One Of The Best – Why PNC Financial Is Such A Great Regional Bank

Introduction

On October 9, 2023, I started covering PNC Financial Services Group (NYSE:PNC) again for the first time since 2019, which now feels like ages ago.

Back in October, I used a very similar title, which was “PNC Financial: One Of The Best Regional Banks Money Can Buy.”

Here’s a part of the takeaway from that article (emphasis added):

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.

Since then, PNC shares have returned 29%, beating the 13% return of the S&P 500 by a significant margin.

In general, despite struggles in the banking sector over the past ten years, like the pandemic and 2023 regional bank failures, PNC has returned 152% since January 2014, beating the regional bank ETF (KRE) by 85 points.

As the company reported earnings this month, I am reiterating my bullish stance in this article, as the bank continues to shine bright, proving that it is indeed one of the best places to put one’s money in the regional banking sector.

PNC Continues To Shine

As I wrote in my prior article, PNC is more than a regional bank. It’s a superregional bank with well-diversified exposure that most regional banks cannot compete with.

The bank, which has coast-to-coast exposure, generates more than 40% of its revenues in Corporate and Institutional Banking, with roughly half of its revenue coming from Retail Banking.

On top of that, it engages in asset-managing operations.

With that said, throughout 2023, the most volatile year for banking since the pandemic, PNC demonstrated resilience.

The company delivered a strong finish in the fourth quarter, reporting a notable increase in earnings compared to the previous year.

Adjusting for the fourth quarter impact of the FDIC special assessment and expenses related to a completed staff reduction initiative, PNC earned $14.10 per diluted share for the full year, reflecting growth from $13.85 per diluted share in 2022.

In the fourth quarter, PNC reported $883 million in net income, translating to $1.85 diluted per share.

On an adjusted basis, earnings stood at $3.16 per share.

The acquisition of capital commitment loans from Signature, one of the banks that failed in 2023, closed in early October, proved immediately accretive to earnings.

Moreover, the quarter saw substantial growth in non-interest income, primarily driven by a rebound in capital markets and advisory fees.

One of the reasons why EPS is strong is the company’s focus on expenses.

PNC strategically completed a workforce reduction initiative in the fourth quarter, positioning the company to realize $325 million of expense savings in 2024.

Despite ongoing investments in key growth initiatives, expense discipline remains a top priority for the company, as it is targeting stable expenses for the upcoming year.

With regard to its balance sheet, the company also made progress.

For example, the loan portfolio saw positive developments during the fourth quarter, as average loan balances saw a 2% increase, primarily driven by a $5 billion rise in commercial loans to $223 billion.

• This surge was attributed to the acquisition of the Signature capital commitment portfolio.
• Excluding the impact from the Signature loan portfolio, commercial loans witnessed a $3 billion or 1% decline.
• On the consumer side, loans grew by approximately $130 million, supported by higher residential mortgage balances.
• However, this growth was partially offset by lower home equity and credit card balances.

The overall loan yield increased by 19 basis points to 5.94% in the fourth quarter.

On the deposit side, average deposits showed growth, reaching $424 billion during the quarter.

This increase was driven by seasonal growth in commercial deposits, partially offset by a decline in consumer deposits.

Noninterest-bearing deposits accounted for 25% of the total in the fourth quarter, slightly down from 26% in the third quarter. The rate paid on interest-bearing deposits increased to 2.48% in the fourth quarter, up from 2.26% in the prior quarter.

Adding to that, average investment securities, amounting to $137 billion, saw a 2% decrease.

This decline was attributed to curtailed purchase activity, which was more than offset by portfolio pay downs and maturities.

The securities portfolio yield increased by two basis points to 2.59%, which reflects the runoff of lower-yielding securities.

Meanwhile, the duration of the investment securities portfolio was reported as 4.1 years as of December 31.

Additionally, the received fixed swaps pointing into the commercial loan book totaled $33 billion, with a weighted average received fixed rate increasing by three basis points to 2.1%. The portfolio’s duration was reported at 2.3 years.

While we’re at it, allow me to throw a few more numbers at you.

Non-interest expenses in the fourth quarter came in at $4.1 billion, reflecting an $829 million or 26% increase.

This increase included $665 million in non-core expenses, notably the FDIC special assessment and workforce reduction charges, related to the efficiency focus I highlighted at the start of this article.

Meanwhile, core non-interest expenses, excluding these non-core items, amounted to $3.4 billion, marking a $164 million or 5% increase.

This increase was attributed to higher business activity, seasonality, and asset impairments.

Notably, in 2023, PNC successfully reduced its non-branch footprint by 2 million square feet, constituting approximately 17% of its total space.

For the full year, core non-interest expenses amounted to $13.3 billion, reflecting a “well-controlled” growth of $177 million or just 1%.

With all of this in mind, one of my favorite segments is credit quality.

Not only does credit quality tell us a lot about PNC, but it also tells us a lot about the state of the economy, as PNC is a giant in its business.

Credit Quality & Financial Stability

While PNC maintained strong overall credit quality, there was a slight uptick in nonperforming loans (“NPLs”) and delinquencies. NPLs increased by $57 million or 3%, including a $12 million increase in Commercial Real Estate (“CRE”).

Total delinquencies increased by $97 million or 8%, primarily driven by seasonally higher consumer delinquencies.

Net loan charge-offs for the fourth quarter were reported at $200 million, aligning with the lower end of expectations.

The annualized net charge-off to average loans ratio was 24 basis points.

PNC’s allowance for credit losses totaled $5.5 billion or 1.7% of total loans on December 31, maintaining stability compared to September 30.

Also, as expected, the CRE office portfolio continued to experience stress, with net loan charge-offs of $56 million in the fourth quarter.

During its earnings call, PNC mentioned the expectation of future losses on this portfolio but emphasized having adequately reserved for potential losses.

The reserves on the office portfolio were reported at 8.7% of total office loans, including 12.9% on the multi-tenant portfolio.

While it is important to keep an eye on these developments, one cannot make the case that PNC Is close to credit trouble, as we’re only seeing normalization so far.

Speaking of financial stability, the company maintained a strong capital position, reporting an estimated Common Equity Tier 1 (CET1) ratio of 9.9% as of December 31, which reflects a ten basis points increase compared to the prior quarter.

Even more important, the bank’s fully phased-in expanded risk-based CET1 ratio, based on new proposed capital rules, stood at approximately 8.2%, comfortably exceeding the current requirement of 7%.

As a result of its strong financial position, the company repurchased roughly 500 thousand shares.

Over the past ten years, PNC has bought back a quarter of its shares.

When combined with $600 million of common dividends, the bank returned a total of $700 million of capital to its shareholders.

PNC currently pays $6.20 in annual dividends, which translates to a 4.1% yield.

This dividend is protected by a low 40% payout ratio.

The five-year dividend CAGR is 11.3%.

Valuation

Unlike many smaller regional banks, PNC is not trading at a discount to its book value. The bank currently trades at 1.2x its book value.

This year, analysts expect the book value to rise by 6% to $120.

The company is also cheap using its (expected earnings).

Looking at the data in the overview below.

• PNC trades at a blended P/E ratio of 11.9x.
• This year, EPS is expected to fall by 2%, followed by a recovery of 12% growth in 2025 and 18% growth in 2026.
• Its normalized valuation is 12.8x earnings.
• The combination of its dividend, a 12.8x multiple, and expected earnings growth paves the way for an annual return of 15% per year and a price target of $211.

The current consensus price target is $163, as analysts are not willing to incorporate a major recovery into their models.

I agree with that and believe that elevated economic risks could keep a lid on regional bank stocks.

Nonetheless, I’ll maintain a Buy rating on the stock, as I believe that PNC continues to be one of the best regional banks money can buy.

However, investors need to be aware that regional banks are volatile. Overall, the risk/reward is poor, as recessions tend to cause steep sell-offs.

So, please keep that in mind when making investment decisions.

Takeaway

PNC continues to stand out as a superregional powerhouse.

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 regional banks can be volatile, PNC remains a promising option for investors seeking banking exposure.