aspect of consumer health.

Management also discussed an expected net charge-off rate of 30 to 35 basis points for the next year, indicating potential stability and improvements in credit quality. As of 2Q23, NCOs were 0.24%, meaning an increase of at least five basis points is now expected.

With that in mind, the company has a very strong dividend scorecard.

It has a 5.2% yield, backed by a 41% payout ratio and a 5-year dividend CAGR of 13.6%.

The company has a history of 12 consecutive annual dividend hikes since cutting its dividend during the Great Financial Crisis.

Another reason why PNC is performing so well versus its peers is its focus on buybacks. Over the past ten years, PNC has bought back a quarter of its shares.

Depending on its cash buffer (and CET1 capital ratio), the company may adjust buybacks going forward.

This is what the company discussed during the aforementioned conference (emphasis added):

Jason Goldberg

So all right, actually, so a little bit better than I think people were thinking. Maybe just talk to against that backdrop and how do you think about your target CET1 level? And how — you need to be there and just how you think about share buyback?

William Demchak

Yes. So, so many ways to answer that. We’ve operated call it, between [ 8.25% ] is a target. We’ve kind of always never gotten down to our target. We’re sitting at 9.5% today. By the way, with the phase-ins on this thing, we’ll be over 9% our best expectation, absent a lot of buybacks, the whole way through the phase-in period.

Our presumption here is that we’ll have to run at somewhat higher capital, haven’t figured that out yet, at least for the near term, both because of rating agency reaction and also just uncertainty in the market. Theoretically, we could actually run lower just because they put the op risk capital increase stress test or draw down all else equal could be somewhat less. We’re not going to do that. But practically, you could, I think.

So we’re in a period of time right now where I think you — because of the uncertainties that still exists, you build capital. We’re in a position where we don’t have to change a thing in terms of our operating model to comply with these rules, which is a good place to be.

So, what about the valuation?

Valuation

PNC is trading at 1.4x its tangible book value. This is close to the longer-term median and a valuation that makes sense in this uncertain environment.

The current consensus price target is $199, which is 67% above the current price.

Using its earnings (and expectations), the company is trading at less than 9x earnings. If we assume that the valuation returns to the 10-year normal of 12.8x, we could see 23% annual returns through 2025. As seen in the overview below, this includes expected earnings contraction in both 2023 and 2024.

Having said that, I’m not going to make the case that PNC investors who buy the stock at current prices will get these returns.

The economy could see meaningful weakness, leading to potentially lower prices.

While it is a long shot, I would really like the risk/reward if PNC shares were to fall to $100. Again, it’s a long shot, but if the Fed does too much damage without achieving its inflation goal, this may be a suitable target for buyers.

I will give the stock a Hold rating.

However, I do believe that PNC is one of the best regional bank stocks on the market. After analyzing this company, I am inclined to say that investors looking for exposure in this industry might benefit from buying PNC instead of most of its peers.

Takeaway

In a world where regional banks often disappoint long-term investors, it’s essential to uncover the gems among the rubble. Regional banks are notorious for their volatile nature, often suffering during economic downturns. However, amid the chaos, one standout emerges: PNC Financial Services.

PNC isn’t your typical regional bank; it’s more of a super-regional powerhouse. Its diversified income sources, extensive branch network, and strategic acquisitions set it apart.

Despite macroeconomic challenges, The PNC Financial Services Group remains robust, with a strong balance sheet and prudent lending practices.

It boasts a solid dividend history, consistent buybacks, and attractive valuations. With careful consideration, investors might find that The PNC Financial Services Group, Inc. stands out as a more promising option among its peers.

Source: seekingalpha.com