Ever since the European debt crisis became the issue that the markets trade alongside, bank stocks have risen and fallen together. Correlation in the banking sector, much like the overall stock market, is at record levels, as investors paint all financial firms with the same broad brush. But, the truth is that not all banks are created the same. There are some that can rise above the challenges presented in Europe and can thrive in such an environment. And we would like to highlight just such a bank today.
PNC Financial (PNC) is a large regional bank that caters to the eastern United States. PNC is currently the 12th largest bank holding company in the U.S. by assets. As a regional bank, it has none of the European exposure that is currently plaguing many of its peers, yet it is trading as if it was exposed to Europe.
While it is true that PNC has outperformed the broader financial sector, it has underperformed the S&P 500. We see little reason for this other than the sentiment surrounding the financial industry. PNC's strong operating characteristics, and financial profile are not reflected in its stock price, and we delve into the 4 factors that should drive PNC going forward below.
- Exposure to Europe: In its third quarter earnings release, where PNC posted EPS of $1.55 on revenues of $3.5 billion. Europe was not mentioned in the press release. In an environment where bank executives rush to show a lack of exposure to Europe, PNC is doing just the opposite. Nor was Europe mentioned on the conference call. No one, be they executives OR analysts mentioned Europe as an issue for this bank. We take that as a bullish sign. Dick Bove of Rochdale Securities agrees. Banks perceived as the healthiest in the U.S., such as PNC, stand to benefit from the uncertainty surrounding European banks, as well as their larger counterparts. If investors are concerned with the exposure to Europe of the banks they own, why not invest in a bank that has no European exposure?
- Customer growth: PNC has been aggressively expanding as it utilizes its strong balance sheet to grow profitably. Virtual Wallet, the company's new online banking account, is adding an average of 10,000 customers per week, and 70% of the accounts opened in August and September were relationship accounts, which have 2 to 3 times more revenue than a "free" checking account.
- Loan growth & credit quality: One of the factors causing negative sentiment in bank stocks is a lack of loan growth, a problem PNC does not have. In the third quarter, PNC grew loans by $4.2 billion, to $155 billion, including $1 billion in loans to small businesses. PNC is seeing loan growth of around 4% in its commercial & industrial division. Furthermore, credit quality is continuing to improve, with non-performing assets falling by 4% to $4.3 billion. Net charge-offs dropped by nearly 12% from the second quarter, to $365 million.
- RBC acquisition: Unlike many banks, PNC is not looking to sell assets. Rather, it is looking to expand, much like it did in the financial crisis with the takeover of National City. In June, PNC announced that it was buying RBC's (RY) U.S. branches and assets for $3.45 billion. The deal gives PNC a new presence in the southeastern U.S. and should be immediately accretive to earnings when it closes in 2012. CEO James Rohr expressed confidence on the conference call that no new stock will need to be issued to fund the transaction, saying, "I think the regulators have their act together to be honest, but I can't speak on behalf of them. But they're very consistent about wanting us to meet capital requirements. And I think that's why we're optimistic that we won't have to issue any common because they're really focused on the longer-term capital adequacy of the company and the risk profile that we have, and I think they do have their act together. So that's why we think we'll hear on the RBC transaction before the end of the quarter, and then we'll take a look at our income projections for next year and talk to it about or making submission about dividends." The RBC acquisition reflects PNC's optimism in its future and we think it will be a successful and profitable deal.
PNC is a plain vanilla bank, with none of the risk of the Wall Street megabanks. The company's balance sheet proves it. PNC ended the quarter with $269 billion in assets and a Tier 1 Common Capital ratio of 10.5%. PNC also retains a 21.7% interest in BlackRock (BLK) and given the strong performance of BlackRock, we think this stake will increase in value in the years to come.
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PNC is not only undervalued relative to its growth trajectory, it is also undervalued relative on a book value basis. We think that at 0.84 times book value, PNC is an attractive stock, for 2 reasons. First, a bank such as PNC should not be trading below book value, for there is far less risk than at a larger financial firm. Secondly, the fact that even after selling off, PNC still trades at a premium to its peers is encouraging. It shows that investors have more faith in management's ability to execute. We think that faith is well-placed. PNC yields over 2.6%, and that payout will grow over time as the company keeps growing. PNC's stock buyback program allows it to repurchase nearly 5% of its shares, and in an age where banks are skittish about returning capital to shareholders, PNC's commitment to do so makes it stand out. PNC is poised for great success in the years to come, and analysts agree. Credit Suisse sees the stock at $68, S&P sees it at $65. Barclays sees it at $75, and Jefferies sees it at $62. The Reuters average price target is $63.53, implying a gain of 22% over current levels. PNC is a bank that is a world apart from its larger peers. But its stock is one that should not be apart from your portfolio.