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PNC: Success in Subprime

Posted on: October 10, 2008 - Email Article - Printable Version

TJ Smith

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The subprime crisis has decimated large financial institutions and has ultimately transformed the current financial services landscape as we known it. Tarnished assets have continued to grow and develop on balance sheets across the markets as mergers and acquisitions, along with governmental action, has been a necessity to keep the economy afloat. In what seems like the blink of an eye, Fannie Mae [FNM: 0.82, 0.00 (0.00%)], Freddie Mac [FRE: 0.82, 0.00 (0.00%)], Lehman Brothers, Wachovia [WB: 0.00, N/A (N/A)] ,AIG [AIG: 1.66, 0.00 (0.00%)], and Merrill Lynch [MER: 0.00, 0.00 (0.00%)] all have had to call upon the help of the government or another firm to salvage themselves.

One company that has withstood this market turbulence has been PNC Financial Services [PNC: 48.10, 0.00 (0.00%)]. With their superior foresight and pristine executive leadership, PNC identified subprime lending as a detriment to their business model and ceased to divulge in this business practice. Currently, only 2% of PNC’s $143 billion in assets is tied to subprime mortgages. Year-to-date, PNC’s stock has actually appreciated in value by approximately 16% while the XLF index has lost over 33%. That is a stunning out performance of 49%. With this performance the Pittsburgh based corporation, with over 1,000 branches and 28,000 employees, is positioned to emerge in this battered financial landscape as one of the top tier banks in the United States.

PNC’s Subprime Suvival

It takes more than just a conservative, wise approach to lending practices to withstand the financial distress being realized in the markets today. A company needs to be diverse, with multiple revenue streams to compliment their strong leadership. Not many companies exhibit this trait as PNC does.

PNC has four business lines; retail banking, corporate and institutional banking, PNC global and investment servicing, and asset management. Their bread and butter is in retail banking, which accounts for just over 50% of their revenue. Through their retail banking, PNC provides deposit and cash management services to their 2.9 million customer base. Their corporate and institutional banking division accounts for 25% of their revenue and is the branch within PNC which is responsible for not participating in the subprime markets. The CI banking unit is responsible for their lending and capital market products. PNC global and investment servicing is responsible for approximately 8% of PNC’s revenue, providing business services to global clients. And finally, PNC has a 34% stake in BlackRock Solutions, another business that has conquered the subprime crisis. BlackRock [BLK: 138.78, 0.00 (0.00%)], an asset management subsidiary, accounts for nearly 15% of PNC’s revenue. With BlackRock, PNC has a unique revenue source that most regional banks do not have, which has allowed them to remain financially stable.

Performance Breakdown

If PNC’s diversity and share appreciation does not have one convinced, then take a look at the company’s financial performance thus far in 2008. For the second quarter in 2008, PNC realized a 19% increase in revenue to $505 million from $423 million. The company earned $1.46 a share, 25% higher than analyst expectations of $1.16 a share. In particular, their net interest income, which across all their business lines comprises about 43% of revenue, increased 32% from the second quarter in 2007. Furthermore, the company was able to increase their interest spread 45 basis points to 3.47% and boost their tier 1 ratio 40 basis points to 8.1%.

Looking Forward

So the obvious question is what is next? Does PNC’s financial success make it a viable acquisition target? It certainly is possible that Goldman Sachs [GS: 88.78, 0.00 (0.00%)] would be interested in taking on PNC for the capital security presented in PNC’s depository business. However, with a market cap of $25 billion and a thriving business line two more questions arise. Is Goldman willing or in position to fork over the premium it would take to acquire PNC? In addition, would PNC sell itself with the type of growth opportunities it has positioned itself to take advantage of as the financial system rebuilds itself? No one can really be certain but for now we know that PNC should continue to gain retail customers and new business projects because of their recent performance. The right price can create any deal, but Goldman would probably not consider making an offer without further extensive deterioration of their balance sheets that would create a more dire need for capital security. Regardless, expect PNC to remain financially superior. Their excellent management and diverse revenue stream has created a premier bank built to handle even the most turbulent economic conditions. The company has all the pieces to grow and maintain the success it has seen this year.

-T.J. Smith

Disclosure: The mutual fund the author is associated with is long GS and has interest in PNC.

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