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Does the PNC Financial deal indicate the sweet spot for banking?
06/21/2011 2:01 pm EST
This industry wide reshuffling is a reaction to new capital requirements from global regulations in Basel III and moves by national regulators to require stronger balance sheets at banks under their jurisdiction. Banks know that they will have to hold more capital against their assets—even though as of yet they don’t know how much more—and they’re examining their balance sheets to see if its better to sell off some assets (thus lowering the amount of capital they’ll have to have) or to keep them and raise the extra capital that regulators will require. Raising more capital doesn’t look particularly attractive right now given how the market has been beating up bank stocks.
The result of these calculations depends a lot on where a bank sees its growth opportunities. Buying the U.S. retail business of Royal Bank of Canada gives PNC a big boost in the Southeast including the opportunity to expand the foothold in Florida it acquired with its October 2008 purchase of National City. The deal will bring PNC 420 branches and about $25 billion in assets.
For PNC management the purchase is worth it because it continues the bank’s move to expand beyond a regional bank. In 2007, for example, PNC acquired banks in New Jersey, Maryland and Virginia. The 2008 acquisition of National City, besides giving PNC its foothold in Florida, strengthened its presence in the Midwest. And now, with the Royal Bank of Canada acquisition PNC moves up in such core Southeastern markets as North Carolina and Florida.
The price is either reasonable or too much depending on the quality of the assets that PNC has bought. The price works out to about 97% of tangible book value but during this stage of the financial recovery almost no portfolio is worth its book value. The question Wall Street is asking is how many impaired loans are among those that PNC just bought from Royal Bank of Canada. PNC did give itself some protection in the deal with a provision that lets it write down the value of those acquired loans by about 12.5% or $2.2 billion.
To me the more important question is how this deal positions PNC in the banking industry of the next decade or so. The deal has two things definitely going for it. The bank bought loans, not a bad idea when loan organic loan growth is anemic to non-existent. The deal concentrates on consumer loans and consumer deposits at a time when commercial loans aren’t growing and when consumer deposits are one of the lowest cost sources of capital.
I can’t give you an opinion yet on a third potential advantage to this deal. After all the dust has settled on the new global banking regulations some banks will find themselves in a sweet spot in the industry. They will be big enough to compete for national and global business and to capture many of the cost savings that come with scale. But they won’t be big enough to trigger the extra capital required by regulators from the biggest banks, those judged systemically important to the global financial system.
PNC looks like it could hit that sweet spot—as could US Bancorp (USB). US Bancorp is in my Jubak’s portfolio http://jubakpicks.com/ with a target price of $33 a share by September.
Investors will have to wait for the full rules in November to know for sure.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of PNC Financial and US Bancorp as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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