As the banking world changes all around us, banks are having to shift the way they make money -- yet to investors' potential delight, one has been proactive in responding to this change.
Fundamentally, banks are pretty simple: They pay interest to depositors to borrow money, lend that money out at a higher rate to their customers, and make money on the spread between those two activities. That difference is called the net interest margin, or NIM, and it has compressed radically over the last 20 years:
Source: St. Louis Federal Reserve.
Because of a change in accounting rules, income from credit cards was shifted to be included in the calculation beginning in 2010. If not for that, net interest margin trends might look even worse. These margins are anticipated to begin ticking upward as the Federal Reserve starts to raise interest rates, but banks' earnings may not reflect that meaningful impact to NIM for years.
Checking the percentage of total revenue that is made from net interest income versus non-interest income (fees and other associated things) in the most recent quarter, we can see which banks are heavily dependent on a revenue source with shrinking margins:
Source: Company Earnings Reports.
From this chart alone, investors might reasonably hesitate before pursuing banks that rely heavily on net interest income. But looking at one quarter in isolation doesn't tell the entire story.
While the tried-and-true model of banks making money primarily through their NIM worked for generations, that has clearly started to change. As you can see below, PNC has begun to fundamentally shift away from a complete dependence on NIM toward fee-income:
|
Non-Interest Income to Total Revenue | |||||
|---|---|---|---|---|---|
|
Bank |
2010 |
2011 |
2012 |
1Q 2013 |
2Q 2013 |
|
PNC |
39% |
39% |
38% |
40% |
44% |
|
Wells Fargo |
47% |
47% |
50% |
48% |
50% |
|
US Bancorp |
46% |
46% |
46% |
44% |
46% |
|
BB&T |
43% |
36% |
39% |
41% |
42% |
Source: Company Earnings Reports.
A focus on fees
At a recent conference, CEO Bill Demchak said PNC planned to "create a company that is predisposed to increasing fee income, making us less susceptible to downturns and less dependent on chasing higher risk assets and betting on how fast interest rates may or may not rise."
This focus on increasing fee income should give investors confidence, because it suggests PNC is clearly ahead of the curve, appropriately responding to the changes in the broader banking market. Also, PNC did not simply roll out these fees to a swath of customers, but focused on cross-sell opportunities to its Asset Management Group and Corporate Banking clients, which often represent a more loyal, safer, and longer-term source of revenue.
As it shifts the way it generates revenue, PNC is essentially attempting to change the large-scale banking model we've known for decades. Investors should closely watch how far this shift goes in the coming quarters. But considering that PNC's margins have swung from trailing those of its peers to besting them, this seems like one bank worth watching.
