2023-10-17 12:33:01 ET
Summary
- PNC Financial's Q3'23 performance was mixed, with decent net interest income performance, good expense control, and lower provisioning driving upside.
- Lending growth has vanished, and PNC is losing a little share in commercial lending, but pulling back during downturns is typical for the bank.
- Deposit betas will continue to climb, but deposit costs are well in-hand and management doesn't need to chase funding.
- The shares likely need the Fed to switch to a more dovish position to work but look undervalued for long-term investors.
The performance of PNC Financial (PNC) since my last update has been curious. Down about 27% since then, PNC doesn't seem to be getting much benefit from its reputation as a more conservative, "all-weather bank" better able to manage the ups and (more importantly) downs of the credit cycle. To that end, it seems like investors are more concerned with issues like sluggish fee income and iffy operating leverage than better-than-average loan beta, solid funding, and credit ratios that are still above average.
Few banks are really going to work well until the Street's confident that the tightening cycle is over and the Fed is prepared to start cutting rates, and PNC isn't really structured to generate exceptional profitability in a "higher for longer" rate cycle. Still, even relatively modest long-term core earnings growth (around 3%) can drive a meaningfully higher share price, and I think this is a good name to consider among quality super-regionals waiting for that catalyst to get moving again.
A Fairly Typical PNC Quarter Of Late - Some Good, Some Bad, But Okay On Balance
PNC has become a little inconsistent of late when it comes to pre-provision profit performance relative to Street expectations, with almost alternating quarters of beats and misses. Even so, overall performance has tracked my basic expectations as management has started pulling in the reins in response to a less certain macro environment.
Revenue fell more than 5% year over year and about 1% quarter over quarter (or closer to 4% on a core basis), missing by about $0.14/share. Net interest income was okay, falling 2.5% qoq but beating by $0.04/share as net interest margin met expectations (down 8bp qoq to 2.71%) and earning assets (flat qoq) slightly exceeded them. Of the larger banks that have reported as of this writing, that's the weakest NIM performance, which is even more surprising given an above-average loan beta.
Fee income rose 2% sequentially as reported and fell about 5% on a core basis, but I note here that seemingly no two analysts have exactly the same definition of core. That was still weaker than the Street expected, though, to the tune of about $0.18/share. Trading revenue and private equity income were both notably weak; capital markets isn't an especially large part of the business at this point, but this is an "everything counts" part of the cycle, so this doesn't help.
Operating expenses declined 4% qoq, with efficiency ratio improving almost two points to 61.6%. That was good for a $0.24/share beat and one of the better sequential performances so far. Pre-provision profits rose about 4% as reported and fell about 3% in core terms, beating by $0.10/share.
Sluggish Lending Isn't So Unusual, And Deposit Costs Remain A Contained Risk
Having followed PNC for a number of cycles now, it's not surprising to me that the bank is pulling back on lending in this environment. It's a pretty typical part of the bank's conservative underwriting culture, though it does still limit some of the company's leverage to higher rates.
Loans declined 1% qoq on an end-of-period basis and slightly more on an average balance basis; PNC modestly underperformed the slight growth in lending for large banks as a group (as per Fed H.8 reports). Likewise, the 2% qoq decline in C&I lending was a little softer than average, though mortgage lending (up 1.1% qoq) was a bit of a positive outlier.
Deposit costs rose another 24bp sequentially, with interest-bearing deposit costs up 30bp to 2.26% and the cumulative interest-bearing deposit beta climbing another four points to 43%. With the Fed likely not through raising rates yet, expect this to continue going higher, as deposit costs usually continue to rise for another quarter or two after the Fed finishes tightening. Non-interest-bearing deposits declined another 24% yoy and 4% qoq and management is not competing aggressively on rates to keep deposits - they don't really need to give the excess liquidity and the modest outlook for lending growth.
Speaking of liquidity, the bank had $41B at quarter end (of $557B) earning Fed funds rates, so again, capital and liquidity aren't issues. Moreover, with a CET1 ratio of 9.8% management has the option to deploy some capital if the opportunity arises. Look at the recent loan acquisition as an example of such opportunities - the company acquired $16B of capital commitment facilities, including $9B of funded loans yielding around 8%, at 99% of par earlier in October. This, in turn, is fueling the 3% sequential loan growth guide.
The Outlook
Judging by the reaction of the stock, the Street wasn't impressed that management didn't have more to offer in terms of top-line growth or operating leverage. A 4% headcount reduction will help the ongoing cost reduction program, with management looking to keep operating expenses flat in 2024. Credit costs are also likely to head higher, though PNC's net charge-off ratio (0.15%) and non-performing loan ratio (0.67%) are still fine on balance.
Next year will be challenging for earnings growth, as although pre-provision profit growth shouldn't be down much (and could even be up), provisioning expenses for worsening credit losses will take a bigger bite. With that, I'm expecting a mid-single-digit core earnings decline this year, a mid-teens decline next year, and a high-teens rebound in FY'25. Long term, I think core earnings growth in the 4% range is still achievable.
A weak near-term and a stronger long-term outlook set up some noisy fair value metrics. The shares look undervalued below $160 on discounted core earnings, but EPS and ROTCE-based methodologies only get me into the $140's.
The Bottom Line
There's nothing wrong with PNC that a shift in the cycle won't change - once the Fed switches to rate cuts and the credit cycle completes, PNC will look fine. Longer term, the story is still underpinned by organic growth of middle market lending operations in select metro markets and opportunistic capital deployments (whether into M&A, loan purchases, or what have you), all of which backstopped by a relative conservative culture on expenses and credit. While banking will only get more competitive from here, PNC is built to emerge as one of the long-term winners.
For further details see:
PNC Financial Will Be Back, But Needs Lower Rates First