Introduction
Earnings season has arrived!
This means we get to discuss countless fascinating companies that tell us a lot about their ability to make money and everything we need to know about the industries and sectors they operate in.
As I'm a "big picture" guy, I am very excited to increasingly focus on earnings in the next few weeks, which obviously won't mean I will neglect my general focus on dividends. So, don't worry about that.
Today, we will discuss one of the largest "super-regional" banks in America, The PNC Financial Services Group (NYSE:PNC), often referred to as PNC Financial or PNC.
My most recent article on this company was written on January 31, when I went with the title "One Of The Best - Why PNC Financial Is Such A Great Regional Bank."
Here's a part of the takeaway I wrote back then:
Despite macroeconomic challenges, PNC's diversified income sources, extensive branch network, and strategic acquisitions make it a resilient choice.
The recent earnings report proves the company's strength, with a focus on expense discipline, positive developments in the loan portfolio, and continued financial stability. PNC's commitment to shareholder value through buybacks and dividends further solidifies its position.
While I gave the stock a long-term Buy rating in January, I also put an emphasis on current struggles.
In this article, I'll update my thesis and use PNC's numbers to explain the bigger picture.
So, let's get to it!
A Piece Of A Big Puzzle
PNC is not just a regional bank. It's a super-regional bank with cost-to-cost exposure and 40% revenue generation in Corporate and Institutional Banking.
Roughly half of its revenue comes from Retail Banking.
In other words, the company's numbers tell us a lot about the U.S. as a whole, not just a certain region or financial segment.
That's one of the reasons why it makes so much sense to track this Pittsburgh-based giant.
With that said, generally speaking, I'm watching for a few things:
- Deposit trends. I want to know how banks are dealing with competition from elevated rates on risk-free government bonds. During last year's bank "crisis," this was a big issue.
- Loan demand. A strong economy often leads to strong loan growth, as people are investing in the economy. As we can see below, recessions always result in a decline in loan demand. Currently, total commercial and industrial loan demand is down roughly 1%.
- Credit quality. This is my number one topic, as I have been in the "higher for longer" camp for a while when it comes to interest rates and inflation. Earlier this month, I wrote an article titled "I'm Deeply Worried About Ares Commercial Real Estate's 14% Yield (Rating Downgrade)." In that article, I explained how toxic the situation could become if the Fed were to be forced to keep rates higher for longer due to inflation - even if credit quality is already declining.
I used the quote below from Bloomberg to highlight what is already happening in certain real estate segments:
As of December, offices accounted for 41% of the value of distressed US properties, which stood at nearly $86 billion, according to MSCI. Potential distress, which refers to the erosion of an asset's current financial standing, is at nearly $235 billion across all property types. Apartments are high on that list, with more than $67 billion in potential distress. More than 30% of that value is tied to buildings bought in the last three years, many at peak prices. - Bloomberg
Loans, Balance Sheet, And Credit Quality
Going back to PNC, in the first quarter, the bank's loan portfolio saw a 1% decline, mainly driven by lower commercial loan balances.
Commercial loans decreased by $3.4 billion. This was attributed to lower utilization and soft loan demand. Consumer loans also saw a decline of roughly $600 million. According to the company, this was mainly due to softness in credit card and home equity balances.
Despite these declines, total loan yields increased by seven basis points to 6.01%.
These loan trends make sense, given the trend in commercial and industrial loans I just showed using the FRED chart.
Meanwhile, the bank's investment portfolio saw a decline of 1%, mainly due to lower purchase activity offsetting portfolio paydowns and maturities.
The good news is that the portfolio yield increased by 3 basis points to 2.62%, supported by the runoff of lower-yielding securities.
Looking at the data below, as of March 31, the duration of the securities portfolio was four years.
In deposits, we saw some good news.
While average deposits declined by $4 billion to $420 billion, it is just a seasonal quarter-over-quarter decline driven by commercial deposits.
Consumer deposits saw growth, which offset some of these commercial declines.
Moreover, non-interest-bearing deposits remained stable, consisting of almost a quarter of total deposits.
The bank noted a slight increase in interest-bearing deposit rates to 2.6% and expects a potential increase in deposits as it expects the Fed to potentially cut rates starting in July.
Moving over to credit quality, we're witnessing two things:
- Loan quality is not a problem yet.
- The trend in the wrong direction is gaining momentum.
According to the company, while overall credit quality remained resilient, the commercial real estate ("CRE") office sector faced continued pressure, leading to an increase in non-performing loans.
As we can see below, the so-called NPLs increased to $2.4 billion, mainly by CRE. The total NPL ratio ended the first quarter at 0.74%. That's up from 0.62% in the prior-year quarter.
Net loan charge-offs totaled $243 million in the first quarter, with an annualized net charge-offs to average loans ratio of 30 basis points.
The good news is that despite these trends, the company maintained a stable allowance for credit losses, which remained at $5.4 billion, or 1.7% of total loans.
On a side note, we are seeing similar developments when looking at numbers from an even bigger bank. Bank of America (BAC) perfectly visualized the accelerating trend in net charge-offs, which ended the first quarter slightly below 0.6%.
BAC's allowance for loan and lease losses was $13.2 billion, 1.26% of total loans.
Going back to PNC, the company is actively working to reduce risks in the most critical areas, including office CRE.
While NPLs have increased over the past few quarters, our criticized balances have remained relatively consistent. The migration of criticized loans to nonperforming status is an expected outcome as we work to resolve the occupancy and rate challenges inherent to this portfolio. In the first quarter, net loan charge-offs within the CRE office portfolio were $50 million, essentially in line with the previous quarter level. - PNC 1Q24 Earnings Call
The bank itself remains well-capitalized.
Our tangible book value increased to $85.70 per common share, an 11% increase compared to the same period a year ago. We remain well capitalized with an estimated CET1 ratio of 10.1% as of March 31. - PNC 1Q24 Earnings Call
This brings me to the next part of this article.
Interest Rates Are A Headwind
Putting everything together, total revenue declined by $216 million. That 4% decline was driven by lower net interest income and a seasonal decline in free income.
Meanwhile, asset management saw a brokerage revenue increase of 1%, while capital markets and advisory fees declined by 16%. Credit card and cash management declined by 2% due to seasonal declines in consumer transactions.
As a result, net income came in at $1.3 billion, or $3.10 per share. Excluding non-core expenses, EPS was $3.36 per share.
This marks a 16% decline.
Bloomberg reported on it as well, as it noted the fifth consecutive quarterly decline in net interest income, citing the developments we discussed in this article as well:
PNC Financial Services Group Inc. missed estimates for net interest income in the first quarter, a sign that the Pittsburgh-based lender has continued to grapple with muted loan growth. - Bloomberg
The good news is that PNC expects stability in average loans, a decrease in net interest income by approximately 1%, and a trough in NII and net interest margins in the second quarter.
As a result, full-year guidance remains unchanged from the previous earnings call, with expectations for stable to down 2% total revenue and stable core non-interest expense.
On top of that, the company also announced a $1 billion investment in its branch network to renovate more than 1,200 locations and open new locations in growth markets, including Austin, Dallas, Denver, Houston, Miami, and San Antonio.
So, what does this mean for its valuation?
Valuation
PNC's valuation remains extremely attractive - at least used on the current EPS growth outlook.
Despite market headwinds, analysts continue to be upbeat, as they expect a 2% EPS contraction this year to be followed by 14% growth in 2025 and 18% growth in 2026. This could potentially result in a $16.80 2026 EPS.
In my prior article, written in January 2026, EPS expectations were $16.52.
If we apply the company's normalized P/E ratio of 12.80x, we get a price target of roughly $215 (46% above the current price).
The current consensus price target is $168.
Since 2022, price targets have come down quite consistently, with a bottom at the end of 2023.
While I believe that PNC remains one of the best banks in America, I cannot make the case that it's a strong buy because of its favorable EPS outlook.
Economic risks remain elevated, which could keep a lid on the stock price for a while.
Even worse, if the Fed is forced to keep rates higher for longer, I expect more pressure on loan growth, credit quality, and deposits.
Given these developments, I would make the case that investors looking for banking exposure may benefit from waiting for a steeper correction to juice the risk/reward a bit.
I believe if economic conditions were to worsen, we could be looking at 10-20% more downside.
Please note that I'm going against the consensus here. Technically speaking, one can make the case that PNC is a screaming buy based on its expectations of bottoming growth in the second quarter of this year - especially when combined with its attractive valuation.
If you disagree with me, which is perfectly fine, you may find tremendous value in PNC at these levels.
Takeaway
In diving deep into PNC Financial's recent earnings report, I found a compelling narrative that speaks volumes about the broader economic landscape.
Despite facing challenges, PNC's diversified income streams and strategic moves prove its resilience.
However, in light of soft loan demand and emerging credit concerns, caution is warranted.
While PNC's valuation remains attractive, I believe economic uncertainties suggest a wait-and-see approach for potential investors.
Pros & Cons
Pros:
- Diversified Income: PNC's diverse revenue sources, including Corporate and Institutional Banking, provide stability in light of market fluctuations.
- Resilient Performance: Despite macroeconomic challenges, PNC has shown resilience through expense discipline and prudent risk management.
- Branch Network Expansion: The $1 billion investment in branch network renovation and expansion reflects a commitment to growth in key (Sunbelt!) markets.
Cons:
- Soft Loan Demand: Declines in commercial and consumer loan balances indicate softness in loan demand, potentially impacting revenue growth on a longer-term basis.
- Credit Quality Concerns: Increasing non-performing loans, particularly in the commercial real estate sector, raise concerns about asset quality.
- Net Interest Income Decline: Continual declines in net interest income, coupled with muted loan growth, pose challenges to revenue generation.
- Economic Uncertainty: Economic risks, including potential impacts of Fed policy and market fluctuations, could pressure PNC's growth prospects in the near term.
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