Last week, the Federal Reserve released the first part of the annual banking stress tests results, which examined the impact of a severe economic downturn on the largest U.S. banks. While almost every bank showed improvement year over year, PNC Financial Services (NYSE:PNC) posted especially encouraging results. The results highlighted the strength and sustainability of PNC's balance sheet and loan portfolio.
How it fared last week
Despite posting a lower actual Tier 1 common ratio in Q3 in 2012 compared to 2011 because of its acquisition of RBC Bank, PNC posted an impressive minimum Tier 1 common ratio of 8.7% under the severely adverse scenario. During the previous year's tests, PNC's minimum Tier 1 common in the doom-and-gloom scenario was 6.6%. Regardless of some investors clamoring about the ease of the tests this year, it is hard to deny the improvements PNC has made to its balance sheet and business prospects.
These strong results have driven investors to tune into the Comprehensive Capital Analysis and Review results, which will be released on Thursday afternoon. Within this release from the Fed, investors will know if the participating banks sought and received approval for any increases in dividends or share buyback programs. Investors will also get to see the impact of any new capital plans on stressed ratios.
Should PNC request another bump?
Last year, PNC asked and received approval for an increase in its quarterly dividend payment, and later, it bumped its quarterly dividend up by roughly 14%. Additionally, the Fed did not reject the company's proposal for a modest share repurchase program. PNC ultimately purchased $190 million of common stock in 2012 under a $250 million authorization. Given the substantial improvement of its balance sheet under a stressed scenario, PNC seems to have ample leverage in negotiating any additional actions to return more cash to shareholders.
While it seems that PNC is strong enough to request a substantial increase in dividend, I believe investors may want to temper their expectations. The Fed has explicitly said that dividend payout ratios above 30% will receive "particularly close scrutiny." PNC's current dividend payout ratio is hovering around the 30% level. If the Fed and the bank cannot agree on a substantial dividend increase, PNC may request additional share buybacks, an action that could be scaled back and would receive much less scrutiny than cutting a dividend. Therefore, I expect PNC to ask and receive approval for a slight dividend increase, as well as a share buyback program.