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I think that about the worst anybody can say about PNC Financial (PNC) is that it’s a conservatively-run bank. With that conservatism, it’s never going to have the fastest loan growth or the greatest asset-sensitivity, nor is it likely to invest large sums into uncertain growth projects. Of course, as the last cycle has shown, it’s also not going to self-destruct because aggressively-written loans go “bang” during a downturn.
I’ve liked these shares for a while, and I’d describe the stock’s performance since my last update as “lackluster”, and it has underperformed larger bank peers who have more leverage to self-improvement and the economic recovery in 2022/23. Still, relative to where the shares are now and what other stocks seem to offer, I find the return today less compelling, and this isn’t the first large-cap bank I’d think to buy with new money.
Unimpressive Q4 Results
While the PNC story is very much about what happens in 2022 and beyond, as the company leverages the Compass acquisition, higher rates, and past investments into digital bank and middle-market loan growth, the reality is that fourth quarter results weren’t impressive, with lackluster spread income performance and core operating expenses driving a pre-provision miss.
Revenue declined less than 1% sequentially this quarter, and because of the BBVA-Compass deal, year-over-year comparisons aren’t very useful. There was a wide spread of sell-side estimates for the quarter, with multiple services reporting very different “consensus” numbers. While PNC’s top-line number was a little better than I had expected, relative to reported consensus numbers, it was anywhere from in line to a $0.10/share beat.
Across the board, though, there was broader agreement that PNC’s spread income was weak, barely rising on a sequential basis with underwhelming balance sheet growth (weaker loan growth) and a small miss on net interest margin (which was flat at 2.27%). Fee-based declined 2% sequentially, but was still a fair bit better than expected.
Core operating expenses rose more than 1% qoq, missing expectations. Core pre-provision profits fell about 4% qoq, missing expectations by $0.20/share (at least relative to one set of reported consensus estimates).
Reaping The Benefits Of Past Investments
Things are going to start getting interesting at PNC in 2022, as the company is going to see some of its past investment decisions bear more fruit. First and foremost, the acquisition of Compass should start showing more meaningful synergies, offering the company a useful operating leverage kicker.
Spread income should also improve more meaningfully. Management guided to 5% end-of-period loan growth, net of Compass run-off, but average loan growth could hit double-digits, and PNC should benefit from strengthening demand for business loans, particularly with the years of investment that the company has put into developing new middle-market lending operations in attractive metro areas.
PNC’s asset sensitivity will also be interesting to watch. If you just look at PNC’s asset sensitivity in terms of the commonly-reported leverage to a 100bp shock move, you wouldn’t think PNC is all that exceptional; indeed, it would look a little below average. But “one-size-fits-all” measurements like sensitivity to a 100bp shock move sacrifice nuance (and in some cases, accuracy) for convenience.
PNC has above-average exposure to floating-rate loans, with about 60%, meaning that this bank will have more to gain as rates start to head higher (though it will take multiple moves, as some loans are at floor rates already). PNC also has above-average cash balances to deploy, be that into loans or securities. Deposit beta, too, is another area of differentiation. I’m concerned that sector-wide deposit betas will end up higher than expected in this tightening cycle, but the way PNC has built their operations, including a strong digital banking core and not chasing deposits with above-average rate offers, I think they could outperform.
The Outlook
I’m expecting around 5% core earnings growth (by CAGR) over the next five years and long-term growth above 4% (around 4.5%). Importantly, I think PNC stands to post double-digit year-over-year growth in pre-provision profits for the next three years, which should help drive relative performance. I likewise think there’s more room for earnings-boosting reserve releases, as the reserves are at about 1.9%, still well above pro forma CECL Day 1 of 1.6%.
Discounting those earnings back, I think PNC is priced to generate high single-digit annualized total return, which isn’t bad, but also isn’t a standout among other quality large-cap banks that I follow. Likewise, other approaches like ROTCE-based P/TBV (2x) or P/E (13x) don’t flag these shares as meaningfully undervalued.
The Bottom Line
With stocks like JPMorgan (JPM), Citizens (CFG), and Truist (TFC) still looking less than fully-valued (you can read articles on those here, here, and here), I don’t necessarily think that PNC is the best idea for new money. I’m not saying you should sell PNC, and I still think it’s an excellent bank for the long term, but I don’t think the market is exactly sleeping on the future performance and quality on offer here.
