INVESTMENT THESIS
We believe a recent move higher in the 10-year Treasury yield is sustainable, resulting in a steeper yield curve and helping net interest margins. In addition, we are now expecting considerably lower loan loss provisions as the jobs market sees more stabilization.
In mid-November, PNC reached an agreement to acquire BBVA USA Bancshares, the Houston-based U.S. banking subsidiary of Banco Bilbao Vizcaya (BBVA), for $11.6 billion in cash. The acquisition includes $104 billion in assets, $86 billion in deposits, and 637 branches in Texas, Alabama, Arizona, California, Florida, Colorado and New Mexico.
The company said the purchase would provide it with a presence in 29 of the 30 largest markets in the U.S.
We like this deal for several reasons, including the expansion it provides in the faster-growing Sunbelt region of the U.S., as well as a more coast-to-coast branch presence. At a price of 1.34-times tangible book value, the valuation is comparable to PNC’s. The company projects 21% earnings accretion in 2022, the first full year after an assumed mid-2021 closing, based on an expected $900 million in cost savings.
The acquisition also replaces the dividend income lost after PNC’s May 2020 sale of its 22.5% stake in BlackRock (BLK), which resulted in net proceeds of about $14 billion. PNC realized a considerable windfall from that sale (estimated at about 70-times its original purchase price), allowing it to acquire BBVA USA Bancshares for cash and paving the way for strong expected earnings accretion.
In the near term, the economic environment has created headwinds, but we believe the company’s strong capital position provides insulation, while monetary and fiscal support will help minimize the fallout on the lending businesses. Credit losses remain a wild card, but the sizeable first-half credit loss provision provides a strong buffer. Along with its 3Q results, PNC was very transparent in providing a breakout of its exposure to industries that could be highly impacted by the coronavirus.
PNC trades at an elevated P/E on our 2020 EPS estimate due to depressed earnings. Our revised target price of $173 (raised from $150) implies a multiple of 19-times our revised EPS estimate for 2021, when earnings will still be under pressure from low interest rates, a slow recovery from the pandemic, and income from BlackRock not yet fully replaced. Our estimates do not yet factor in benefits from the BBVA USA Bancshares acquisition.
RECENT DEVELOPMENTS
PNC shares have fallen 6% over the past year, versus a 15% advance for the broad market.
On October 14, PNC reported 3Q20 EPS of $3.39, up from $2.94 a year earlier and above the consensus of $2.12. Revenues rose 1% to $4.3 billion.
Net interest income declined 1%, as growth in average earning assets (with a boost for commercial & industrial loans) was offset by a narrower net interest margin of 2.39%, down from 2.84% a year earlier.
Net charge-offs of $155 million (0.24% of average loans) were flat with $155 million (0.26%) a year earlier. Loss provisions dropped to $52 million from $183 million in 3Q19; the decline followed substantial provisions in the first half of the year in preparation for higher pandemic-related delinquencies.
EARNINGS & GROWTH ANALYSIS
On the 3Q conference call, management provided guidance for the fourth quarter. It expects average loans to decline sequentially at a low single-digit rate, and looks for stable net interest income and fee income. It expects noninterest income to be down in the high single digits, while expenses are expected to be up 1%.
The economic environment remains uncertain, but we believe the company’s strong capital position provides insulation, while monetary and fiscal support will help minimize the fallout on the lending businesses. Credit losses remain a wild card, but we view the very large first-half loss provisions of $3.4 billion as a sign that management is being conservative. Along with 3Q earnings, PNC was very transparent in providing a breakout of its exposure to industries that could be highly impacted by the coronavirus.
The company has a Continuous Improvement Plan (CIP) designed to reduce costs and improve efficiency. PNC generated $350 million in cost savings from the CIP in 2017, $250 million in 2018, and $300 million in 2019, which it expects to help fund business and technology investments.
We are maintaining our 2020 EPS estimate of $4.96 while raising our 2021 forecast to $9.11 from $7.40 to reflect what we believe is a sustainable move higher in the 10-year Treasury and lower loss provisions from an improving economy. Our estimates do not yet factor in benefits from the BBVA USA Bancshares acquisition.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating on PNC is Medium-High, the second-highest rank on our five-point scale.
In June 2020, the Federal Reserve released stress test results for large U.S. banks, but did not approve dividend increases or share buyback plans as it required banks to conserve capital during the coronavirus downturn. During the prior review in June 2019, the Federal Reserve did not object to PNC’s Comprehensive Capital Analysis and Review plan (CCAR), which included a repurchase program of $4.3 billion of common stock (up from $2.0 billion a year earlier) for the four quarters through June 2020. The plan included a 21% increase in the quarterly dividend, to $1.15 from $0.95.
We now expect quarterly dividends to be maintained at the $1.15 level through mid-2021. Our dividend estimates are $4.60 for 2020 and $4.66 for 2021.
PNC’s Basel III common equity tier 1 capital ratio was 11.7% on September 30, 2020.
MANAGEMENT & RISKS
PNC is led by Chairman and CEO William S. Demchak. The company is transparent with its growth strategy and cost-savings initiatives and provides guidance with respect to balance sheet metrics, near-term expenses, and credit loss provisioning.
The company is subject to a number of risks, including changes in interest rates, credit quality, loan demand, and capital markets liquidity. It also faces risks from financial services regulation.
COMPANY DESCRIPTION
Based in Pittsburgh, PNC provides a range of retail and commercial banking, residential mortgage lending, and asset management services. It has operations in Pennsylvania, Ohio, New Jersey, Michigan, Illinois, Maryland, Indiana, North Carolina, Florida, Kentucky, Washington, D.C., Delaware, Alabama, Virginia, Missouri, Georgia, Wisconsin and South Carolina.
In May 2020, PNC disposed of its 22% stake in BlackRock Inc. (BLK) in a registered offering. The company received large cash dividends from its BlackRock stake totaling approximately $459 million in 2019, $422 million in 2018, $354 million in 2017, and $331 million in 2016.
VALUATION
PNC trades at an elevated P/E multiple on depressed 2020 earnings. We view the bank as well positioned, with strong capital levels to ride out the headwinds caused by the coronavirus, and a strong allowance for credit losses to handle defaults. Our target price of $173 (raised from $150) implies a multiple of 19-times our revised EPS estimate for 2021, when earnings will still be under pressure from low interest rates and a slow recovery from the pandemic. Our estimates do not yet factor in benefits from the BBVA USA Bancshares acquisition, which we expect to be 21% accretive in 2022.
On January 6 at midday, BUY-rated PNC traded at $157.18, up $8.78.
