PNC and National City, An Inorganic Approach
Posted on: October 27, 2008 - Email Article - Printable Version
On Friday, leaders from PNC Financial Services Group [PNC: 59.96, +1.34 (+2.29%)] came to an agreement to acquire National City Corp [NCC: 2.20, 0.00 (0.00%)] for about $5.2 billion in an all stock deal. The deal came to a close after the U.S. Treasury invested $7.7 billion in preferred shares of PNC in association with the deal. An agreement wouldn’t have been reached if the government didn’t step in to provide some type of funding for the deal.
Terms of the Deal
PNC is aware of the bad loans that are still left on National City’s books, but feel they received favorable terms on the deal. PNC agreed to pay $2.23 a share for National City, which was a 19% discount to their closing price on Thursday. PNC will pay 0.0392 a share for every National City share plus $384 million in cash to warrant holders. PNC made its formal offer to National City on Thursday night. The lenders who were looking at National City included: Bank of Nova Scotia [BNS: 49.69, +0.22 (+0.44%)], US Bancorp [USB: 26.21, +0.09 (+0.34%)], and PNC Financial Services. US Bancorp and PNC were the final bidders for National City. Citigroup, J.P. Morgan and Sandler O’Neil advised PNC on the transaction, while Goldman advised National City. The deal is expected to close by the end of the year.
New Business
The deal doubles PNC’s size and will significantly increase their branch network and deposits. The deal bumps PNC up to the number 5 spot for banking deposits at $180 billion of deposits. They are behind banking behemoths Citigroup [C: 4.05, 0.00 (0.00%)], J.P. Morgan [JPM: 43.79, +0.55 (+1.27%)], Bank of America [BAC: 17.27, +0.24 (+1.41%)] and Wells Fargo [WFC: 30.55, +0.27 (+0.89%)]. They will also expand their branch size to 2,747 from 1,177 branches, which ranks fourth among major banks. The branches of National City will assume the PNC name, and the headquarters will remain in Pittsburgh. Peter Raskind, CEO of National City, will become vice chairman of PNC, while James Rohr will remain as PNC’s CEO.
As I mentioned in my previous article titled the “The Future of Investment Banks”, I talked about how many financial institutions will be moving towards acquiring banks with depository assets. There are three ways to fund banking businesses. The first is to go to the market and raise equity. Equity issuances are extremely expensive for companies to do. Many banks are realizing that issuing new common stock equity may not be the best idea for them to do. Bank of America [BAC: 17.27, +0.24 (+1.41%)] tried to issue $10 billion in new capital after they acquired Merrill Lynch [MER: 11.78, 0.00 (0.00%)], but had to price it at an extreme discount to where they were trading. Debt is the next option for the companies to consider. Debt has also become extremely expensive for companies to issue as spreads have increased to all time highs. The final option is for companies to gain depository assets. With these assets, banks are able to lend against them. In this market, financial institutions are willing to pay a premium for depository assets. At the same time, a lot of institutions with deposits are getting bought at discounts due to their risky balance sheets.
Government Assistance
PNC received very favorable terms from the U.S. Government, in their first attempt to use their newly approved money from lawmakers to spur merger related activities. The government agreed to invest $7.7 billion in PNC in exchange for preferred shares. Earlier this month, the government passed $700 billion to shore up the U.S. financial system. So far $125 billion was already used to invest in the nation’s largest banks and financial institutions. A few weeks ago, the Treasury announced that they will buy $25 billion in preferred stock in J.P. Morgan [JPM: 43.79, +0.55 (+1.27%)], Bank of America [BAC: 17.27, +0.24 (+1.41%)], and Citigroup [C: 4.05, 0.00 (0.00%)]; between $20 and $25 billion of Wells Fargo [WFC: 30.55, +0.27 (+0.89%)]; $10 billion in Goldman Sachs [GS: 176.64, +0.45 (+0.26%)] and Morgan Stanley [MS: 30.28, -0.03 (-0.10%)], and around $2.5 billion in Bank of New York Mellon [BK: 30.69, +0.44 (+1.45%)] and State Street [STT: 46.27, +1.18 (+2.62%)]. The government also announced that they will be using an additional $125 billion to inject money into other banks. Government officials have been hinting that they will be giving more funding to merger related transaction in an effort to shore up the financial system. The goal of the plan is to boost confidence in the financial system to get banks to lend again. One reason why the government may have chosen to invest $7.7 billion in PNC compared to the Bank of New York Mellon and State Street’s investment of ~$2.5 billion is because of the size of the deal. If you exclude the size of the deal to acquire National City, the government would have invested around the same size as BNY and State Street.
National City’s Fall
National City was one of the top 10 subprime lenders, which included Wachovia Corp. [WB: 0.00, 0.00 (0.00%)] and Washington Mutual [WM: 33.97, +0.09 (+0.27%)]. Over the past year, National City has lost almost $3 billion due to below quality assets and their stock has been down almost 90%. Some of their problems stem back to their subprime lending business, First Franklin Financial, which they sold to Merrill Lynch [MER: 11.78, 0.00 (0.00%)] at the end of 2006. National City kept some of the loans from First Franklin on their books, which is what has contributed to a majority of their losses.
New Credit Issues
PNC may issue $1 billion of common equity in the near future, but will hold off on their decision until after they speak with top shareholders. After the treasuries capital injection of $7.7 billion, PNC’s combined Tier 1 capital ratio would be around 10% up from its current capital ratio of around 8%. PNC’s credit rating of A+ is on watch from Standards & Poors and may be downgraded because of the bad assets that they will be acquiring from National City. In a statement issued on Friday, S&P stated: “the transaction materially increases PNC’s exposure to residential mortgage-related loans in some of the weaker banking markets in the Midwest and Florida.” PNC also may choose to raise capital by issuing $1 billion in new common equity, cut their dividend, or by selling off their PFPC asset management servicing division. PNC also owns about one third of BlackRock [BLK: 222.80, +10.45 (+4.92%)], but will most likely choose to leave that investment alone.
Wrap Up
Although this deal bumps PNC up to one of the banking powerhouses in the U.S., there are still unsolved issues that are surrounding the deal. It would be prudent to wait until more information is released with what PNC will choose to do to combat S&P’s negative outlook. I would recommend that those who currently own PNC should not sell and stay alert for more news. PNC has been destroyed in recent weeks relative to the rest of the sector because of the fact that they were not included in the government’s original forced capital injection in U.S. banks. All in all, this is a very good long-term deal for PNC that will allow it to expand their commercial banking and asset servicing operations.
-Steve Murray
Disclosure: The mutual fund the author is associated with has interests in PNC, JPM, GS, and BLK. Images used in this article were taken from a presentation located on PNC’s website.
The Following Stocks Were Mentioned In This Article: BAC, BK, BLK, BNS, C, GS, JPM, MER, MS, NCC, PNC, STT, USB, WB, WFC, WM
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