PNC Financial Has A Better Mix Of Drivers In A Sector That's Still Off Its Highs

The bank sector has done a little better since my last update on PNC Financial (NYSE:PNC), but the story remains pretty similar – investors are favoring smaller “Main Street” banks that they believe have better rate leverage, stickier deposits, better prospects for loan growth, and more benign capital requirements. As a more Main Street-type bank than many of its large peers, PNC has continued to outperform, beating the large bank group and the S&P 500 since my last article, but underperforming smaller regional banks.

This is an interesting time to evaluate PNC’s investment prospects. The valuation doesn’t stand out as exceptional relative to many other large banks (not to mention many smaller banks), but I like PNC’s skew to commercial lending and its strong credit quality history. If the economy does better than expected next year, PNC will likely be a laggard, but PNC is a good option for investors who may have a less robust outlook for 2023, but still want some bank exposure. I’d also note that in terms of P/TBV, P/E, and so on, PNC is trading below longer-term averages.

 

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PNC Financial Has A Better Mix Of Drivers In A Sector That's Still Off Its Highs

PNC Financial Benefiting From A Hot Main Street And Valuation Is Better

I was lukewarm on PNC Financial (NYSE:PNC) back in February, as although I really liked (and still like) management and how they have positioned this bank for durable commercial lending-driven growth, I thought the valuation more or less reflected those qualities. The shares have since modestly underperformed their peers, falling about 25% in a weak market for bank stocks.

Not much surprised me in this quarter, including considerably above-average commercial lending growth and managements relatively more conservative view on the larger economy. With the company still poised to reap long-term benefits from the BBVA deal, as well as this strong lending environment, I think solid mid-single-digit core earnings growth is still in the cards, and with the shares now cheaper, it’s a name worth reconsidering.

 

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PNC Financial Benefiting From A Hot Main Street And Valuation Is Better

PNC Financial Offers Strong Upcoming Earnings Leverage - And It's Baked Into Stock Price

 

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.

 

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PNC Financial Offers Strong Upcoming Earnings Leverage - And It's Baked Into Stock Price

PNC Financial's Core Operations Still Under Some Pressure, But The Future Is Bright

 

There was no reason to think that second quarter results would show a big operational shift for banks, and that has been the case so far, with banks still seeing pressure from flat spreads and weak loan demand, partly offset by reserve releases driven by better-than-feared credit quality evolution. So too with PNC Financial (PNC), where core net interest income was okay relative to expectations, but where core growth was still pretty soft.

I’m not bothered that this quarter’s results here weren’t outstanding, and they don’t change my view that this is a high-quality bank for the long term. With BBVA’s (BBVA) Compass in hand, PNC has some attractive growth opportunities – both in terms of expanding its footprint in higher-growth markets and in improving the operations at Compass. As the economy continues to recover, I expect this middle market-driven bank to benefit, I expect healthy growth for some time to come.

PNC isn’t a bargain basement stock, but I do think the valuation is reasonable, and I think long-term investors can reasonably expect an annualized long-term total return in the very high single-digits from here.

 

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PNC Financial's Core Operations Still Under Some Pressure, But The Future Is Bright

PNC Financial Still Offers A Lot To Like As It Shifts To Recovery And Growth

 

PNC Financial (PNC) stands out as one of the very few banks I follow that doesn’t generate many complaints – the worst that’s usually ever said about PNC is that management takes a conservative approach and the business isn’t especially flashy. That’s fine with me, though, and few banks have generated better long-term returns than PNC.

With the purchase of BBVA’s (BBVA) U.S. banking assets complete, PNC has a coast-to-coast footprint and a presence in 29 of the 30 largest MSAs. Moreover, it’s a footprint skewed to some attractive growth markets, including the Southeast U.S., and a greater-than-average exposure to corporate lending.

I was bullish on PNC with my last update and the shares have continued to modestly outperform. While today’s price doesn’t offer an eye-popping total annualized return, I still believe PNC will continue to generate above-average returns, and I believe PNC will be a long-term winner in the ongoing consolidation of the U.S. banking sector. At a minimum, I think it’s a good candidate as a core long-term holding.

 

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PNC Financial Still Offers A Lot To Like As It Shifts To Recovery And Growth

PNC Financial's Valuation Is More Demanding, But Management Has A Good Execution History

With the rebound in bank stocks, largely on improving outlooks for the economic situation and rates in 2021, expectations are now higher going into 2021. For PNC Financial (PNC), that means that executing on the synergy opportunities from the acquisition of BBVA's (BBVA) U.S. operations (Compass) is a must-have. Luckily, management has a good track record where M&A synergies and post-deal growth are concerned, and I have few real concerns there.

As has been the case with many other banks, including JPMorgan (JPM), PNC's valuation and stock outlook have evolved from what I considered nearly can't-miss to "still alright for long-term investors". I no longer see the obvious bargains in this sector that I once did, but I do believe the long-term prospective returns from PNC are good enough to earn it a spot in (or at least consideration for) quality growth-at-a-reasonable-price portfolios.

 

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PNC Financial's Valuation Is More Demanding, But Management Has A Good Execution History

PNC Financial's Long-Term Qualities Seem Less Than Fully Appreciated

If you look at how PNC Financial (PNC) shares have traded this year, you might think it was “just another bank”. Given that the management team has shown itself to be a good steward of shareholder capital, I don’t believe that’s fair.

Clearly, the macro environment matters; rates are going to be low for a while, and the market is clearly worried about a “second wave” of COVID-19 shutdowns, uncertainty over further stimulus, and turmoil around the election. Still, for patient investors with a longer-term horizon, I think PNC offers decent return potential.

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PNC Financial's Long-Term Qualities Seem Less Than Fully Appreciated

PNC's Core Banking Ops Are Under Pressure, But M&A Optionality Is A Plus

This is a tough time to model PNC (PNC), as the company’s decision to sell its large position in BlackRock (BLK) reduces near-term earnings and only adds to the burden of excess liquidity in a low-rate environment. I continue to believe that PNC management will prove themselves good stewards of capital, and will likely look to use that excess capital to acquire one or more banking franchises to accelerate the company’s development into a national commercial-focused banking giant.

PNC shares have underperformed since my last update, and I can see how ongoing uncertainty regarding the use of that excess capital may weigh on the shares for some time – no doubt there will be some investors pushing the company to forget about empire-building and just return the capital in the form of a big buyback and/or special dividend. While there’s above-average modeling uncertainty here (given the significant impact that a large acquisition could have on future financials), I believe PNC remains undervalued and underappreciated as a high-quality bank in a challenging operating environment.

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PNC's Core Banking Ops Are Under Pressure, But M&A Optionality Is A Plus

COVID-19 Has PNC Back On The Hunt

What a difference a pandemic makes. While PNC Financial’s (PNC) management had spent the better part of a few years now explaining why whole bank M&A no longer made sense as a growth strategy, management decided to sell its sizable stake in BlackRock (BLK) and is now openly discussing its intention to be opportunistic in bank M&A.

Good managers adapt to new circumstances, and I believe that is what PNC is doing here. If management is right about the fed funds rate staying at 0.25% or below for the next three years, there will be more than a few regional banks struggling to generate any meaningful earnings growth, and PNC is likely to have multiple options. How quickly a deal materializes is a key unknown, though, and the absence of BlackRock will be felt in the earnings until the company finds a better use for that capital.

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COVID-19 Has PNC Back On The Hunt

PNC Financial Getting Ready For Higher Loan Losses

Time will tell how much pain PNC Financial (PNC) spared its investors through presumably sound underwriting during the good days of the banking cycle, but management is definitely getting ready for the other shoe to drop and warning investors that it may have to increase its reserves even further to cover losses as Covid-19 pushes the U.S. into recession.

Maybe this is obvious, or at least redundant, but the margin of error for modeling banks now is extremely high. It’s unclear when businesses will be able to get back to normal, let alone what the ongoing impact of this shutdown will be in the short term, and the rate and credit cycle was already moving against banks. PNC looks like it will be okay even in a dire scenario, though, and as is the case with most of the quality bank names, the market seems to be pricing in an overly severe scenario today.

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PNC Financial Getting Ready For Higher Loan Losses

PNC Financial Comes Up A Little Short Where It Counts In Q4

Given what I thought was only “okay” valuation back in October, I’m not too surprised that PNC Financial (PNC) shares have done only slightly better than its peer group over the last three months. It’s a well-run, well-liked bank, but with core earnings only a bit better than expected, valuation is perhaps a more pressing concern right at the moment. I’m still not really enthusiastic about PNC as a new buy idea. It’s a fine bank, and a fine hold, but I don’t see enough growth differentiation here to really support a significantly higher share price.

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PNC Financial Comes Up A Little Short Where It Counts In Q4

PNC Financial Delivers A Low-Drama Quarter

I didn't think PNC Financial (PNC) was all that cheap coming out of second-quarter earnings, but I thought a relatively better outlook for stable, positive performance from this well-respected bank could give an edge to the shares. The shares have outperformed the sector by a small margin since then (by around 1% to 2%), and PNC's low-drama third quarter should be reassuring for investors.

Despite a less-favorable (at the moment) skew toward commercial lending, PNC has a good set of fee-generating businesses, credibility on cost leverage improvement, and organic growth opportunities as the bank continues to target new markets for its middle-market lending operation (Boston, Phoenix, Portland, and Seattle). Valuation is just "okay", with prospective long-term annualized returns in the high single digits to low double digits, but an okay price for an above-average bank isn't a bad trade-off for long-term investors.

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PNC Financial Delivers A Low-Drama Quarter

Quality, Value, And A Little Bit Of Growth - Bank Of America Seems To Offer Quite A Bit

There are some exceptions, of course, but investors who want to invest in U.S. banks today have to make some choices and trade-offs between quality, value, and growth. JPMorgan (JPM) has quality and growth, but not as much value. U.S. Bancorp (USB) has quality and maybe more growth potential than believed, but also not much value. Citi (C) and Wells Fargo (WFC) may offer more value, but quality is certainly an issue with both franchises.

And that brings me to Bank of America (BAC). Bank of America has the scale (#2 overall in deposits and assets) to keep up with the likes of JPMorgan and Wells Fargo in IT investments and drive operating scale, but it also done quite well with expenses and deposit costs without overly compromising loan growth. I don’t wish to position or suggest Bank of America as a scintillating growth story, because it’s not, but management continues to invest in growth opportunities like digital banking and opening branches in new strategic markets, and I believe Bank of America can beat the average large bank in pre-provision profit growth over the next three to five years.

All that, and a stock I think should trade closer to the mid-$30’s.

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Quality, Value, And A Little Bit Of Growth - Bank Of America Seems To Offer Quite A Bit

With More Earnings Reports In Hand, Wells Fargo Looking Even Worse

Expectations have been relatively low for Wells Fargo (WFC) ever since the asset cap was put into place, but this large bank has nevertheless managed to disappoint, with the shares underperforming banking indices by about 12% over the last six months and 10% over the last three months. With a sizable number of Wells Fargo’s peers now having reported their first quarter earnings, a look back at Wells Fargo does not look so good for this struggling bank.

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With More Earnings Reports In Hand, Wells Fargo Looking Even Worse

BB&T Basically On Track Ahead Of Its Game-Changing Merger

Despite the significant long-term potential benefits of BB&T’s (BBT) merger of equals with SunTrust (STI), the market is still generally against M&A in the banking sector, and BB&T shares have lagged regional bank indices a bit since the deal announcement (about 300bp of underperformance). I continue to believe this is a strong merger, though, and I think BB&T shares remain one of the more interesting values among banks in its weight class.

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BB&T Basically On Track Ahead Of Its Game-Changing Merger

U.S. Bancorp Doing Fine And Ready To Start Making Some Moves

As one of the best banks out there in terms of quality, U.S. Bancorp (USB) tends to be better as a “safe haven” or a long-term holding. When bank stocks were falling apart in late 2018, U.S. Bancorp held up a little better, but the shares have also lagged peers since the start of this year as banks have largely kept pace with the S&P 500.

I expect that it is going to be harder for banks to grow going forward, as I think net interest margins are peaking and credit costs are likely to head higher from here. Loan growth is healthy now, but I do still have some concerns about the overall economy. With that backdrop, I think organic growth drivers are going to be more important, and with U.S. Bancorp now free of its consent orders, it has more options to drive growth through organic expansion and branch rationalization. U.S. Bancorp isn’t particularly cheap now, but it’s definitely a name to watch for relative underperformance.

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U.S. Bancorp Doing Fine And Ready To Start Making Some Moves

M&T Bank Doing Fine, But Also As Expected

Buying quality can be a frustrating exercise, as M&T Bank (MTB) shares have shown over the last couple of years. Fairly regarded as a conservatively-run, high-quality bank, M&T Bank’s share price performance hasn’t really stood out as exceptional over the last year or two. I do believe there could be more separation from the pack when the economy slows further, though, and there’s another reckoning as to which banks did the best job of managing their credit exposures. As is, the shares look somewhat undervalued, more so in terms of the multiple to tangible book than on a discounted earnings basis, but JPMorgan (JPM), PNC (PNC), BB&T (BBT), and U.S. Bancorp (USB) offer similar or better prospective returns.

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M&T Bank Doing Fine, But Also As Expected

Citigroup Making Slow Progress, Which Is Still Better Than What's Priced In

Being somewhat bullish on Citigroup (C), mostly in the “it’s really not that bad” sense, has felt a little lonely at times, but the shares do seem to have started reflecting a bit of the slow progress that has been underway here. The shares outperformed banking peers over the past year by more than 5% and by a similar amount over the last three months and management has reiterated its target for a return on tangible common equity of more than 13% by the end of 2020.

If we’re only talking about quality, I wouldn’t recommend Citi over JPMorgan (JPM), U.S. Bancorp (USB), PNC (PNC), or BB&T (BBT) (and that list could probably go on a while…). But factoring in the substantial apparent discount to value, and Citi looks like an interesting risk/reward proposition, particularly as the bank’s non-US banking exposure could help offset some of the cycle risk in the U.S. banking sector.

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Citigroup Making Slow Progress, Which Is Still Better Than What's Priced In

Commerce Bancshares Investors Pay For Better Than This

Given that I thought Commerce Bancshares (CBSH) shares were fairly expensive back in January, I’m not all that surprised that the shares underperformed the major regional bank indices since then, particularly as sentiment seemed to be shifting across the market a bit more towards “risk on”. Still, I was surprised to see the first-quarter miss. Seeing as how I believe that Commerce Bancshares’ premium is often justified by analysts and investors on the basis of superior quality and operating stability, I do worry that if this quarter is more than just an aberration, it could mean more significant underperformance for shareholders.

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Commerce Bancshares Investors Pay For Better Than This

A U.S. Bancorp - PNC Financial Tie-Up Could Be A Win-Win

Speculating on M&A is a tried and true way of passing the time between major news releases, and it’s overwhelmingly just a theoretical exercise, as the number of potential deals always dwarfs the number of deals done. That said, a recent turn toward mergers of equals in the banking space, including the large proposed tie-up of BB&T (BBT) and SunTrust (STI), adds a new element to the story.

Although I don’t think you can count it as any sort of “base case”, and both banks have expressed their disinterest in large-scale whole bank transactions, I believe a merger of equals (or near-equals) between U.S. Bancorp (USB) and PNC Financial (PNC) could not only be very interesting from an EPS and TBV accretion point of view, but also from the perspective of creating a truly national bank with strong positions in commercial and retail lending, payments, wealth management, and other fee-generating businesses.

I want to emphasize again that I’m not expecting such a transaction, and I do not recommending buying either U.S. Bancorp or PNC on the basis of M&A potential. Still, these are two high-quality banks traded below my estimates of fair value as is, and a transaction could create value for both shareholder groups.

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A U.S. Bancorp - PNC Financial Tie-Up Could Be A Win-Win