The roughly $412 billion asset Pittsburgh-based PNC Financial Services (NYSE:PNC) is absolutely a stock you want in your portfolio. Don't believe me? Then at least listen to Warren Buffett.
After a crazy first quarter of the year in which all banks got hit hard due to the coronavirus pandemic, Buffett disclosed that his company Berkshire Hathaway dumped 84% of its stake in Goldman Sachs (NYSE:GS) and even trimmed its position in JPMorgan Chase (NYSE:JPM) by 3%. PNC was one of the few companies that Berkshire increased its stake in.
The bank has solid fundamentals, and after selling its entire 22% stake in BlackRock (NYSE:BLK), the world's largest asset manager, it is now sitting on a large pile of cash. It could use this cash as an extra buffer if unforeseen loan losses arise, or to make a game changing acquisition that could see PNC leave the coronavirus pandemic a very different company than when it entered.
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Solid fundamentals
In the first quarter of the year, PNC reported net income of $915 million, a 28% drop in profits from the first quarter of 2019. That's actually pretty good for a bank of its size, considering other larger banks saw profit declines in the first quarter that were much larger, or losses in the quarter.
The bank is not immune to the coronavirus. In a presentation, PNC disclosed that about $19.3 billion of its loan portfolio, or about 7% of outstanding loans, are exposed to industries negatively affected by the virus such as restaurants, retail, travel, and hotels, among others. The bank also has about $4.6 billion, or less than 2% of outstanding loans, tied up in the oil and gas industry, which has been on a bumpy ride since the coronavirus sent large chunks of the world into lockdown. But with less than 10% of PNC's loan book exposed to vulnerable industries, it could be worse.
The bank also appears to have really strong liquidity right now. At the end of the first quarter, PNC's common equity tier 1 (CET1) ratio, a measure of a bank's core capital expressed as a percentage of its risk-weighted assets, settled at 9.4%. PNC is only required by regulators to keep this ratio above 7%, and PNC executives said on the company's most recent earnings call that it believes it could maintain its current dividend if an extremely adverse economic scenario were to occur and the bank's CET1 ratio dropped to 8.5% .
Additionally, the sale of its BlackRock stake will build the bank's CET1 ratio even higher. S&P Global reports that analysts are estimating that the sale will build the bank's CET1 ratio to 11%, with the potential to go as high as 11.6%. That should safeguard the company against any unexpected loan losses that could arise this year, and protect the dividend.
One other thing to mention is that PNC seems to be making good progress in its expense reduction initiatives. The bank dropped its efficiency ratio from 60% in the first and last quarters of 2019 to 56% in the first quarter of 2020. The efficiency ratio is a measure of a bank's expenses as a percentage of its total revenue, so lower is better because it shows the bank is spending less to generate revenue .
I think expense reduction should continue for the bank as well. Recently, PNC applied with regulators to close nearly 30 branches. The bank also said it expects to increase branch closures to 80 to 100 per year for the next five years. There might be some debate over the role that branches will play in the future of banking, but eliminating that many branches will undoubtedly reduce expenses.
The possibility of a huge deal
While the sale of its BlackRock stake does provide more cushion should PNC start experiencing unexpected loan losses, the main reason for the sale was to position PNC for a big acquisition while banks are trading at lower valuations. PNC CEO and Chairman William Demchak has publicly said that ideally PNC would look to acquire another bank that drives the company's overall strategy of becoming a national player in both retail banking and commercial and industrial (C&I) loans.
In 2008, during the Great Recession, PNC acquired National City Corp. for $7 billion less than National City's tangible book value, according to The Wall Street Journal . The acquisition at the time took PNC from an $140 billion asset bank to roughly $260 billion in assets after the transaction was complete.
Since that time, the National City deal has been viewed as a success, and Demchak has said he would like to emulate it. Another big deal will separate PNC from the regional banking cluster -- even though it is already toward the larger end -- and make it more like the JPMorgan Chases and Wells Fargos of the world, which presents a huge opportunity for the stock long term.
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