PNC Financial Services: A More Conservative Risk-Reward Play

The super-regional bank PNC Financial Services (NYSE: PNC) recently reported first-quarter earnings results that easily beat analyst estimates, although they slightly missed on revenue.

Like most bank shares, PNC has sold off pretty significantly this year due to turmoil in the banking industry and now trades at roughly 143% of its tangible book value or net worth, which is definitely toward the low end of where the stock has traded since 2017.

While near-term challenges remain, I think PNC presents a more conservative risk-reward opportunity when compared to some of its more immediate peers like U.S. Bancorp and Truist. Here's why.

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PNC's balance sheet is well positioned

One thing that stands out about PNC is that its balance sheet is very sound when you look at liquidity, capital, its securities book, and deposits.

Despite the challenging environment for deposits, PNC managed to increase deposit balances on an average and period-end basis. The bank's total funding costs rose from 1.55% in the fourth quarter of 2022 to 2.20% in the first quarter of the year. This reduced the bank's net interest income (NII), the money it makes on loans and securities after funding those assets, by 3% from the prior quarter. I would have thought NII would have performed better, given the strong performance on deposits, but the addition of more expensive time deposits and the issuance of senior debt in the quarter seemed to weigh on average funding costs.

Still, I feel very comfortable about PNC's deposit base, which has $230 billion of consumer deposits, with an average account balance of $11,500. Close to 90% of consumer deposits are insured by the Federal Deposit Insurance Corp. (FDIC). In PNC's $207 billion commercial franchise, 80% of the deposits are uninsured, which is not surprising, given that these accounts hold larger balances, but 94% of commercial accounts are operating or relationship accounts, meaning these clients use the bank for more than just holding deposits.

The bank's capital position is also strong. The common equity tier 1 (CET1) capital ratio, which looks at a bank's core capital expressed as a percentage of its risk-weighted assets, is 9.2%, well over its 7.4% requirement. Capital helps a bank withstand losses, lend, buy back shares, and pay dividends. Furthermore, the bank has fewer unrealized losses in its bond portfolio that it intends to hold to maturity than Truist and U.S. Bancorp.

The unrealized losses in PNC's bond portfolio it expects to sell before maturity are projected to decline by 40% between now and the end of 2024. Even if you did apply the current losses in this bond portfolio to the bank's CET1 capital (super-regional banks like PNC do not currently have to do this), the CET1 ratio would still be above its regulatory requirement.

Guidance is not too bad and conservative

For the full year, PNC is still expecting average loan balances to rise 4% to 5%, despite a looming recession, and still expects to grow total revenue by 4% to 5%. Meanwhile, PNC expects expenses to only rise 2% to 3%, so the bank still expects to generate positive operating leverage, which means revenue rising faster than expenses. This is something that some of PNC's peers like Truist may struggle to generate this year.

The other interesting thing about PNC's forecast is that management is assuming that the Federal Reserve will increase interest rates by a quarter-point at its May meeting and then pause for the rest of the year. This is quite different from many other banks, which expect the Fed to cut rates later this year. If the Fed cuts rates, PNC's deposit pricing, NII, and revenue may actually perform better than management is predicting, which is why I find its forecast to be more conservative than other banks.

PNC also seems to have a good handle on commercial real estate, which many investors have sharpened their focus on. Office loans make up less than 3% of the bank's total loan portfolio, and PNC has reserved enough capital already to cover losses in excess of 7% of the total office loan book.

Checking a lot of boxes

There are certain aspects of PNC that I find less attractive than the likes of peers like Truist and U.S. Bancorp, which for the record, are other stocks that, I believe, are buys. For instance, PNC doesn't have some of the specialized streams of fee income as some of its peers and tends to also have a more elevated expense base.

But the bank has done a better job managing the balance sheet in recent years by not investing too heavily in securities, by maintaining strong levels of capital, and as of right now, it looks like the bank also has prudently underwritten its loan book. Therefore, overall, I view PNC as more of a conservative play right now.

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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends PNC Financial Services. The Motley Fool has a disclosure policy.