By H.J. Huney:
In spite of a general decline in nonperforming loans across the
US banking system and a pick-up in housing, the US banks are still
priced rather inexpensively. There are many banks that could
benefit immensely in the next few years, with beaten-down
bulge-bracket banks like
Citi
(
C
) and
Bank of America
(
BAC
) being at the top of the list. Yet, for investors with a more
moderate risk tolerance, there's no bank more attractive than
PNC Financial
(
PNC
).
The Macro Case for US Banks
There's a strong macro case to be made for US banks (
KBE
). The biggest boon for the banks right now is that Americans are
slowly starting to buy more houses again. Housing starts have been
inching upwards as we've gone from 550K to 750K annualized starts
in a matter of 15 months.
(click to enlarge)
In the grand scheme of things, we are still at very depressed
levels, as the chart below shows. This means there is still a lot
of room for improvement in the market.
(click to enlarge)
But if we can move closer to a more normalized environment,
lending activity should pick up significantly. In my article "
Housing Should Rebound Stronger than Expected
", I argued that a normalized environment might be closer to 1.4 -
1.6 million starts. We are at about half that level right now, and
this low level of production is likely unsustainable given the
shortages in the market.
Housing prices are also finally starting to show an upward
trend, as the Case-Shiller data below shows. It's important to
realize that prices don't necessarily have to rise significantly
for the homebuilders and banks to benefit, but it certainly doesn't
hurt things. Of course, we've already experienced at least one head
fake, as prices moved upwards in late 2009 and early 2010, before
declining again. But this price recovery looks more sustainable
given the dramatically shrinking inventories, coupled with low
vacancy rates in the rental market.
(click to enlarge)
There is another reason to like the banks here: inflation. We
haven't seen much of it lately and it's harmed some of the banks
and insurers. Yet, the United States has run the largest peacetime
government deficits as a % of GDP in its entire history over the
past few years. In the chart below from
US Government Spending
, you can see that the only three comparable periods in US history
were the Civil War, World War I, and World War II.
(click to enlarge)
Higher interest rates are not necessarily good for the nation as
a whole, but they might prove beneficial to banks, that will see
their net interest margins increase. Banks that have excess
liquidity particularly might stand to benefit.
This macro outlook makes the banks more intriguing, but even if
none of this comes to fruition over the next few years, PNC
Financial still looks inexpensive.
Are You Better Off Today Than You Were Five Years
Ago?
The media has focused a lot on the trials of the bulge-bracket
banks as well as the regional banks. PNC's sneaky ascent has almost
been largely ignored. Not only has PNC survived the crisis, but it
has strengthened significantly as a result of it.
With the US Presidential election coming up, Americans will
continually hear the phrase, "are you better off today than you
were four years ago?" It's interesting to examine the banks and ask
a similar question to long-term shareholders: "
are you better off as a shareholder today than you were five
years ago?"
There are very few bank shareholders that could answer that
question in the affirmative. PNC is a rare exception.
Let's take a look at a broad cross-sectional view of banks over
the past 5-6 years, with a focus on loan income, total assets, and
total deposits. Nearly every bank in America has suffered in terms
of top-line loan income, with only a few being able to break the
trend. Those that have managed to grow deposits have largely done
so via acquisitions.
In the chart below I examine 11 different banks, including the
Goliaths like C, BAC, and WFC; as well as large regional banks,
such as
M&T Bank
(
MTB
),
BB&T
(BBT),
Suntrust
(STI), and
Regions
(RF); a few smaller regionals with
Huntington
(HBAN) and
Synovus
(SNV); and one "micro-regional" that I follow closely,
Pacific Continental
(PCBK).
(click to enlarge)
Notice that all but two of the above banks have seen declines in
total loan revenue since 2007. The only two gainers are Wells Fargo
at +28.3% and PNC at +79.5%. Wells Fargo's gains have come due to
the 2008 acquisition of Wachovia. In fact, if anything, it's
somewhat surprising that WFC has only achieved 28% growth given
this.
Of course, none of this information is all that relevant taken
in isolation. Rather, we have to examine one of the other big
trends in banking since the financial crisis began:
dilution.
Most bank shareholders who have held on for the past five years
have probably seen a considerable amount of dilution in their
ownership. Indeed, it's difficult to find many banks that have seen
their share count increase by less than 20%. We can see that in the
chart below:
(click to enlarge)
The last column in the chart above might be confusing at first,
so I'll explain it better. I am essentially asking the question,
"if a bank earned $1.00 per share in 2007, and its net income was
exactly the same in 2011, then how much would its earnings per
share be in 2011?" If you've ever seen a chart showing the
"purchasing power of a Dollar" over time, this is a similar
concept.
Note that almost all the banks suffer considerably on this
metric. M&T looks to be the best with only a 13.7% share
increase, and $1.00 EPS in 2007 would be worth $0.88 in EPS in
2011. Citi's shareholders got absolutely murdered based on the
metric above, seeing a 486% increase in shares and a $0.17
equivalent EPS value in 2011. BAC's shareholders didn't fare much
better. Even PNC does not look incredibly good on this metric, with
a 57% share increase and a $0.64 equivalent EPS value in 2011. Yet,
dilution is not necessarily bad if it occurred in the context of
acquiring other banks at significant discounts. This is where PNC
stacks up nicely.
If we combine the two charts above to look at loan income per
share, we discover some intriguing results:
(click to enlarge)
PNC is the only bank on the list that sees an improvement on
this metric. This is particularly amazing because lending volume
for the overall US financial system has declined significantly
since 2007 and 2011 was right around the bottom of the housing
market. For PNC to improve loan income per share 14.3% in spite of
everything that happened says a lot about their management
team.
Assets and Deposit Growth
Let's also take a look at asset and deposit growth. While loan
incomes have declined dramatically for most banks, asset and
deposit growth have been more mixed.
(click to enlarge)
We can see here that PNC's total assets have increased by more
than any other bank in our survey group, with the exception of
Wells Fargo. The same is true with deposit growth.
(click to enlarge)
If you want to see both of those charts on a per share basis, as
well, here they are:
(click to enlarge)
(click to enlarge)
Note that only four of the eleven banks saw an increase on the
deposit front. And that might be a bit misleading as a
representation for the entire banking system, because my sample
group is somewhat skewed to the stronger banks, with BB&T,
M&T, and Wells Fargo being included. Still, PNC looks
impressive on both fronts.
Pricing, Dividends, and Capital Ratios
We can also take a quick look at some comparative pricing and
capital adequacy metrics for the banks.
(click to enlarge)
I've cut down our list of banks to the eight largest, which are
the most comparable to PNC. From this group, PNC has the second
highest dividend yield at 2.6%, and actually appears to be priced
attractively comparatively speaking. I'd focus most on Price to
Tangible Common Equity ["TCE"], which puts PNC at 1.44x; lower than
peers WFC, MTB, and BBT. Meanwhile, it has the second highest Tier
1 capital and TCE ratio ["TCE / TA"] of this group of four
banks.
C, BAC, STI, and RF have all had major struggles, which is why
they are priced lower than the other four banks. I actually believe
that C and BAC provide major opportunities, but those two banks
also come with higher risk.
With this, we can see potential reasons why PNC might be
attractive compared to some of the other banks that have also fared
well through the crisis. The dividend is nice, the price is
reasonable, and many of the above metrics speak to the quality of
its management team in guiding the bank through the financial
crisis.
PNC's Recent History
Now that we've gone through a spate of comparative metrics,
let's analyze PNC by itself. The chart below shows PNC's "vital
stats", including Tier 1 capital, net interest margins, and
non-performing loans. The "Present" column looks at data, as of
PNC's 2nd quarter SEC filing. The "1 Yr Ago" column looks at data
from its 2011 2nd quarter filings.
There is a lot of good news here. For starters, PNC's net
interest margin is impressive at 3.99%.
However, it's nonperforming loans that I find myself more
interested in. Nonperforming loans, as a % of total loans
(including OREO + foreclosures) is down from 2.97% to 2.21% year
over year. This is part of a broader trend in the industry, with
nonperforming assets shrinking. Naturally, this is good news. We
can see the bigger picture in the chart below, which runs through
the end of 2011.
(click to enlarge)
PNC's nonperforming loans peaked around mid 2009 at 4.0% and have
been in decline since then. The decline in NPLs should also focus
our attention on another positive development: loan growth.
If you take a look back at one of the first charts analyzing the
banks in this article ("Loan Income of US Banks: 2006 - 2011"), you
can see that loan income has been falling for almost all the banks
over the past several years. Even where there has been some loan
growth, it's normally come from acquisitions, rather than
organically. There might be a bit of that going on here, as well,
since PNC
acquired RBC's US operations
. Still, PNC managed to achieve nearly 20% Y-O-Y loan growth, with
little dilution. This is further testament to how PNC has been able
to acquire assets on the cheap during the past few years.
PNC has an impressive dividend history, as well. Before the
financial crisis, it had a track record of nearly two decades'
worth of dividend increases. It was forced to cut the dividend
during the crisis, as were virtually all other banks, but it has
managed to restore its dividends much quicker than competitors.
While the current rate of 40 cents per quarter is still below its
peak of 66 cents, this is still impressive given how dismal the
lending environment has been for the past several years.
(click to enlarge)
It's also worthwhile to peek at PNC's payout ratio
historically.
(click to enlarge)
As you can see, payout ratio for PNC is at a much lower level
than normal, around 20%. This likely reflects a lot of the
conservatism around the banking system, with regulators pressuring
the banks to keep dividends low. I expect this conservatism to wane
a bit in the upcoming years.
One figure I always like to examine is what I call the "earnings
yield", or EPS divided by stock price. (This is the inverse of
P/E.) PNC's 2011 diluted EPS was $5.73 per share, while the stock
price is currently near $62. That gives it an earnings yield of
9.2%. Ignoring a few one-time gains and losses, that falls slightly
to 9.0%, but it still looks quite attractive. All the more so,
because housing is cyclical, and the banks are still in a somewhat
depressed environment due to the lack of activity in the housing
sector.
A Normalized Environment
The next question to ask is what a more normalized banking
environment might look like? Taking a look at historical loan
income levels at the banks, I don't believe it's a stretch to
suggest that we'd see at least a 30% - 50% improvement in loan
volume.
First thing, we should look at PNC's most recent fiscal year
results.
It's always somewhat folly to try to piece together an earnings
or cash flow picture for a company based on hypothetical future
improvements. Yet, it's also necessary if we want to understand the
potential upside. When I conduct these exercises, my goal is more
to get a sense of the potential, rather than to pretend I can
achieve some great level of accuracy.
My hypothetical income statements based on increases in loan
volume are below. I examine 30% - 50% increases in loan income as
my starting point, and make other projections on margins,
noninterest income, and noninterest expenses, as well. There are a
lot of factors that are difficult to predict in an exercise like
this, such as whether interest margins will contract with higher
interest rates (they likely will) and how much a bunch can sell
other services to consumers once they are in the doors.
Based on these rough "guestimates", I don't think it's
unreasonable to suggest that with a more normalized environment,
PNC could churn out earnings in the $8.00 - $10.00 per share
range.
This is upside, but what I really like is that even in 2011, PNC
earned $5.73 per share, in what was a fairly dismal environment.
That puts it at a P/E ratio of about 10.8. Even if things were to
stay the same for a few years, PNC still looks attractive at the
current price. But if we start to see the housing market improve
significantly, and the banks begin to see loan growth again, we can
see that PNC has some significant upside. If it could achieve a $9
EPS and sold at a more normal 14 P/E ratio, that would put its
price at $126; a double from where it currently sits.
Even if 2012 earnings are only at $6.50 per share (below
analysts' average expected earnings of $6.75), and you apply a low
P/E of 12, that implies a price of $81, about 30% above where the
stock trades now.
Conclusions
PNC's ability to improve itself through the financial crisis is
a testament to how well it's run. Not only has it increased
deposits, assets, and loan volume, it's done so without harming
shareholders. While I view more beaten down banks like Citi and
Bank of America as having higher upside potential, PNC Financial is
still relatively cheap at 1.4x tangible common equity, and has
enough upside to make it worthwhile. Likewise, it has significantly
lower risk than many of its peers and should have more growth left
in it than bulge bracket banks like C, BAC, and WFC.
At $62, it is selling at a trailing P/E of about 10.8, and we
appear to be at a cyclical bottom in the lending market. This means
that it might even be significantly cheaper than it looks on the
face of it. Overall, I view PNC as one of the most attractive bank
stocks on a risk / reward basis.
Disclosure:
I am long [[PNC]], [[C]], [[PCBK]]. I wrote this article myself,
and it expresses my own opinions. I am not receiving compensation
for it. I have no business relationship with any company whose
stock is mentioned in this article.
See also
McDonald's: Testing A Multi-Year Trend
on seekingalpha.com