RBC Capital Markets, LLC Gerard Cassidy (Analyst) John Hearn, CFA (AVP) (207) 780-1554 (617) 722-4881 [email protected] [email protected] Steven Duong (AVP) Matthew Deschesne, CFA (207) 780-1554 (Associate) [email protected] (207) 780-1554 [email protected] March 23, 2018 Sector: Banks/Large-Cap PNC Financial Services Group Racing to Top-Level Performance Top Pick NYSE: PNC; USD 153.28 Our view: We believe that shares of PNC do not adequately reflect the value of the underlying business. We contend that PNC has multiple Price Target USD 170.00 levers to pull in order to increase profitability and manage expense WHAT'S INSIDE growth. Additionally, we expect that well executed acquisitions such as Rating/Risk Change Price Target Change EQUITY RESEARCH the National City Corporation and RBC Bank transactions will accelerate profitability improvement as integration matures; and keep management In-Depth Report Est. Change disciplined on any future transactions. Preview News Analysis Scenario Analysis* Key points: • Revisiting our Top Pick: We believe PNC Financial Services Group, Downside Current Price Upside Inc. is poised to achieved the levels of profitability and operating Scenario Price Target Scenario efficiency seen in top banking franchises such as U.S. Bancorp and M&T 136.00 153.28 170.00 204.00 Bank Corporation. Through diligent expense management, strategic 9% 13% 35% investments in modernizing its retail branch network, the continued *Implied Total Returns development of its Southeast footprint, and its focus in its middle Key Statistics Shares O/S (MM): 473.0 Market Cap (MM): 72,501 market business, we believe PNC has the potential to further improve Dividend: 3.00 Yield: 2.0% profitability and efficiency metrics while maintaining its high quality BVPS: 91.94 P/BVPS: 1.67x product offerings and robust credit quality. Tangible BVPS: 72.28 Avg. Daily Volume: 2,095,424 ROE: 10.2% • BlackRock holdings: PNC holds a 22% economic interest in BlackRock Float (MM): 474.7 (BLK). The investment has performed extraordinarily well for the company with unrealized gains reaching $10.2 billion and BLK earnings RBC Estimates adding 14.9% to PNC's fee income. FY Dec 2016A 2017A 2018E 2019E EPS, Ops Diluted 7.27 8.47 10.70 11.55 • Long-term value and allocation of capital: PNC's 10-year cumulative P/E 21.1x 18.1x 14.3x 13.3x dividend tangible book value per share growth of 17% was the highest among peers, driven by strong operational performance, capital return EPS, Ops Diluted Q1 Q2 Q3 Q4 2017 1.94A 2.10A 2.16A 2.29A management, and opportunistic acquisitions. 2018 2.49E 2.67E 2.76E 2.80E • Poised for loan growth: PNC has outperformed industry C&I loan All values in USD unless otherwise noted. growth in 2017 driven by its middle market market initiative. PNC is in 26 of the 50 U.S. metropolitan markets with Dallas, Kansas City, and Minneapolis expansion markets in 2017. PNC plans to expand into Denver, Houston, and Nashville in 2018. On the consumer side, PNC is enhancing its consumer lending platform and expects to see results from its universal banking branch format. • Investments in technology and infrastructure: In the past few years, PNC has built out its infrastructure to effectively manage CCAR and operate in a new tech environment with three state-of-the art data centers in its internal cloud. The company has now shifted its focus to consumer-facing development with its universal branch model, numo incubator, PNC iLab, and its Innovation Center with Carnegie Mellon. • Focused on efficiency: Cost savings from PNC's Continuous Improvement Program (CIP) has allowed the company to reinvest in the company to drive further savings and increased growth. • Potential profitability analysis: Our potential profitability analysis examines the drivers of ROAA and ROACE. We believe PNC could reach an ROAA of 1.48% and ROACE of 14.19%. Disseminated: Mar 23, 2018 03:05ET; Produced: Mar 23, 2018 03:05ET Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Conflicts Disclosures, see Page 45. Banks/Large-Cap The PNC Financial Services Group, Inc. Target/Upside/Downside Scenarios Investment summary Exhibit 1: The PNC Financial Services Group, Inc. We rate PNC shares Top Pick for the following reasons: 125 Weeks 31OCT15 - 22MAR18 • Well positioned for rising interest rates: As of 4Q17, a 12- 175 UPSIDE 204.00 TARGET 170.00 month, gradual 100 basis points parallel shift in interest 155 CURRENT 153.28 145 135 DOWNSIDE 136.00 rates would result in net interest income increasing 2.7%, 125 115 down from the prior quarter of 2.9%. 105 • Expansion of middle markets and corporate finance 95 business: PNC has expanded into the Dallas, Kansas City, and 85 Minneapolis markets with its middle markets and corporate 75 finance products. The company is expected to deliver a 30m full suite of products and services into these markets. 20m 10m Additionally, we expect it to expand organically into Denver, 2016 2017 2018 Houston, and Nashville over the next 9-12 months. N D J F M A M J J A S O N D J F M A M J J A S O N D J F M Mar 2019 PNC Rel. S&P 500 COMPOSITE MA 40 weeks • Well-balanced business mix tied to an improving economy: Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target Most of PNC's business is focused on traditional banking, Target price/base case with a commercial/consumer loan breakout of ~67%/33%. For our base case scenario of $170, we expect interest rates to An improving economy should lead to solid loan growth, climb 50–75 basis points through year-end 2018, an effective and we expect the company to increase penetration of its 8 tax rate of ~17, a lower regulatory burden, and U.S. real GDP million consumer customer base with residential mortgages growth of 3% or higher per year. and credit card loans over the next 12-24 months. • High level of recurring fee revenues: Noninterest income Upside scenario accounts for approximately 45% of PNC’s total revenues, in Our upside scenario of $204 assumes U.S. real GDP growth line with top-performing peers at 40–50% or higher. above 4.0%, interest rates increase 75–100 basis points • A continued focus on reducing operating expenses: Bill through year-end 2018, an effective tax rate of 17% or Demchak has brought PNC’s efficiency ratio down to ~60% lower, an improvement in the regulatory environment beyond range by closing redundant branches and focusing on our expectations, and credit quality to remain the same or alternative banking channels. Currently, 54% of deposits are improve. transacted through non-teller channels. The company's roll- out of its universal branch model to ~21% of total branches Downside scenario supports this strategy. We believe the company's efficiency Our downside scenario of $136 assumes U.S. real GDP growth ratio could pierce below 60% in 2018. below 2%, interest rate increases of 25 basis points or • Strong capital: PNC’s CET1 ratio of 9.8% at 4Q17 well less through year-end 2018, no change in the regulatory exceeds the 8.5% level that we believe the company needs environment, and an effective tax rate greater than 20%. to run a conservative but highly profitable bank. The company repurchased $0.5 billion common shares in 4Q17 under its $2.7 billion share repurchase plan. • Deferred tax liability: The company has about $1.6 billion in deferred tax liabilities (DTLs) arising from its investment in Blackrock, Inc. at 4Q17, after a $1.2 billion revaluation of the DTLs due to tax legislation. • Monetization of BlackRock: The company may be able to monetize its BLK investment in a tax-efficient manner given the new tax legislation. In addition to the gain that PNC would record on the monetization, it would also free up ~$4 billion of capital that is required to support its investment in BLK, an increase from $3 billion last quarter due to the DTL revaluation. We believe, however, BlackRock remains a valuable investment for the company and PNC is expected to continue to hold onto this investment unless valuations reached levels that would make it financially prudent to monetize it. March 23, 2018 Gerard Cassidy, (207) 780-1554; [email protected] 2 Banks/Large-Cap The PNC Financial Services Group, Inc. Table of Contents Executive summary .............................................................................................................. 3 Company Overview .............................................................................................................. 4 Company Description ................................................................................................................. 4 Business lines ............................................................................................................................. 6 BlackRock Holdings .............................................................................................................. 9 BlackRock sale and special buyback impact to EPS .................................................................. 10 Long-term value ................................................................................................................. 15 Poised for solid loan growth ............................................................................................... 18 Investments in technology and infrastructure .................................................................... 20 PNC Center for Financial Services Innovation .......................................................................... 21