PNC Financial (NYSE:PNC) stands out as one of the very few banks I follow that doesn’t draw many complaints – the worst thing that is usually said about PNC is that the management picks a conservative Approach and the store is not particularly flashy. That’s fine with me, though, and few banks have delivered better returns than PNC over the long term.
With the purchase of BBVA‘s (BBVA) US banking assets in full, PNC has a coast-to-coast presence and is represented in 29 of the top 30 MSAs. Additionally, it’s exposure to some attractive emerging markets, including the US Southeast, and has an above-average exposure to corporate credit.
I was bullish on PNC when I last updated, and the shares have continued to slightly outperform. While today’s price doesn’t offer a compelling annualized total return, I still believe PNC will continue to outperform and I believe PNC will be a long-term winner of the ongoing US banking sector consolidation. At least I think it’s a good candidate as a long-term core investment.
Mixed leverage on current conditions
not how Bank of America (BAC) or Wells Fargo (WFC) does not offer PNC investors above-average leverage on a steeper yield curve. While these two banks would expect net interest income to rise nearly 10% on a parallel 100 basis point rate hike, PNC’s impact on this type of rate hike would be about half that. However, that’s well above the 1.4% sensitivity the bank had in the first quarter of 2020, so it’s not as if management didn’t reposition the bank.
I believe that asset sensitivity will be a positive driver for banks over the next few years. I don’t know if the US economy will manage to stay in a “goldilocks” zone with inflation around 2% where banks can enjoy profitable spreads but where the Fed will not be as motivated to drive the economy to tighten and curb, but I believe that interest rates will rise and that this will offer banks like PNC some spread relief.
PNC’s leverage to improve US economic conditions is also “mixed.” Consumer lending is growing, but not so much in home equity lending (where PNC is stronger), and PNC doesn’t have a card business anywhere near the size of Bank of America, city (C) or JP Morgan (JPM).
Commercial lending remains weak as corporates are broadly cash-rich and capital markets remain fairly strong. What’s arguably more relevant to PNC, looking at first-quarter earnings reports and industrials sector comment, is that capital spending has been slower to recover and credit growth could remain sluggish for a few more quarters (at best).
Ultimately, however, corporate borrowing will recover. When that happens, PNC’s above-average exposure to C&I loans becomes a positive driver. For the comp group of PNC (larger banks), C&I exposure is about a third of the loans, but PNC accounts for over 50% – only KeyCorp (KEY) has higher skew in its peer group (and Comerica (CMA), depending on how you treat the mortgage stock business).
In addition, PNC has actively expanded its loan syndication, asset-based financing and specialty lending activities in recent years, including selective market expansions. While many banks are targeting the mid-market commercial lending market where PNC is thriving, this does not seem to have affected the bank, and I would also note that PNC’s commercial banking operations are quite a bit more efficient than those of its competitors (roughly 10 points -ER advantage).
Compass points to more possibilities
PNC completed the acquisition of Compass from BBVA in early June, and in a presentation at a sell-side conference a few days later, PNC management noted that improvements in BBVA’s business since the announcement had reduced the actual deal multiple below that 1.3x tangible book value (it was 1.34x at the time of announcement). Additionally, management increased its original growth target in ’21 from $600 million to over $700 million.
Compass offers PNC many possibilities. The deal expands PNC’s footprint west, including California, while also giving the bank a significantly larger footprint in Texas and Florida. The loan book rebalance is likely to weigh on reported loan growth in the first year post-transaction, but I see significant opportunity for PNC to improve Compass’s operating efficiencies and underwriting quality. Given PNC’s track record of exceeding M&A synergy targets and the fact that Compass’ key weaknesses are PNC’s strengths, I believe the upside of this transaction could ultimately be significant.
Even with the addition of Compass, I don’t see PNC moving away from its core focus of selective commercial expansion into new markets and the ongoing adoption of a “branch-lite” national banking model. A shortage of national products (including mortgages and cards) is still a challenge for the consumer business, but I think there’s plenty of room for growth on the commercial side. I will also reiterate my belief that there could be a merger between PNC and the more consumer-facing companies at some point in the future U.S. Bancorp (USB), although a deal of this magnitude with regulators and lawmakers would definitely be controversial.
I continue to rate PNC on the basis of adjusted earnings growth in the mid-single digits, with return on equity rising towards the mid-teens over time, and the bank continuing to make a generous return of capital to shareholders (dividends and buybacks). I also expect PNC to continue generating above-average ROTCEs over the next five years, with potentially mid to high teens ROTCEs in the mix.
The final result
Compared to a year ago, or even six months ago, it’s not easy to find big banks that are expected to deliver long-term annualized returns in the double digits, and PNC is no exception. Generally, this type of return requires betting on turnaround stories where there’s still above-average street skepticism (like Citi).
If PNC can deliver the earnings growth I anticipate, a high-single-digit annualized return above the long-term industry average is still possible. This combination of above-average bank and above-average return potential appeals to me, and this is still a bank I think should be considered as a long-term core holding.