PNC Financial: Loan Growth, Cost Savings to Increase Profits (NYSE: PNC)

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PNC Financial Services Group, Inc. (NYSE: PNC) earnings will likely benefit next year from expanding net interest margin and cost savings resulting from BBVA USA’s systems integration. In addition, the downward trend in organic lending is expected to eventually reverse next year, as loan drawdowns decline and economic strength sharpens demand for credit. Overall, I expect the company to report earnings of $ 14.47 per share in 2022. Next year’s target price suggests a small downside to the current market price. Therefore, I take a neutral rating on PNC Financial.

Organic growth in loans likely to recover

Excluding the impact of the acquisition of BBVA USA (which added $ 60.5 billion in loans as of 2Q 2021), the company’s loan portfolio has shrunk every quarter since Q2 2020. This prolonged downtrend shows that the company faces underlying issues. The loan portfolio is likely to decline further over the next two quarters due to the following two factors.

  1. Pardon PPP remaining. PNC significantly reduced its Paycheck Protection Program (“PPP”) loan portfolio from $ 12.0 billion at the end of December 2020 to $ 6.8 billion at the end of September 2021, as mentioned in the 10-Q file. However, there is still a significant portion of PPP loans that need to be canceled. Outstanding PPP loans represented about 2.3% of total loans at the end of the last quarter. Therefore, the impending cancellation over the next two quarters will have a significant impact on the total size of the loan portfolio.
  2. Continuation of the resizing of the BBVA USA portfolio. After intentionally liquidating some BBVA loans in the last quarter, management mentioned on the conference call that they plan to take out an additional $ 5 billion in loans. Of these, management intends to release $ 2 billion in the fourth quarter and the remainder over the next two years.

However, there is hope that the loan portfolio will soon reach its lowest point due to recent macroeconomic trends. Commercial and industrial (“C&I”) loans represented 52.6% of total loans at the end of September 21, according to details provided in the 10-Q file. Therefore, PMI and GDP are appropriate measures to assess the demand for PNC credit products. PMI and GDP measurements show that the economy is comfortably in a state of expansion, which bodes well for loan growth.

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Data by YCharts

In addition, there are positive signs in PNC’s wealth portfolio, which grew by 2% in the third quarter of 2021, excluding the PPP impact, as mentioned in the presentation to investors.

Overall, I expect loan growth in 2022 to remain moderate, below the historic pre-pandemic average. As a result of weak loan growth, the composition of productive assets is likely to continue to deteriorate. The mismatch of organic growth and deposit growth has led to an accumulation of securities and excess cash in recent quarters. As a result, low yielding securities rose to represent around 26% of interest earning assets at the end of September 2021, as shown below.

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As a result of below-average loan growth, the composition of earning assets is likely to continue to shift toward lower performing assets. Management also mentioned on the conference call that they expect stocks to reach a range of 25-30% of total earning assets by the end of the year. Considering these factors, I expect loans to increase by 1% and other productive assets (including securities) by 4% in 2022. The following table shows my balance sheet estimates.

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Slight margin expansion likely

The continued deterioration in the asset mix will likely put pressure on the net interest margin in the coming quarters. On the other hand, the anticipated rise in interest rates will likely increase the net interest margin. The Federal Reserve projects an increase of about 75 basis points in the fed funds rate in 2022. The net interest income of the PNC is quite sensitive to changes in interest rates, as shown by the sensitivity analysis to interest rates of the direction presented in the 10-Q file. A 100 basis point increase in interest rates could result in a 4.5% increase in net interest income in the first year of rate changes. Net interest income is even more sensitive in the second year of rate changes. The following table presents the results of management’s sensitivity analysis to interest rates.

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Source: 10-Q from the company

Considering these factors, I expect the net interest margin to decline by two basis points in the fourth quarter, down from 2.27% in the third quarter of 2021. For 2022, I expect the margin increases by four basis points.

Branch and system conversions to generate cost savings

PNC’s non-interest expense has increased over the past two quarters due to one-time costs associated with the merger. As of the end of September 2021, the company had incurred nearly half of the total integration cost of around $ 980 million, according to details given on the conference call. Since half of the integration costs remain to be incurred, non-interest costs are likely to remain high in the last quarter of 2021.

Beyond 2021, however, non-interest charges are likely to plunge due to the non-recurrence of integration costs. In addition, management expects significant cost savings from the synergies resulting from the acquisition of BBVA USA. Management estimated the execution rate of cost savings to be around $ 900 million, as mentioned in the investor presentation. MManagement mentioned on the conference call that it expects all actions that generate savings of $ 900 million, including branch and system conversions, to be completed by the end of the year. year 2021.

Considering these factors, I expect the efficiency ratio to drop to 59.6% by the last quarter of 2022, compared to the average efficiency ratio of 60.9% in 2020.

Expected 2022 earnings of $ 14.47 per share

Expected margin expansion and growth in productive assets will likely boost earnings in 2022. Additionally, improved operational efficiency will likely support bottom line. On the other hand, a higher provision charge will likely weigh on earnings. The provision charge will increase primarily due to additions to the loan portfolio. On the other hand, the existing loan portfolio will most likely not require additional provisioning as the current provisions comfortably cover non-performing loans. Provisions represented 1.85% of total loans at the end of the last quarter, while non-performing loans represented 0.87% of total loans at the end of the last quarter, as mentioned in the 10-Q case.

Overall, I expect the company to report earnings of $ 14.47 per share in 2022. For the last quarter of 2021, I expect the company to report earnings of 3.31 $ per share, which will bring annual earnings to $ 13.14 per share. . The following table shows my income statement estimates.

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Actual profits may differ materially from estimates due to the risks and uncertainties associated with the COVID-19 pandemic, particularly the Omicron variant.

Current market price close to the coming year Target price

PNC offers a 2.5% dividend yield at the current quarterly dividend rate of $ 1.25 per share. Earnings and dividend estimates suggest a payout rate of 35% for 2022, which is higher than the 2016-2019 average of 29%. Therefore, I do not expect an increase in the level of the dividend next year.

I use the historical price / earnings (“P / TB”) and price / earnings (“P / E”) multiples to value PNC Financial. The stock has traded at an average P / TB ratio of 1.62 in the past, as shown below.

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Multiplying the average P / TB multiple by the tangible book value per forecast share of $ 106.40 yields a target price of $ 172.40 for the end of 2022. This price target implies a 12.5% ​​decline compared to the closing price on December 22. The following table shows the sensitivity of the target price to the P / TB ratio.

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The stock has traded at an average P / E ratio of around 14.6x in the past, as shown below.

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Multiplying the average P / E multiple by the expected earnings per share of $ 14.47 yields a target price of $ 211.60 for the end of 2022. This price target implies a 7.4% increase from at the December 22 closing price. The following table shows the sensitivity of the target price to the P / E ratio.

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The equal weighting of the target prices of the two valuation methods results in a combined target price of $ 192.00, which implies a decrease of 2.6% from the current market price. Adding the term dividend yield gives an expected total return of minus 0.1%. Therefore, I take a neutral rating on PNC Financial Services. I would not consider investing in the stock unless its price drops more than 12% from its current level.


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