How Profitable Is PNC Financial?

Earlier this week, I took a look at where PNC Financial (PNC 2.98%) gets its money, but revenue is only part of the story. It is more important to take a look at what is spent in the form of expenses to make that money, and how much money eventually makes its way to investors.

In this article, I will do just that, exploring some of the larger costs associated with running a bank of PNC's size. I will also take a look at one area where PNC has been able to improve dramatically over the past few years, as well as compare PNC to some of its competitors in one very important banking metric.

To the numbers!
As I mentioned in my previous article, PNC Financial breaks its business into six segments, and these six segments earned $14.9 billion in revenue during 2012. However, after all the costs associated with running the business, these segments earned nearly $3.4 billion, with one segment ending with a loss:

Source: Company 10-K. 

It is not all that surprising that PNC's largest expense last year was the nearly $4.6 billion it spent for personnel. The bank had over 56,000 employees at the end of last year, including nearly 28,000 in the Retail Banking business alone. Unless it chooses to close some of its 2,900 branches, this is an expense that will probably remain a large portion of its business going forward, but it should also be seen as one of the costs of being one of the largest regional banks out there.

Another expense that tends to be high at banks, especially since the 2008 banking crisis, is the provision for credit losses. This is money set aside by banks that gives them some leeway should some loans go bad and they have to write off the the loan. This is one area where PNC shines. Since reporting $3.9 billion in this expense in 2009, PNC has been able manage its loan portfolio, as well as benefit from improving economic conditions, and reduce this cost to $987 million in 2012. In essence, this has freed up nearly $3 billion in income over the past four year, further strengthening the bank's bottom line.

A bank's efficiency is important
One important and often overlooked metric that we can examine with banks is its efficiency ratio. This ratio, which is calculated by dividing noninterest expense by net operating revenue excluding loan loss provisions, is a measure of how much it costs for a bank to produce every dollar of revenue. With this metric, we want to see a lower percentage, which means it "costs" less to earn each dollar at the bank.

Source: Company Annual Filings. *Includes other revenue earned outside of primary business segments.

PNC Financial is one of the larger banks out there, making it difficult to find other banks to compare it to. Nevertheless, the average efficiency rating for banks of PNC's size is just over 64%, indicating that PNC has some work to do to get on their level. U.S. Bancorp truly is the model of efficiency, especially given its size, which is one of the reasons it is one of Warren Buffett's favorite banks. Bank of New York Mellon has a slightly different business model than other banks, mainly working as an intermediary between other financial institutions, and doesn't have the consumer banking revenue to compete with other banks.

The bottom line
The more I dig into PNC Financial, the more that I think it could be one of the best banks out there. It's not that far away from being as efficient as its peers, and its dwindling provision for credit losses tells me that it is fairly conservative with a lot of the loans that it writes. Hopefully, it will be able to continue to increase its revenue without adding too many new employees over the next few years, which in turn would improve its efficiency ratio.