After reviewing the attached report for PNC Bank, write your conclusions for the report, be as detailed as you can based on the information provided.
3-4 pages
PNC_Strategy_Analysis_Draft_New.pdf
PITTSBURGH NATIONAL
CORPORATION BANK STRATEGY
ANALYSIS
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FIN-6246 Financial Markets and Institutions Project
Contents Bank Strategy Analysis ……………………………………………………………. Error! Bookmark not defined.
Company Overview ………………………………………………………………… Error! Bookmark not defined.
Competitive Overview …………………………………………………………….. Error! Bookmark not defined.
Growth Drivers ………………………………………………………………………. Error! Bookmark not defined.
Metric Analysis ………………………………………………………………………. Error! Bookmark not defined.
Analysis of Key Components ……………………………………………………. Error! Bookmark not defined.
Non-Interest Income ………………………………………………………………. Error! Bookmark not defined.
Loan Portfolio and Deposit Mix ………………………………………………… Error! Bookmark not defined.
Historical Trends ……………………………………………………………………. Error! Bookmark not defined.
Competitor Comparison ………………………………………………………….. Error! Bookmark not defined.
Financial Performance 2023 …………………………………………………….. Error! Bookmark not defined.
Stock Valuation ……………………………………………………………………… Error! Bookmark not defined.
Return on Equity ……………………………………………………………………. Error! Bookmark not defined.
Return on Assets ……………………………………………………………………. Error! Bookmark not defined.
Profit Margin Ratio …………………………………………………………………. Error! Bookmark not defined.
Liquidity Coverage Ratio …………………………………………………………. Error! Bookmark not defined.
Leverage Ratio ……………………………………………………………………….. Error! Bookmark not defined.
Common Equity Tier 1 (CET1) Ratio ………………………………………….. Error! Bookmark not defined.
Risk and Return ……………………………………………………………………… Error! Bookmark not defined.
Interest Rate Risk Profile …………………………………………………………. Error! Bookmark not defined.
Credit Risk Profile …………………………………………………………………… Error! Bookmark not defined.
Liquidity Risk Profile ……………………………………………………………….. Error! Bookmark not defined.
Insolvency Risk Profile …………………………………………………………….. Error! Bookmark not defined.
Market Risk Profile …………………………………………………………………. Error! Bookmark not defined.
Risk Management Strategy ……………………………………………………… Error! Bookmark not defined.
Risk Management Strategy ……………………………………………………… Error! Bookmark not defined.
Risk Mitigation techniques ………………………………………………………. Error! Bookmark not defined.
Current Position and Future Outlook ………………………………………… Error! Bookmark not defined.
Management and Governance …………………………………………………. Error! Bookmark not defined.
Ownership and Control …………………………………………………………… Error! Bookmark not defined.
Corporate Governance ……………………………………………………………. Error! Bookmark not defined.
Interaction with the Markets …………………………………………………… Error! Bookmark not defined.
Conclusion ……………………………………………………………………………. Error! Bookmark not defined.
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Overview I. Bank Strategy Analysis Process
Assessing the fundamental drivers of a bank’s growth and value involves an in-depth evaluation of a bank’s business model and financial performance with emphasis on the balance sheet and income statement, as these key reports depict a financial representation of a bank executing its business. This strategy analysis of Pittsburgh National Corporation (PNC) Bank, herein referred to as “the Bank” includes:
(1) An analysis of the Bank’s risk profile that includes an assessment of the Bank’s compliance with regulatory requirements, as well as a consideration of the composition of the balance sheet for certain asset/liability classes and an identification of their unique characteristics and associated risks,
(2) Understanding the management and governance, and (3) An evaluation of the Bank’s financial performance and standing relative to its past
performance and peer group in terms of certain key financial metrics and ratios, and stock performance
II. Summary The balance sheet illustrates the economic quantification of the execution of the various lines of business within the Bank. PNC is the sixth largest deposit base in the United States and operates in both physical locations and online with a national bank charter and footprint. It operates three primary lines of business: Retail Banking, Corporate & Institutional Banking, and the Asset Management Group. Though not a line of business, the Bank’s Capital Markets and Treasury departments enter into: (i) purchase and sale transactions on behalf of the business lines; and (ii) hedging and other balance sheet management transactions to manage and mitigate risk (e.g., interest rate risk, price (market) risk, and liquidity risk).
The Bank is heavily engaged in both commercial and mortgage banking activities and generates a significant portion of its deposits from customers both online and through its expansive branch network. While core-deposits are a relatively stable source of funding, PNC’s business model results in unique inherent and residual risks associated with the Bank’s core business activities, principally related to credit, interest rate, liquidity, and price risk.
The primary credit risk associated with both commercial and mortgage lending is that a borrower or counterparty will be unable to repay their loan. From an interest rate risk perspective, the economically sensitive nature of bank lending activities may generate volatility in earnings, as both production volume and margins vary significantly with interest rates. Mortgage assets contain a certain portion of prepayment risk, which is due to the borrower’s option (right) to prepay a loan. This creates volatility in the duration of these assets. Additionally, retail depositors acquired through the internet tend to be more sensitive to changes in interest rates, thus making them more difficult to both attract and retain. The cyclical nature of mortgage banking can cause certain assets like Held-For-Sale (HFS) loans to experience large swings in volume. Additionally, the need to fund these assets with short-term wholesale liabilities draws on the Bank’s available liquidity. The credit quality of the loan portfolio overall will further impact the Bank’s asset-based liquidity sources, as well as the capacity for other
sources of funding. Finally, mortgage servicing rights (MSR) and certain securities are highly sensitive to changes in interest rates and are a significant source of price risk.
Managing the balance sheet of a financial institution is a complex and dynamic process as strategies change based on current rate and market environments. Through both the established Asset and Liability Committee and the Board of Directors and its Risk Committee, PNC’s Management bears the responsibility of overseeing the risks of the Bank’s balance sheet and ensuring that the Bank complies with all regulatory requirements regarding the balance sheet composition and capital ratios. A key measure of how effective Management is at managing the balance sheet to generate earnings for the Bank is the net interest margin (NIM). The ability to optimize the distribution of a bank’s balance sheet and adapt it to address the current context’s challenges or liquidity needs is based on a need to preserve improve the NIM. The challenges associated with preserving and protecting the NIM from a strategic perspective include a combination of factors: varying maturities/duration, variable vs fixed interest rate products, (the pace of) movements in interest rates, loan portfolio performance, trends in economic cycles, and more.
III. Risk Profile As the primary regulator of federally chartered banks, the Office of the Comptroller of Currency (OCC) has the responsibility for evaluating the overall or consolidated risk profile of such banks . PNC Bank evaluates its risk exposures according to the OCC’s defined eight categories of risk for bank supervision purposes: credit, interest rate, liquidity, market, operational, compliance, strategic, and reputation. This assessment focuses primarily on compliance risk as it relates to regulatory capital adequacy requirements, and the financial categories of credit risk, interest rate risk, liquidity and insolvency risk, and market risk. Assessing operational risk is not the primary focus of this risk profile analysis and is therefore only addressed when it is a material component of a balance sheet item.
Compliance Risk Mortgage lending is subject to numerous consumer protection and fair lending laws and regulations, which have undergone extensive changes following the financial crisis in 2008. Compliance with those federal consumer financial laws is regulated by the Consumer Financial Protection Bureau (CFPB), and while they have a significant aggregate impact on mortgage banking operations, are not considered in this risk profile assessment.
As PNC Bank is chartered as a national bank, Basel III reforms establish the minimum capital ratios that must be maintained to support the safety of the institution and its customers. The table below illustrates both the regulatory minimum capital ratio requirements of an institution to be considered “well capitalized”, as well as PNC Bank’s results corresponding to each capital ratio over the last five quarters.
PNC Bank has consistently surpassed the minimum capital requirements and was considered “well capitalized” over the last five quarters. Moreover, federal banking regulators stated that they expect PNC Bank to have a capital buffer sufficient to withstand losses and allow them to meet certain needs of their customers through estimated stress scenarios. By maintaining their capital ratios above the regulatory requirement, the Bank represents its commitment to managing capital in a manner consistent with and aligned to their provided regulatory principles.
Credit Risk Credit risk arises due to client defaults within any of the credit portfolios and can be exacerbated by high concentrations within those portfolios relating to industry, geographic region, product type, etc. PNC Bank mitigates its credit risk through its quality of loan underwriting, diligent portfolio management, and effective administration over its entire lending lice cycle. The Bank has a history of conservative underwriting, reaffirmed by the results of annual capital stress testing exercises and performance of these loans during economic downturns. Successful mitigation tactics demonstrate a positive correlation with the Bank’s ability to sustain itself from deterioration to its loan portfolio through downturns in the economic cycle and the negative impact on its client base.
Loan Portfolio
The Bank’s loan portfolio consists of two segments – Commercial and Consumer. Each of these segments comprises multiple asset classes which are characterized by similarities in risk attributes and the manner in which the Bank monitors and assesses credit risk. The table below outlines the asset classes categorized within each segment.
Commercial Consumer Commercial and industrial Residential real estate
Commercial real estate Home equity Equipment lease financing Automobile
Credit card Education Other consumer
The Bank uses several indicators in monitoring the economic conditions and loan performance trends to manage exposures within its loan portfolio. Most notably, it uses credit quality indicators and trends in delinquency rates, nonperforming status, probability of default (PD) and loss given default (LGD) ratings, updated credit scores, and originated and updated loan-to-value (LTV) ratios To mitigate losses and enhance customer support, the Bank’s credit activities are continuously refined to meet needs
associated with the changing environment and, when deemed necessary, loan modification and collection programs are offered to its customers for assistance.
The table below presents an analysis of PNC Bank’s loan portfolio as of 2023 year-end, including a breakout of days past due and nonperforming loans relative to each segment and asset class. The table includes a historical analysis component which assesses 2023 year-end performance to that of the prior quarter, and prior year-end. The Bank considers loans past due to be those that have not received payment within 30 days, and considers nonperforming loans to be those which have experienced credit quality deterioration to the extent that full collection of the contractual principal and interest is not probable.
On the consumer side, the Bank is involved in originating residential mortgage loans nationwide for its balance sheet and for sale into the secondary market and expands its credit portfolio by offering products such as home equity lines of credit (HELOCs), auto loans, and student lending. The Bank also purchases residential mortgage loans for its balance sheet and, depending on market conditions, may securitize loans originated or acquired. The Bank services the majority of those residential mortgage loans that it holds on its balance sheet and acquires mortgage servicing rights .While the diversification in the consumer credit portfolio may present a certain degree of risk mitigation, due to the optionality embedded in mortgage lending products, the majority of the loan portfolio has some exposure to the broader real estate market.
PNC Bank actively manages its consumer credit portfolio by tracking borrower performance and segmenting the portfolio based upon loan delinquency, nonperforming status, modification and bankruptcy status, FICO scores, LTV, lien position, and geographic concentration.
On the commercial side, the Bank is heavily involved in originating commercial and industrial loans nationwide for its balance sheet. As of 2023 year-end, commercial and industrial loans comprised 55% of the Bank’s total loan portfolio. The majority of the Bank’s commercial and industrial loans are secured by collateral that serves to provide a secondary source of repayment should a borrower experience a cash generation difficulty. PNC Bank actively manages its commercial and industrial loans to assess any changes (both positive and negative) in the level of credit risk at both the borrower and portfolio level. To evaluate the level of credit risk, the Bank assigns internal risk ratings reflecting its estimates of the borrower’s PD and LGD for
each related credit facility, and monitors concentrations of credit risk pertaining to both specific industries and geographies that may exist in the portfolio. While total nonperforming loans increased $57MM and $195MM QoQ and YoY, respectively, the increase in total nonperforming loans was attributed to the Bank’s commercial credit portfolio. Nonperforming loans in the Bank’s commercial credit portfolio increased $96MM QoQ and $449MM YoY, while nonperforming loans in the Bank’s consumer credit portfolio decreased $39MM QoQ and $254MM YoY. Moreover, as of 2023 year-end, approximately 97% of total nonperforming loans were secured by collateral. The Bank maintains an allowance for credit losses (ACL) to absorb expected losses in its credit portfolios. The table below presents PNC Bank’s ACL as a % of total assets for 2023 year-end, the prior quarter, and prior year-end.
PNC Bank’s allowance for credit losses as a percent of total assets is relatively small, representing only 85 basis points of total assets as of 2023 year-end, and has remained relatively both QoQ and YoY. The Bank’s small reserve for absorbing losses across its credit portfolios reaffirms the positive impacts its quality of loan underwriting, diligent portfolio management, and effective administration of credit risk management and monitoring activities have in its lending business activities.
Interest Rate Risk Interest rate risk results primarily from traditional banking activities of gathering deposits and extending loans. PNC Bank has moderate amounts of interest rate risk prevalent in its loan portfolio. Periods of increasing interest rates can reduce home buyers’ willingness or ability to finance a real estate loan and therefore can adversely affect the volume of loan originations and can negatively affect the Bank’s profitability. Rising interest rates, however, and the accompanying lower prepayments can increase servicing income and the value of the MSR portfolio. The table below shows PNC Bank’s MSR portfolio, as well as MSR as a % of total assets for 2023 year-end, the prior quarter, and prior year-end.
As of 2023 Q4, the Bank’s MSR portfolio totaled approximately $3.7 billion, a $263MM increase YoY, offset by a $320MM decrease QoQ. MSR exhibits negative convexity, as the value of the asset does not move in a linear relationship with interest rates. When rates rise, MSR values do not increase as much as they decline when rates fall (asymmetrical effect). Decreasing interest rates, by contrast, normally result in faster loan prepayments, which can reduce projected interest income from the lending portfolio. When interest rates fall and prepayment speeds increase, MSR values will also decline. The effect of
changes in interest rates on the fair value and market price of MSR depends on both the severity of rate movements and the asymmetrical nature of MSR value changes. Falling interest rates and mortgage refinancing can also subject the Bank to premium recapture. The Bank may have to forfeit premiums received from the sale of loans that refinance within a defined period.
In addition to its MSR portfolio, real estate loans and lines of credit expose PNC Bank to interest rate risk because they can be written on a fixed-rate basis, variable-rate basis, or a combination of the two, in which either the rate is fixed for a period and then becomes variable, or the rate is variable and then becomes fixed. In times of rising interest rates, interest income on loans made on a fixed-rate basis may fall below the Bank’s cost of funds. With variable rates, using different indexes for loans than for the cost of funds can increase exposure to interest rate risk. All of these scenarios should be adequately identified and addressed in the Bank’s primary processes and tools for managing interest rate risk.
On the liability side, the Bank’s composition of deposits illustrates a larger concentration in higher priced, interest-bearing (IB) deposits, relative to its non-interest-bearing (NIB) deposit accounts. When rates are higher, customers tend to shift deposits from NIB accounts to IB accounts, thereby negatively impacting net interest income. PNC Bank has acknowledged its need to increase its deposit rates in order to remain competitive, despite the negative impact to net interest income that effort has. Deposits are a low-cost source of funds for PNC Bank and, therefore, losing deposits could increase the Bank’s funding costs, further reducing its net interest income. The charts below depict PNC Bank’s deposit mix between interest-bearing and non-interest-bearing as of 2023 year-end, the prior quarter, and prior year-end.
The Bank has experienced a deposit mix shift from IB to NIB, with a 1% and 6% increase of its total deposits shifting to IB accounts QoQ and YoY, respectively. The deposit mix shift has been largely driven by the Bank’s commercial deposits, which comprised 48% of its total deposits as of 2023 year-end. While the Bank’s rate paid on interest-bearing deposits has increased to an average rate paid of 2.48% as of 2023 year-end, the Bank anticipates declining its rate paid with future rate cuts.
PNC Bank utilizes derivative contracts to mitigate certain forms of interest rate risk. A derivative is an instrument or contract whose cash flow or value is derived by the fluctuation or performance of its
underlying. An underlying can be an interest rate, index, or asset. The Bank uses derivatives to offset risks associated with a position or activity with a counterbalancing instrument. Risks are mitigated through the use of derivatives (e.g., cash flow hedges) to hedge an exposure to either overall changes in the cash flows associated with a recognized asset or liability or of a forecasted transaction, or changes in the cash flows attributable to a particular risk of a qualified hedge item. The Bank primarily uses interest rate derivatives to hedge floating rate commercial loans and fixed rate debt. As of 2023 year-end, PNC Bank has $33.3 billion in receive fix / pay float swaps, with a weighted average duration of 2.3 years and an average fixed rate of 2.1%.
A rising rate environment in conjunction with a continued flattening of the yield curve presents the potential for heightened interest rate risk; the risk to earnings (net interest income) or capital (equity). Changes in interest rates also affect the Bank’s underlying economic value – the value of the Bank’s assets, liabilities, and interest-rate-related, off-balance-sheet contracts is affected by a change in rates by way of the present value of future cash flows. The nature and mix of the Bank’s business lines and interest rate risk characteristics of its activities dictates the type of quantitative measures of interest rate risk used by the Bank. PNC Bank utilizes sensitivities of net interest income (NII) forecasts, and economic value of equity (EVE) to identify and measure short-term and long-term structural interest rate risks .The Bank’s Asset and Liability Management group centrally manages interest rate risk prescribed by its internal, risk-related management policies.
Liquidity and Insolvency Risk Traditionally speaking, banks can be perceived as inherently fragile due to the term mismatch between short-term liabilities (in the form of non-maturity deposits) and longer-term, illiquid assets (including loans). This term mismatch exposes banks to runs on deposits, which puts them at increased risk of insolvency. Liquidity risk involves the inability to access funding sources or manage fluctuations in funding levels. Banks with large mismatches between liability maturities and asset maturities have greater earnings exposure to changes in interest rates. Changes in market conditions are often unpredictable and sometimes severe. These changes can make it difficult for banks to secure funds, retain additional funding, and manage the maturity of their funding structure.
From a purely mortgage banking perspective, the degree of liquidity risk is affected by a variety of factors, including whether portfolio production is underwritten to secondary market standards and the ability to fund commitments to borrowers. PNC Bank originates and acquires mortgages with the intention of maintaining a vast majority of these loans in the held for investment (HFI) portfolio. Contingent liquidity needs, however, may require the Bank to sell some of these loans in the secondary market. Credit and operational risk management weaknesses can cause liquidity problems if the Bank fails to underwrite or service loans in accordance with investors or insurers’ requirements. If the mortgages considered for sale are not underwritten in compliance with investor guidelines, like those of Fannie Mae, Freddie Mac, or private investors, the Bank may be unable to sell mortgage inventory or servicing rights at an acceptable price. Additionally, the investor may require the Bank to indemnify or repurchase loans that were inappropriately underwritten or serviced. As a servicer of mortgages, the Bank could face increased liquidity risk from elevated levels of defaulted loans that require continued remittance of principal and interest to investors during the liquidation process of properties where the loan has gone into default. Failure to appropriately manage the liquidation process can result in delayed or denied reimbursement from the insuring agency.
Liquidity risk is present on both sides of the Bank’s balance sheet. On the asset side, liquidity risk resides in the ability and time for the Bank to convert an asset to cash without a discount, and on the liability side, it arises from the ability to fund the Bank in support of its operations and lending activities.
The Bank’s ability to grow depends on its ability to generate deposits, which can be deployed to fund additional loan growth. Developing and sourcing an inflow of new customer deposits that provide a reasonable source of cost of funds is key to any bank’s sustainability. In addition to customer deposits, other sources of liquidity at PNC Bank include investments in its securities portfolio, the ability to sell or securitize loans in secondary markets, and to pledge loans to access secured borrowing facilities through the Federal Home Loan Bank (FHLB).
Generally, when loans-to-deposits (LTD) ratios exceed 100%, this becomes a potential indicator of unbalanced growth. A LTD ratio of 100% means that a bank loaned one dollar to customers for every dollar it received in core deposits. When a LTD ratio exceeds 100%, this indicates that the bank has a loan book greater than its deposit base and is overextending themselves. Banks with LTD ratios above 100% are more likely to be risky along many dimensions besides liquidity risk. Conversely, banks with low LTD ratios may have lower interest income, resulting in lower earnings due to foregone opportunity in not utilizing deposits to earn revenue. The table below shows PNC Bank’s LTD ratio for 2023 year-end, the prior quarter, and prior year-end.
PNC Bank’s LTD ratio was 76% as of 2023 year-end, up 1% QoQ and YoY. With a LTD ratio of 76%, the Bank is maintaining a healthy balance of maintaining its lending activity compared to its deposit base.
Deposits are an important low-cost source of funding for PNC Bank and affect both net interest income and the net interest margin. The table below includes details of the Bank’s funding sources for 2023 and 2022 year-ends.
Deposits for PNC Bank include interest-bearing and noninterest-bearing demand deposits and transaction accounts, as well as other non-transaction accounts such as savings and money-market accounts and time deposits. PNC’s deposit base comprised 85% of its total funding sources as of 2023 year-end – down 3% YoY, reflecting the impact of competitive pricing dynamics and inflationary pressures. While the Bank’s funding sources include brokered deposits and borrowed funds (primarily from the FHLB) to support growth in the loan portfolio, manage volatility in certain asset categories, and help manage interest rate risk, the Bank is mature and not heavily dependent on these external sources for its funding. PNC Bank is predominantly funded by core deposits, which provide a relatively stable, low-cost source of funding.
As part of its liquidity risk management ac
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