We are maintaining our Neutral recommendation on PNC Financial Services Group Inc. (PNC). Though continued strengthening of its balance sheet, with focus on risk and expense management were impressive, we expect the top line to remain under pressure with continued soft loan demand and low interest rate environment.
In January, PNC Financial announced fourth-quarter 2010 adjusted earnings per share of $1.60, outpacing the Zacks Consensus Estimate of $1.40. Results also compare favorably with adjusted earnings of $1.56 in the prior quarter and 90 cents per share in the prior-year quarter.
A substantial decrease in the provision for credit losses, strong balance sheet and improved credit quality were the key positives during the quarter. However, lower revenues and higher non-interest expenses resulting from a challenging operating environment, were the downside.
At year end 2010, PNC Financial’s economic interest in BlackRock Inc. (BLK) was approximately 20%. BlackRock, one of the largest publicly traded investment management firms in the United States, ended 2010 with $3.6 trillion of assets under management on December 31, 2010. BlackRock’s global reach, specialized and well-regarded financial expertise and commitment to client service would continue to benefit PNC Financial.
With one of the most attractive business mixes in the banking industry, PNC Financial is making strong progress on improving its core profitability coming out of the cycle. We expect the company to perform better than its peer group due to its limited dependence and exposure to the credit environment, as more than half of its revenue is derived from fee businesses.
Since the economic downturn began in the middle of 2007, the company has been profitable in every quarter, except the fourth quarter of 2008, when the conforming provision was utilized for the National City acquisition.
PNC Financial remains focused on expense management. Efficient management has enabled the company to offset continued investments in distribution channels by acquisition cost savings and branch divestitures. PNC Financial succeeded in achieving its acquisition cost savings goal of $1.8 billion on an annualized basis in the fourth quarter of 2010.
Going forward, we expect the company to manage its expenses more efficiently to generate positive operating leverage in a circumstance of slow revenue growth.
On the flip side, PNC Financial’s top line remains under pressure. The company has been experiencing a weak loan demand for the past couple of years, with both commercial and consumer lending businesses witnessing a decline.
Further, the company has been suffering from deteriorating credit quality for the past couple of years. Though credit metrics have stabilized over the past few quarters, volatility in charge-offs continued, and we believe a substantial improvement will take a long time, given the sluggish economic recovery.
The economy is undergoing a slow recovery, with uncertain prospects. This is compounded by changes within the financial services industry and regulatory actions, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was signed into law in July 2010. The Dodd-Frank Act is expected to adversely impact revenues and increase both direct and indirect costs for PNC Financial.
Regulatory issues also remain a headwind to both top and bottom lines. Yet, loan loss provisions are expected to decline. Continued strengthening of balance sheet, with focus on risk and expense management, should propel it ahead. Strategic acquisition of National City also augurs well. With solid capital levels, the company may opt for dividend increases in the upcoming quarters.
PNC Financial currently retains its Zacks #3 Rank, which translates into a short-term Hold rating.
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