When it comes to analyzing bank stocks, few metrics are as important as the efficiency ratio, which reflects the percentage of a bank's net revenue that's consumed by operating expenses. But while most banks struggle to get their efficiency ratios below 60%, PNC Financial (NYSE: PNC) turned in a ratio of 52.5% last year, ranking it first in its peer group.
Listen in to the following segment of Industry Focus: Financials, as The Motley Fool's Gaby Lapera and contributor John Maxfield discuss PNC Financial's industry-leading efficiency ratio, as well as its two primary profitability metrics.
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A full transcript follows the video.
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Gaby Lapera: The reason we're talking aboutPNC Bank isbecause we talked about how great U.S. Bancorp'sefficiency ratio is, and PNC Bank has aneven better one.
John Maxfield:Yeah. If you think about it, when you'reanalyzing banks as an investor,there's a couple of statistics that are really central that you'regoing to want to check first. Efficiency ratio is one of those. We talked about it last week, theefficiency ratio tells you thepercentage of net revenue that is beingconsumed by operatingexpenses. Most banks want to get around 60%,that's what most are targeting right now. But PNC'sefficiency ratio is 52.5%. So, what does that mean? The average bank in its peer group has a 62%efficiency ratio. What that means is that 10% more of PNC's revenue is available to pay taxes,cover loan-loss provisions, and to drop to the bottom line. So it has an enormous advantageright out of the chute.
Lapera:Definitely. Andthe things that make up the efficiency ratio are expenses and assets.
Maxfield:Expenses and revenue, rather.
Lapera:Expenses and revenue, sorry. Not assets. Thank you. What I was going to say is, PNC has the highest revenue as a percent of asset.PNC does have the highest revenue as a percent of assets in its class,and it's over 1%, which is great. That's generally what you want to see in banks, anything over 1% isgravy. Most banks are not there yet.
Maxfield:I think we mixed up some numbers. Theirrevenue as a percent of assets is4.92%, which is the highest in its peer group, and itspeer group are the really large, too-big-to-fail banks,JPMorgan Chase,Citigroup,Bank of America,Wells Fargo, plusother large regional banks. So that's the largestwith one exception, and that isCapital One. The reason that Capital One'srevenue is so high as a percentage of assets is because a very largeportion of its loan portfolioconsists of credit card loans, and those yield,as everybody knows, a lot more than, say, a homemortgage does. So its revenue as a percent of assets isthe top in its peer group. But then,if you translate that over intoprofitability,that's where that 1.1% return on assets is. When you'retalking about profitability for banks, there'stwo measures that you want to look at: yourreturn on assets andyour return on equity. Return on assets is basically yourunlevered profitability. Your return on equity is your leveredprofitability. Here's the interesting thing about PNC, andthis is one of the reasons that it doesn't pop up a lot wheninvestors are looking for the top-performing banks -- it's because theirreturn on common equity last year was8.58%. When you'relooking for a 10% return on equity, you think, that'sactually meaningfully below that standard industry benchmark that you want to see. But the reason that it's below,as we see with its good return on assets,is just because it's not very levered,which means it's a very safe bank that'sstill earning a lot of money if you look at it on a levered basis.
Lapera:Yes. Andin my defense, 4.92% is above 1%.[laughs]
Gaby Lapera owns shares of JPMorgan Chase. John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.