2023-12-18 13:22:07 ET
Summary
- PNC Financial's shares have seen a significant revaluation due to strong Q3 earnings and Jerome Powell's comments on interest rates.
- Lower interest rates could impact the bank's loan operation positively next year, but the net interest margin is set to remain under pressure.
- With shares trading at a premium to book value and being overbought, it may be a good time to sell.
The PNC Financial Services Group, Inc. ( PNC ) has seen a massive revaluation of its shares since October, in part due to strong third quarter earnings but also because of Jerome Powell's recent comments that the Federal Reserve sees no real upside in interest rates in the wake of falling inflation. Lower interest rates could imply a rebooting of its loan operation, but also continual pressure on the bank's net interest margin. Considering that PNC Financial's shares are now trading at a material premium to book value, I don't believe the risk profile is skewed to the upside anymore. Because PNC is trading at a 23% premium to book value and because shares are now widely overbought based off of the Relative Strength Index (RSI value of 82.37), this may be a great time to sell into the strength!
Previous coverage
I recommended PNC Financial aggressively during the financial crisis in the regional banking market which developed after the failure of Silicon Valley Bank in the first quarter. In my work PNC Financial: Now A Value Stock With A 4.9% Yield , I suggested that the bank could benefit from a recovery once deposit flows in the regional banking market stabilized and valuations normalized. With shares now trading above the 1-year average P/B ratio and with a 24% price return, I am changing my rating to sell.
Solid deposit base with little variance during the financial crisis
PNC Financial retained a mostly stable deposit base during the turmoil in the regional banking market in the first quarter meaning customers didn't depart the bank due to its perceived deposit risks. However, the bank's deposits decreased in the last year due to higher interest rates resulting in cash-reshuffling efforts on the part of the bank's commercial clients.
At the end of the September quarter, PNC Financial had $423B in consolidated deposits on its balance sheet compared to $439B in the year-earlier period, showing a decline of approximately 4%. However, with Jerome Powell indicating that inflation is no longer perceived as the most serious threat in the economy and inflation falling slowly towards the Fed's long-term 2% inflation rate goal, I believe this cash-sorting behavior has all but ended now.
Reboot of the loan business, continual pressure on NIM
Last week's Fed announcement strongly implied declining interest rates in FY 2024 which has two major implications for PNC Financial and other banks: 1) Net interest margins are set for a contraction in a low-rate world, and 2) Lower available interest rates may spur demand for new loans, thereby rebooting PNC Financial's loan business.
PNC Financial's average loan balance has decreased in Q3'23, largely because record high interest rates have made debt very expensive. The bank's average loan balance declined to $319.5B in the third quarter, showing a decline of 1.5% Q/Q. With interest rates now set to fall in FY 2024, PNC Financial may benefit from a reboot of its loan enterprise and return to positive growth next year.
Like most banks, PNC Financial has seen growing pressure on its net interest margin in recent quarters as well. In the most recent quarter, Q3'23, the consumer and commercial bank posted a net interest margin of 2.71%, down 0.11 PP year over year. Given that Jerome Powell provided more clarity about future interest rates last week, investors should expect continual pressure on the net interest margin in the next twelve months.
Massive revaluation has taken place for PNC, time to sell the rally
When I last wrote about PNC Financial, in June 2023, the bank's shares were trading at $123, now they are at $152. Obviously, I didn't catch PNC at the bottom, but the return of 24% (not including dividends) is decent nonetheless.
Shares of PNC Financial are now trading at 1.23X book value which is about 12% above the bank's longer-term P/B ratio of 1.10X. As you can see in the valuation chart below, valuation multipliers for most banks went up drastically in November and December which relates back to expectations of the Federal Reserve ending its tightening policy. I see a fair value of $136-137 for shares of PNC Financial in the long run which implies a BV valuation of 1.1X (last year's average P/B ratio).
Since other regional banks have also seen strong share price appreciation since November, I believe the market is currently driven by exuberance following Jerome Powell's statement about interest rates last week. Considering that shares of PNC are also overbought based off of the Relative Strength Index, I believe the current upsurge in pricing creates a nice exit situation.
Risks with PNC Financial
As for the biggest risks for PNC Financial I would not name interest rates, deposit trends or the potential for a sequential NIM compression. I would say the valuation is the biggest risk factor right now since shares of PNC Financial became overbought last week. A slowdown in the economy and a failed reboot of the loan operation even in a low-rate world is also a risk for investors that want to stay the course here.
Final thoughts
I believe investors are exuberant and appear greedy again, meaning it is time to be fearful and cautious. I bought PNC Financial in the second quarter during the financial crisis which followed the crash of Silicon Valley Bank. However, with a major revaluation having taken place after Q3 and shares now trading at a 23% premium to book value (and shares being overbought), I believe this may be a great time to close this investment chapter and sell into the strength. I do expect weaker net interest income going forward and a reboot of the bank's loan operations in a low-rate world, but the risk profile, in my opinion, is not nearly as attractive today as it was back in March or June 2023!
For further details see:
PNC Financial: Sell The Rally (Ratings Downgrade)