PNC Financial (PNC) reported Q4 2019 diluted EPS of $2.97 that was in line with what the street had expected. Earnings of $1.3B were up just 2% YoY (flat QoQ), as higher revenues were largely offset by expanding cost base and credit costs. With the likelihood of another rate cut this year, net interest income is set for lackluster growth in 2020E-21E, though growing fee franchise will provide some offset.
Non-interest income growth offset the downtrend in NII; Cost control was weak
PNC had an unsurprisingly flattish net interest income (NII) growth during the quarter. Margins fell 6bps sequentially, but was not as bad as its counterpart US Bancorp (USB), which witnessed 10bps contraction.
We still believe that PNC can counterbalance the NIM (net interest margins) trend by raising its low loan-to-deposit ratio (LDR) from 83%. Deposits continued to flow in, with average deposits growing 3% sequentially and 8% in the past year. However, average loan growth did not keep pace, with a flattish 0.5% QoQ (+6% YoY) growth, resulting in a further LDR drop of 220bps since the last quarter.
With another Fed rate cut likely towards the end of the year, 2020E-21E might be shaping up to be quite tepid, not just for PNC, but for the entire banking sector. For Q1 2020, the management expects NII to decline 1%. However, the continued growth in non-interest income will offer a steady offset to margin pressures. During the quarter, non-interest income was up 14% YoY (+7% QoQ), thanks to higher contribution from private equity investments, healthy increase in asset management fees (+18% YoY), corporate services (+7% YoY) and residential mortgage fees (+48% YoY). For the full year, non-interest income was up 6%.
Despite the continued uptrend, the management expects 1Q 2020 fee income to be sequentially down 3%. However, fee income is seasonally weak in the first quarter, and the management forecast implies a solid 7% YoY rise, strongly offsetting the decline in NII.
Operating expenses jumped 7% YoY on higher compensation costs (+9%) driven by continued business investments, while equipment expenses (+22%) jumped on certain write-offs. Consequently, cost-to-income ratio deteriorated 50bps.
Loan growth cooled as commercial side stalled
The bank’s loan portfolio is heavily tilted to the commercial side, and hence the decline in the segment dragged overall book during the quarter. However, it is noteworthy that commercial lending has been the growth driver for the bank during the year, and the fourth quarter has been the only sequentially slow quarter for this segment.
Average loan book remained flattish QoQ, with growth in consumer (+2%) and residential mortgages (+4%) largely offset by fall in commercial (-0.4%, but 52% of the loan book), commercial real estate (-1%), and equipment lease financing (-1%).
The management guided for 4-5% average loan growth in 2020, implying a slower environment compared to the 6% rise in 2019. At a time when margins are under pressure, slowing loan book does not augur well for the net interest income line. However, 4-5% is still a respectable growth, which can somewhat mitigate the margin compression. For the first quarter of 2020, loan growth is expected at around 1% by the management.
Share repurchases might average $3 billion over 2020E-21E
The CET1 ratio seems ample at 9.5%, down 10bps QoQ, as the bank continued its share repurchase program, buying back $1 billion during the quarter. During 2019, the bank spent $3.5 billion to buyback shares, and has recently secured an additional approval from the US Fed to further spend $1 billion through Q2 2020.
Given the CET1 target of 8-8.5%, we believe that the bank has the ability to continue repurchases into 2020E-21E, likely doing $3 billion every year, before hitting the target capital range. This is around 9% of the current market cap, pretty generous in our view.
Stock is expensive
PNC currently trades at one-year forward price-to-tangible-book multiple of 1.7 times, ahead of historical average of 1.6x. Based on a price-to-tangible return on equity model, it should be even cheaper. We will not be buying above $130 levels. Avoid for now.
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