Multiple Acquisitions, But Where is the Growth?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In my local area, the bank PNC Financial Services (NYSE: PNC) is known more for taking over local institutions than for exceptional service or anything else. Specifically, the bank took over Mercantile in 2007, Sterling Financial in 2008, National City 2008, and recently RBC Bank in 2012. With this number of acquisitions, you would expect the company's growth to be speeding up based on additional synergies and cross sell opportunities. However, looking at the company's most recent earnings report this doesn't appear to be the case.
In fact, PNC turned in a relatively uninspiring quarter. Total revenue increased just 1% and EPS was up 4.19%. This is a quarter where on the surface it appears the bank did grow. However, in almost every line item that showed growth, the RBC Bank acquisition was specifically mentioned as the primary reason. In this environment, what investors should be looking for is a bank that can grow organically. After all, if the bank cannot grow organically, the company would have to constantly be on a buying spree to make its numbers.
On the deposit side of the house, the company showed retail deposits up 7.3%, and corporate and institutional banking deposits up 25.79%. In each case the primary driver was RBC Bank. In addition, while other banks and financial institutions have seen both checking and other deposits increase, PNC saw checking account deposits increase, while other deposits were down 9%. The bank explained that it was allowing acquired (higher interest rate) savings and CDs to run off. The challenge for any bank that allows runoff of prior customer dollars is, that these customers may choose to move their whole relationship instead of just their savings. I've seen this play out with other banks in the past, where they attempt to reprice older CDs and in doing so alienate the customer to the point where they switch banks altogether. Just for point of comparison, a local competitor to PNC is BB&T Bank (NYSE: BBT). In the most recent quarter, BB&T showed overall deposit growth of 17.7%. While their corporate and institutional deposits did not grow as quickly, the bank also did not have a large acquisition during the same timeframe. This is the best direct example of one bank growing organically, and the other bank growing by acquisition. Even a bank like Wells Fargo (NYSE: WFC), that does not have as much brand equity in its eastern markets as PNC, showed 8% overall deposit growth. Looking at the lending side of the bank, we see again that RBC was the primary contributing factor to results.
PNC reported retail banking loans up 11.23%, “primarily the result of a full quarter home equity and commercial loans from RBC.” Also adding to the balance sheet, commercial lending increased 28%, which contributed to total loans being up 20%. Probably the most impressive number that PNC reported was the company's net interest margin of 4.08%. This was primarily driven by the additional loans from RBC, and the runoff in the other deposits category, which is more expensive funding. While it doesn't sound like a huge difference, PNC's interest margin beats both BB&T at 3.95%, and Wells Fargo at 3.91%. A second impressive factor in PNC's results was the company's residential mortgage performance.
With mortgage lending income up 12.77%, and originations up 38.46%, there isn't another bank that I've seen that can match these two numbers. Using two local competitors from my area again, BB&T showed an increase of 20.8%, while Wells Fargo showed an increase in originations of just 1.55%. The bad news for investors is, PNC expects both Fannie Mae and Freddie Mac to require substantial residential mortgage repurchases. PNC set aside $438 million to cover these future expected repurchases. This charge contributed toward the decrease in non-interest income of 24% year-over-year. While the mortgage division has a dark cloud hanging over it, a place where the clouds seem to be lifting is the bank's credit quality measures.
PNC stated that nonperforming loans versus total loans equaled 1.92%. This compares favorably with some of their other competitors such as Wells Fargo, reporting non-performers at over 3%, however, cannot match BB&T with just 1.5% non-performing loans. Problem loans decreased 10.65% year-over-year, and the bank currently has a 120% coverage ratio with their provision for loan losses. With decent credit quality comes less chance of charge-offs in the future, which is critical to the bank's ability to grow earnings going forward. The challenge for investors will be to determine if PNC can grow organically or if further acquisitions will be required.
With respect to PNC as an investment, the stock sells for a forward P/E ratio of 10.27, but is expected to grow earnings at just 6.25% in the next few years. While the company's yield of 2.6% is okay, the overall numbers don't look that great. BB&T by comparison, is selling for a just slightly higher P/E ratio, but is expected to grow earnings at more than double the rate of PNC. When you consider that the bank pays a dividend yield of 2.5%, it seems BB&T would be the better choice. Wells Fargo sells for a forward P/E ratio of just over 10, and is expected to grow earnings at about 10%. This is yet another bank paying a similar yield, with better growth expectations. While it's true that both BB&T and Wells Fargo have done acquisitions of their own, the difference appears to be that once these acquisitions are finalized, both of PNC's competitors seem to be able to keep the growth going. Until PNC can show consistent organic growth, it seems investors would be better served to consider either BB&T or Wells Fargo as an alternative.
MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of PNC Financial Services and Wells Fargo & Company and has the following options: short APR 2012 $21.00 puts on Wells Fargo & Company, short APR 2012 $29.00 calls on Wells Fargo & Company, short OCT 2012 $33.00 puts on Wells Fargo & Company, and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
