PNC Financial (NYSE:PNC), one of the largest U.S. regional banks, has strength in its balance sheet, represented by growth in both its loans and deposit base. Despite the declining interest rate environment, and unlike most of its peers, the bank was able to expand its net interest spread. Besides offering a dividend yield of 2.5%, the company offers generous shareholder distributions in terms of stock repurchases. With a YTD stock appreciation of 4%, we believe it is attractively valued when compared to most of its peers.
PNC Financial operates as a major regional bank in the U.S. financial sector, and provides diversified financial products, primarily to Pennsylvania, Ohio, New Jersey, Michigan, Illinois, Maryland, Indiana, Kentucky, Florida, Washington D.C., Delaware, Virginia, Missouri, Wisconsin and Georgia. Also, the bank has less than 1% of its assets in the Eurozone. For the purpose of operations, the Pennsylvania-based bank is organized into corporate and institutional banking, retail banking, residential mortgage banking and asset management. The bank has a competitive advantage of having a diversified geographical footprint within the U.S.
2Q2012 Financial Review
The bank reported a fall of 40% in profits when it presented its second quarter performance on July 18, 2012. PNC reported a net income of $546 million, or $0.98 per diluted shares. Earnings for the second quarter were primarily hit by costs attached to mortgage repurchase obligations. EPS, excluding the onetime item, came out to be $1.2. This was against $912 million or $1.67 per diluted share a year ago, and $1.62 when compared sequentially. As opposed to a 2% average positive surprise over the last five quarters, the bank's reported second quarter earnings missed consensus estimates by 2%. PNC also missed its revenues estimates by 1.4% and reported a top line of $3.66 billion, 2% below what it generated in the first quarter of the current year.
Asset Yields, Cost of Funds and Interest Spread
Despite the near zero interest rate environment in the U.S., PNC Financial was able to increase the average yield it earned during the quarter by 10bps, to reach 4.51%, while it also grew average interest generating assets by 5% over the same period. This resulted in a 7.5% increase in net interest income over the previous quarter, with the number now being $2.8 billion.
The bank appears to have benefited from record low interest rates as far as its cost of funds is concerned. The average rate that the bank paid on its interest bearing liabilities dropped to 0.58% from 0.7% in the previous quarter. This resulted in a 12% decrease in the total interest expense of $207 million for the bank.
Both the improvement in the average asset yields, and a decline in the cost of funds, resulted in the expansion of the net interest spread.
The net interest spread that the company earned during the second quarter was 4.08%, showing an improvement of 18bps over the previous quarter. Total net interest income for the bank improved 10% sequentially to $2.526 billion.
Historically, around 40% of the bank's revenues accrued from fee income. However, during the second quarter, the bank's reliance on non-interest income declined to 30% of total revenues. Fee income of $1.54 billion, excluding the bank's mortgage repurchase obligations, improved 4% and 9% when compared to the prior quarter and the prior year, respectively. Consumer and Corporate Services remained the biggest contributors to the bank's fee income during the second quarter.
Balance Sheet Growth
The bank was able to grow its loans to $180 billion, up by 2.3% when compared sequentially, and 20% above the loans balance of the previous year. The growth in loans was primarily driven by growths in commercial and automobile loans, which improved 35% and 95% over the previous year. The bank was also able to moderately improve its deposits base by 50bps to $207 billion, when compared to the prior quarter. Deposits improved by 14% from a year ago.
Liquidity and Capital Position
The liquidity position of the bank, represented by its loans to deposit ratio, remained strong. The loans to deposits ratio for the bank improved 2% over the prior quarter, and reached 87%. The bank's capital position deteriorated when compared to both the prior year and the prior quarter; however, it still remains safely above the Basel 3 regulatory requirement. Tier 1 common capital for the bank remained at 9.3% for the second quarter, as opposed to 14% in the prior quarter and 16.1% a year ago. This is against the 3.5% Basel 3 regulatory requirement. Fifth Third Bancorp (NASDAQ:FITB) and Regions Financial (NYSE:RF), the other two major regional banks, have Tier 1 common capital ratios of 9.77% and 10%, respectively.
Dividends and Stock Repurchase
As an added advantage, the stock offers a dividend yield of 2.5%, safely above the 10-year treasury yield of 1.6%. The company has plans to repurchase its stock worth $250 million during 2012.
The stock, with a P/B value multiple of 0.93x, is attractively priced. When compared to Fifth Third Bancorp and BB&T Corp (NYSE:BBT), the stock is trading at a discount 3% and 23%, respectively.
In conclusion, we believe the bank has a strong balance sheet and attractive valuations. Its ability to expand its interest spread, despite the declining interest rate environment, makes us bullish on the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.