PNC Financial: Margin Squeeze Offset By Dividend Income Potential

Stock Snapshot

With financial media headlines focused on the Fed meeting recently and unchanged rates, I wanted to revisit a bank stock I covered some time ago to do its 3-month review, after its Q3 results.

Since my last coverage of PNC Financial (NYSE:PNC) in mid-September, when I called it a strong buy, the evidence shows that the share price has gone up +17% as of this writing, showing lots of bullishness lately if you look at the chart below.

In today’s update, we will be applying my updated rating methodology using the score matrix.

Scoring Matrix

My 9-point scoring matrix holistically considers multiple angles, with emphasis on cashflow potential for investors and fundamental trends from the key accounting statements such as the balance sheet and income statements, as well as a future outlook on this stock. I personally use this score matrix in picking stocks for my own portfolio, so it has been tested.

Today’s Rating

Based on the score total in the score matrix above, this stock is getting a rating of hold.

This is a downgrade from my prior rating of strong buy.

And to address recent comments in articles, keep in mind that this rating considers all of the factors mentioned holistically, so this stock may be a buy or sell in one of them but a hold in another. I am looking at the overall picture

contrast to the consensus rating on Seeking Alpha, this time around I have to side with the sentiment from SA analysts, and I think the quant system is being a bit too bullish right now.

Dividend Income Growth

This section uses dividend growth data to explores the 10 year dividend income growth for a hypothetical investor owning 100 shares, to carry out whether this stock is a great dividend income opportunity.

The above 10-year dividend growth chart shows my ideal growth trajectory, which is why I traced it.

If my portfolio had bought a hypothetical 100 shares in 2013 at $1.72/share annual dividend ($172 annual income) it would have grown to $5.75/share in 2022 ($575 annual dividend income), for a 234% growth in 10 years.

Should this trend continue, which is yet to be seen, if we extrapolate to 2032 using this growth trend we could get to $1,920 annual dividend income by the end of 2032.

advance, the history shows steady quarterly dividend payouts since 2018 without interruption.

In this category I would call this stock a strong buy, on the basis of +200% proven dividend growth over a decade as well as stable payout history.

Dividend Yield vs Peers

This section uses dividend yield data to contrast the trailing dividend yield vs 3 similar peers in the same sector, to carry out if this stock presents the most competitive dividend yield on capital invested.

Using the above chart, I compared the dividend yield of my focus stock of PNC with three banking peers. I picked them due to all being US-based and having strength in different regions of the US, rather than being global in nature appreciate a JPMorgan Chase (JPM).

In this peer group, Dallas-based Comerica (CMA) won the guide with 5.37% dividend yield, while PNC came in last at 4.17% trailing yield (4.24% forward yield).

I will call it a hold in this case since a +4% yield is not too bad but compared to peers as an investor I can get a better yield for my capital invested elsewhere.

Revenue Growth

This section explores this company’s revenue growth trends over the last year, using data from the income statement.

In this data point we can see in Q3 the revenue dropped to $5.1B vs $5.3B in Sept 2022, a 3.7% YoY reject.

advance, in looking at longer trends, only two of the last 4 quarters had improved revenue vs Sept 2022.

One thing that sticks out in the income statement is that while interest income grew on a YoY basis, so did interest expense, leading to total net interest income declining slightly YoY. For instance, interest expense paid on customer deposits jumped to $1.79B in Q3 vs $340MM in Sept 2022, a 426% YoY enhance.

With the Fed holding its policy rates steady after the Dec 13 meeting, I expect continued margin squeeze at this bank until rates calm down sometime in 2024 if they end up getting cut.

Although notable to cite is there was a drop in non-interest income as well, what stood out in the company’s remarks in their Q3 results also confirmed a squeeze on interest margins:

Net interest margin was 2.71% in the third quarter of 2023, decreasing 8 basis points in comparison with the second quarter of 2023 and 11 basis points compared to the third quarter of 2022. In all comparisons, higher yields on interest-earning assets were more than offset by increased funding costs.

In this category I will call it a sell, on the basis of a modest YoY revenue reject driven largely by squeezing interest margins, an environment I suspect will continue into 2024 as rates should remain elevated until the Fed begins pulling back on them.

Earnings Growth

This section explores this company’s earnings (net income) growth trends over the last year, using data from the income statement.

From this data point we can see that earnings dropped to $1.55B in Q3 vs $1.62B in Sept 2022, a YoY reject of 4.3%.

The longer trend also was lopsided, with only 1 of the last 4 quarters doing better than Sept 2022.

We can also see that total non-interest expenses actually fell on a YoY basis. One notable to cite is the company’s Continuous Improvement Program which aims to achieve a few hundred million in cost savings. However, they will also take a one-time charge in Q4 for personnel reductions:

In this category I will say it’s a sell, on the basis of declines in earnings and no steady longer-term earnings growth trend, however their cost management scheme in place looks to alleviate some of the pressures on the bottom line. This should help make their profitability sustainable as they continue to face pressure on net interest income and interest margins. In fact, they have been profitable for all of the last 10 quarters and have beat earnings estimates in 3 of the last 4 quarters.

Equity Positive Growth

This section explores this company’s equity (book value) growth trends over the last year, using data from the balance sheet.

This data point is certainly better, with equity growing to $49.48B in Q3 vs $46.72B in Sept 2022, a nearly 6% YoY growth.

In considering the longer trend over the last year, each quarter after Dec 2022 has shown subsequent equity growth since then.

In addition, their quarterly presentation indicates their regulatory Basel III CET1 ratio is up to 9.8%, up from 9.3% in 3Q22. This indicates improvement in capital strength.

In this category I will call it a buy, on the basis of improving book value and improving capital ratios.

Share Price vs Moving Average

This section explores the current share price compared to the 200-day simple moving average, to infer if it currently presents a buy, hold, or sell opportunity.

Let’s look at this chart in the context of this week’s Fed meeting, after which many bank stocks leaped through the air it seems. At this point, it appears I missed the autumn price lows and the general bearish price territory of this stock since spring. As of this article writing, the price is +22% above the 200 day simple moving average (SMA).

I would not consider it a great buy at this premium, so the question is whether it is a hold or a sell now?

I will call it a hold, on the basis of proven dividend income growth of +200% in 10 years, growth in positive equity, and being a steadily profitable company. The offsetting factors are weak earnings and revenue growth. Going into 2024 it will continue to benefit on the top-line from high interest rates holding steady, but also pressure on its interest margin as the cost of funding remains high too.

Valuation: Price-to-Earnings

This section uses valuation data to explore the forward P/E ratio and whether it presents an undervalued opportunity.

The forward P/E ratio of 11.02 is around 3.4% above the sector average of 10.65.

Tying this multiple of 11x earnings back to the financials and share price discussed, we can see the spike in share price is driving this multiple and not earnings since earnings declined.

So, I will call it a hold in this category since the multiple is only slightly above its sector average, and earnings are not keeping up with share price which seems to have spiked along with other bank stocks after the Fed meeting. The Fed fever could subside possibly as those headlines go away by next week and we could see that price pull back down again.

Valuation: Price-to-Book Value

This section uses valuation data to explore the forward P/B ratio and whether it presents an undervalued opportunity.

Here we will use the metric available which is the trailing P/B ratio. It shows 1.37, or 17.4% above the sector average.

Tying back to the equity and share price, the share price spike could be driving this multiple however equity has also grown nicely.

In this case I will call this a hold as well, on the basis of this multiple of 1.37x being above average so not a great buy opportunity but also consider that equity /book value has been growing and not just the share price.

Risk Analysis

This section identifies a key risk to consider about this company and what its probability and impact could be to the business.

A risk I want to cite is increasing or decreasing trends in bad credit.

In the above graphic, we can see that on a YoY basis the non-performing loans as well as net loan charge-offs both are on an increasing trend, while delinquencies have come down. Also in the table we see that although the delinquency ratio has come down, the allowance for credit losses has risen slightly to 1.70%.

In the banking sector overall, a recent late-November headline in the industry portal Bankrate read that delinquency rates were at “highest level in almost 30 years.”

They see auto loans as one of the “drivers” (no pun intended) of this issue:

All borrowers must contend with economic factors such as more expensive vehicles and climbing interest rates. But subprime borrowers, with their extra-high interest rates, face the brunt of increased expenses.

The result has been a dramatic enhance in the percentage of subprime borrowers falling at least 60 days past due on their auto loans.

So, going into 2024 knowing that interest rates will most likely continue to be elevated as will be inflation, and so I think for PNC there could continue to be a risk of increasing rates of bad debt on its books, though not a major risk for a large bank appreciate this.

I will call it a hold in this category, as my sentiment here is a mixed one and the evidence supports it.

Quick Summary

To summarize, in this re-rating I am being less bullish and going neutral/hold on this stock. I believe it is not a great buy now due to the skyrocketing share price +20% above the moving average, combined with poor earnings/revenue growth and a below average yield vs peers.

At the same time, it is a successful and profitable regional/national bank in the US and has shown very strong dividend growth trends, and improvement to equity.

The risk of rising trends in bad debt on its books is something to keep an eye on but I think not a huge risk to this bank now and a greater impact seems to be from the squeezing net interest margin.

Also, I would not call it a sell either as it is a bank I would keep in my banks portfolio longer-term for the dividend income, along with a diversified set of global and regional banks too, so still too valuable to sell off in my opinion.