During the past five years, PNC Financial Services Group (PNC +0.67%) has been one of the top-performing bank stocks in the U.S. No matter how you break down its performance metrics, the bank has truly knocked it out of the park.
But past performance does not necessarily predict future success. The bank faces several major challenges that could change its fortunes -- although it's important to note that no one can predict the future (and consequently, there is no way to know for sure which way the stock will go). Here are three reasons why PNC Financial Services Group could fall.
1. PNC Financial Services Group is struggling to grow revenue
The traditional business model for banks is to gather deposits and extend loans. The pricing of those two products is largely driven by interest rates, meaning that, in today's environment, prices are very low. Low prices and a slow growth economy means banks are struggling to find new revenue.
PNC Revenue (Quarterly) data by YCharts.
It's a difficult operating environment, to be sure, but some banks are handling it better than others. US Bancorp (USB +0.70%), for example, has increased revenues 22% during the past five years.
PNC, on the other hand, has seen its revenues decline by about 1.1% during the same period. Company management has defined the bank's mortgage business and its retail banking operations as the primary growth opportunities within the existing franchise.The challenge, of course, is that every other bank in the U.S. is also fighting tooth and nail for leadership in these arenas.
If PNC fails to successfully increase its market share, the failure to match the revenue growth among its peers could be enough to push the stock lower.
Source: Company website
2. PNC Financial Services Group still has quite a few problem loans
Generally speaking, banks fail when they extend loans that can not be repaid. It sounds obvious, but it really is the fundamental truth. For PNC, the process of correcting all the problem loans from the financial crisis is moving along more slowly than most of its peers.
According to the bank's most recently filed 10-Q, PNC has $3.2 billion in non-performing assets. Non-performing assets, or NPAs, are property in foreclosure, and loans that are substantially past due. This represents almost 1% of the bank's total assets.
NPAs and other problem loans are bad for investors for a few reasons. First, the bank is required to hold higher capital in the form of reserves that limit return on equity and lower net income. Every quarter, in fact, the bank is required to put aside extra reserves to protect the bank if these problem assets create losses. More NPAs mean higher reserves, and that means lower profits.
Second, these problems require more constant management, distracting employees from improving efficiency, growing revenue, and otherwise increasing the bank's value. If PNC is unable to successfully rehabilitate or dispose of these problem assets, the company's stock could easily fall behind its peers.
3. PNC's balance sheet overall may be too conservative
After the financial crisis, banks were universally scorned for using excess leverage to boost returns. When the economy turned for the worse, that excess leverage nearly collapsed the entire financial system.
The knee-jerk reaction, then, is to dramatically cut leverage, a decision that, if taken too far, can cut into returns and stall growth. It's the classic problem of the pendulum swinging too far from one extreme to the other. The key is to find an appropriate balance where leverage is an effective tool for improving financial results without putting the franchise at undue risk (see NPAs, above). PNC may have swung too far away from leverage.
Currently, PNC has an assets-to-shareholder equity ratio of 7.4 times, which falls well below the industry average near 9x. Wells Fargo currently is leveraged 8.8 times, and US Bancorp is leveraged 9.1 times. TD Bank sports a whopping assets-to-equity ratio of more than 17.3x.
PNC Assets To Shareholder Equity (Quarterly) data by YCharts.
As a result, PNC Financial Services' return on equity trails the peer group. Having excess capital is a good thing, but only up to a certain point. With too much capital, a bank can actually hurt its shareholders by limiting returns.
Foolish Takeaway
PNC Financial Services Group has had a terrific run during the past few years. The bank has, in fact, been one of the top-performing banks on the public markets. But past success does not guarantee future performance.
The company has serious challenges to overcome, starting with the three listed here. If management can successfully navigate these issues, the bank's positive run could continue. If not, then PNC Financial Services Group could see its stock fall.
