Sometimes it seems like the markets are against you as an investor. While PNC Financial (NYSE:PNC) issued a strong first quarter report, one of the best among banks for the past earnings, a pretty grim day in the overall market buried the news and kept on a lid on the stock. Since then, the stock has enjoyed a better performance and one consistent with the better-performing regional banks. If PNC can keep up the expense discipline, an eventual recovery in lending activity should bode well for the long-term performance and value of the shares.
Q1 Almost All About Expenses
On an adjusted basis, operating revenue rose 8% from last year, while falling about 6% from the prior quarter. Net interest income was slightly better than expected, up 5% and down 2% respectively, and PNC's net interest margin erosion (down 9bp from last year) wasn't too bad at all. On a more negative note, fee income was a little soft (up 14% and down 12%) on weak mortgage and corporate service income.
Where PNC really shone was with its expense reduction program. Expenses declined 7% from the fourth quarter, fueling a double-digit beat relative to average sell-side estimates. Even so, pre-provision net revenue (roughly equivalent to operating income) was still down about 3% on a sequential basis.
PNC Seeing The Same Growth Problems As Everybody Else
The dominant story coming out of the first quarter in banking seems to be the stagnant lending environment, as bank after bank reported that economic uncertainty has kept a lid on loan demand. For PNC, period-end loan balances increased 6% over last year, but barely increased from the prior quarter. There was a little growth in commercial (particularly C&I lending), but run-off in the consumer portfolio largely offset this.
While PNC has a larger non-interest revenue base than most community banks, it doesn't compare quite as favorably to other banks like U.S. Bancorp (NYSE:USB) and Bank of America (NYSE:BAC) apart from its wealth management business (including a sizable stake in Blackrock (NYSE:BLK). That puts a little more pressure on lending activity as the growth driver. Like Bank of America, it looks like run-off in the consumer loan book counteracted new lending activity, but the company did about as well as Wells Fargo (NYSE:WFC) and other large banks on the commercial lending side.
Integration And Execution Are The Big Drivers
Between the National City deal in 2008 and the acquisition of RBC's U.S. banking operations, PNC has significantly increased its footprint and asset base. Now it's time to run those assets. I have little doubt that the company is still chugging through the integration process with the RBC assets and looking to close redundant branches, streamline operations, and so on.
Eventually, though, the key is running these assets. Consumers in the Southeast have to be a little sick of all of the M&A activity by now, and likely want to stay with a bank whose stationery and livery stays the same for at least a few years in a row. Moreover, with rivals like Bank of America looking to cut costs and Wells Fargo really pushing the cross-selling, there could be a chance to gain some share in this growing region.
But how much will that compromise the company's drive to cut costs? Depositors still expect a certain level of service, and one of the keys for PNC will be establishing not only an attractive deposit base and market share, but also one that makes sense for its desired expense structure.
For PNC, some of the cost containment depends on transitioning depositors to online transactions – processing an online transaction costs about 20% as much as processing a transaction in a branch. Likewise, “right-sizing” the branch base through headcount reductions and branch closures is an important, but tricky, step – customers do choose banks (at least in part) on the basis of the perceived convenience of branches, and that can be particularly true for the more lucrative high-earning customers.
The Bottom Line
While PNC has done pretty well among its peer group over the last five years, the last two years have been a bit more disappointing as the company has struggled to hit the targets it has communicated to the Street. With this solid report and a new CEO taking the helm, maybe that period of turbulence is at an end. The company's net interest margin looks pretty solid, as does its deposit share and efficiency ratio. That's a good start for investors.
Right now, PNC looks like an interesting pick. On the basis of an assumed 10% long-term return on equity, fair value seems to be around $80 to $82 per share. There's certainly ample room for the shares to outperform if PNC can exceed that level, but with a trailing 12-month ROE below 10% there's still something of a “walk before you try to run” element to lifting the long-term targets, particularly as we look at what is likely to be an extended period of low interest rates.
All things considered, PNC isn't a bad pick if you do believe that PNC will now start exceeding cost and credit income metrics. It's not my favorite name in the banking sector, but it is priced at a level that should allow for respectable returns from today.
At the time of writing, Stephen Simpson did not own any shares in any of the companies mentioned in this article.