We are downgrading our recommendation on PNC Financial Services Group Inc. (PNC) to Neutral on concerns of weak loan demand in the near term.
PNC Financial has been experiencing a weak loan demand for the past couple of years. Commercial lending consists of 53% of the company’s loan portfolio while consumer lending covers the rest. Both businesses have witnessed a decline but commercial lending has suffered more. Though this trend eased somewhat at the end of 2009, given lower utilization levels for commercial lending among middle market and large corporate clients, we expect a weak loan demand and low utilization rates until the economy improves. 

PNC Financial, already one of the leading bank wealth managers in the country, strengthened its position through the acquisition of National City in December 2008 and created significant growth potential in new high-net-worth and institutional markets. The acquisition has led to an increase in deposit base besides providing a larger distribution platform for cross-selling the company’s products and services. 

The integration of National City is on track and has been accretive to earnings. Cost savings from the acquisition have been more than expected, and management expects further growth by expanding into new territories.
PNC Financial stands solid from the balance sheet perspective, with capital ratios exceeding the minimum required levels. The loan to deposit ratio of 84% as of Dec 31, 2009 testifies to a strong bank liquidity. Given the uncertain economic environment, management declared a dividend reduction during March 2009. The reduction added $766 million in 2009 and is expected to add approximately $1 billion in 2010 on an annualized basis to the company’s capital, further strengthening its capital ratios. 

PNC Financial has been suffering from a deteriorating credit quality for the past couple of years. Increasing nonperforming assets, net charge-offs and provision for credit losses have restricted earnings. Though credit metrics have stabilized over the past few quarters, we believe an improvement here will take longer, given the sluggish economic recovery.
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