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Morningstar | PNC Posted Slightly Worse than Expected Quarter, Thesis Maintained. See Updated Analyst Note from 16 Jan 2019

No-moat-rated PNC posted reasonable 2018 results, and we are maintaining our overall thesis for the company. After updating our model to adjust the asset side of PNC’s balance sheet to reflect our updated yield curve assumptions and updating the liability side of the balance sheet to show a higher proportion of interest-bearing deposits, we are maintaining our fair value estimate of $134.

PNC posted diluted EPS of $10.71, which missed our EPS estimate by about 1.2%, but we think that the core banking business remains sound. The slight miss is attributable to somewhat less interest income than we anticipated. PNC’s lackluster loan growth led to a smaller earning asset base which prevented the bank from meeting our expectations, though this miss was partially offset by the bank beating our expectations on the yields for earning assets. Looking forward, we see the earning asset yield expanding relatively in line with the yield on liabilities, which would lead to a reasonably stable net interest margin.

Overall, we cannot fault PNC for a slight lack of loan growth. We continue to think that poor underwriting is one of the primary risks that bank equity-holders face and that banks generally should not sacrifice credit quality to achieve asset growth. We think that the prudent underwriters will reap rewards when the credit cycle eventually deteriorates, and we are encouraged by PNC’s credit history and increased provisioning for loan losses. We thought that PNC’s CEO, William Demchak, did well to recognize that credit costs “just can’t stay... that low forever,” which reassured us that the lending standards had not been loosened. We agree with the sentiment that credit costs will eventually increase, and we are forecasting credit normalizing at slightly higher than precrisis levels in our terminal year.

PNC’s asset management arm faced a tough quarter due to the combined effect of the poor fourth-quarter equity market returns and because they faced a $10 million pass-through restructuring charge from their equity position in BlackRock. While we do anticipate a tougher environment for asset managers going forward, BlackRock remains one of only two wide-moat rated asset managers under our coverage, and the only one where we are even expecting some margin expansion. Overall, we do not think that the headwinds within asset management fundamentally impair PNC’s business, and we still expect modest fee growth over the medium term.

For our recent analysis of deposit costs and net interest margins, please see our December 2018 Financial Services Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point."