2023-03-24 10:07:31 ET
Summary
- After taking a big ride on its BlackRock stake, The PNC Financial Services Group, Inc. swapped its investments for BBVA USA in 2020.
- This meant that the bank doubled down exposure on banking, something which hurt the business now.
- The PNC Financial Services Group faces the same issues as all its peers, and while solvency concerns have come down following government intervention, I fear the impact on the sector's profitability.
Shares of The PNC Financial Services Group, Inc. ( PNC ) have seen fresh lows even as the worst financial woes seems to be a thing of the past, as I stress the word "seems" here, yet its shares and that of many other banks are still down a lot. Safe to say is that the bank falls between the category of regional banks and big nationwide banks, making it a bit hard for investors to categorize, which is important in this crisis.
Unlike many other banks, PNC has seen a busy couple of years in its operations. This comes as the company sold its valuable stake in BlackRock, Inc. ( BLK ) in 2020, using proceeds to acquire BBVA USA that year in a near-$12 billion deal. It doubled down on the banking activities, while removing its stake in the asset manager.
A $150 stock pre-pandemic rose to the $200 mark in 2021 and early 2022, with shares down to $160 early in March, but having fallen to just $122 now at the moment of writing, this marks the lowest levels since the pandemic.
The Bank Issue
Banks as a group face two issues. Many banks saw huge deposit inflows as stimulus checks hit the accounts of U.S. consumers in 2020, but consumers were unable to spend their money. This made banks deposit-rich in a low-interest rate environment. With the Fed starting a historically strong and fast hiking cycle last year, banks were slow to increase deposit rates and hence have seen deposit outflows or migration to interest-paying instruments.
This has hurt liquidity of the banks already a bit, and this is where things get tricky. Once banks see continued outflows, banks face little liquidity and might be forced to sell some longer-duration assets like treasuries or agency securities, as the duration of these instruments means that banks have to recognize losses on these given the same increase in rates, if they have to sell these assets in order to meet deposit requests.
Of course, banks can increase deposit rates to keep savers on board, but the reality is that many banks only have relatively little room to hike deposit rates before giving up profitability, while the gap between current deposit rates and risk free rates typically is larger.
The 2022 Results
PNC is a bank with a total asset base of $557 billion by year-end 2022, unchanged from the year before. While the asset base has been the same, the company saw deposit outflows to the tune of $21 billion in 2022, down to $436 billion, as the bank resorted to Federal Home Loan Bank borrowings instead. Interest payments on deposits rose from a mere $26 million in the fourth quarter of 2021 to $812 million in the fourth quarter of 2022, as the $3.2 billion run rate reveals that the bank pays less than a percent on the deposit base, about 73 basis points. Borrowed funds come even more expensive, resulting in more interest expenses.
Despite this dynamic, the bank posted $7.5 billion on operating earnings in 2022, although it took just half a billion in loan loss provisions. The $7.5 billion number is equivalent to a 170 basis point hike in the deposit rate (assuming they all carry interest). In other words, if the bank hikes deposit rates across the board towards 250 basis points, it breaks even. This still marks a huge gap with risk-free rates, making it very hard to maintain these deposits.
If the bank needs to sell assets to finance deposit outflows, it has a whopping $140 billion in investment securities: either held to maturity, or available for sale. Duration risks appear to be managed well, as the annual report shows a combined $9.6 billion in unrealized losses on these, equal to about 7%.
This is a big absolute number, but in relation to the reported equity base of $45 billion it looks manageable, as the same goes for the relative losses. Of course, PNC benefits from the FDIC and implicit government backing of savings in excess of the official $250k limit as well, as the question is if it has seen outflows or inflows since the start of the financial concerns from March.
And Now?
The reality is that the potential for bankruptcies, certainly among the larger names, has become a lot smaller following the intervention by the government and Treasury Department. On the other hand is a real serious issue, that of severe earnings pressure. This is very evident in the discussions above. After all, if The PNC Financial Services Group, Inc. pays an average deposit rate of 2.5% it is unable to make a profit, as the 2.5% rate actually comes in at just half the Federal Funds Rate after this week's meeting.
This makes me very concerned for all banks, not from a credit point of view (given the assistance by the government) but mostly because of the anticipated pressure on earnings as the fight for deposits is fierce, seen by the rapidly increasing deposit rates which banks advertise on their commercial websites. Of course, the upcoming first quarter results are very indicative of deposit flows and the cost of them.
This makes it very hard for me to invest in the banking sector, in which I have traditionally held a large underweight position. I see no need to take on significant exposure to the sector here.
For further details see:
PNC Financial Services Group: A Bank Facing Real Earnings Concerns, Like Many