Summary
- Management has been vocal about their desire to use the $14 Billion BLK sale proceeds to fund M&A activity via another midsize bank.
- PNC stock has outperformed bank peers after every major acquisition over the past two decades.
- While it could be another quarter or two before a deal is announced, relative to bank peers, PNC has also proven to be an out-performer on an organic operating basis.
- Further economic clarity is likely needed before a deal takes place, but my bias is for a larger bank with a footprint located in the Southeastern United States.
Investment Thesis
The PNC Financial (PNC) first quarter earnings took a relatively large hit, driven by both provision expense and margin compression. While PNC, along with a majority of its bank peers across the United States, is likely to have volatile earnings throughout the remainder of 2020, President and CEO William Demchak has clearly positioned his bank to being in driver’s seat in terms of how it navigates through this economic cycle.
When the news of the Blackrock (BLK) liquidation was complete (mid May), I originally believed that PNC would wait and see how quickly the economy recovers before seeking to deploy capital into a massive acquisition. I originally thought the bank would perform in-line with peers as a looming catalyst was waiting in the shadows. However, given this recent economic rebound, palatable peer valuations, and a management team that has a proven history of timing the bottom, I now believe PNC will outperform bank peers over the next few years because of its relative positioning.
Playing Offence or Defense?
If you recall, a couple months ago PNC monetized one of the great investments of the late 20th century. In the words of any over-caffeinated Wall Street trader, PNC’s investment in BLK amounted to nearly a 50 "bagger" (ex-tax). Over the course of the last two decades, PNC has had previous well-timed, watershed investment moments, and while the sale of its stake in BLK will now undergo the scrutiny of time, the old-school saying of "one does not go broke taking profits" comes to mind.
Before PNC sold its stake, the total investment was valued at just over $17 billion near its peak, not bad given the original investment from 1995 was just $245 million. Driven by this thesis changing balance sheet growth opportunity and capital inflow of over $14 billion, PNC now has one the strongest capital bases relative to any other United States based bank. Most importantly, from this sale the management team has positively impacted both the bank’s capital ratios and the holding company’s liquidity ratios - something that is often missed when there is a liquidity impact which would impact the upstream of dividends or downstream capital buffering. When management rang the register on its BLK stake, they successfully increased PNC's common equity Tier 1 ratio by about 200 basis points to just over 11.4%.
Management On The Hunt
"In its most likely form, it would be another bank," CEO Demchak said in an interview with CNBC. "We're not veering off from our strategic direction of wanting to establish a national presence on both the retail and C&I (commercial and industrial lending) side."
While management might be publicly positioning as to being on the hunt for a sizable acquisition, in a much more dire situation, some of this newly liquidated excess capital at the holding company could be injected into PNC Bank should the economic situation turn ugly and the bank-level capital ratios need support. This level of capital ratio support, should they need it, proves the defensive options of my investment thesis.
Either way, in my eyes PNC now holds the title for being in the best offensive- or defensive-position relative to other super-regional bank peers, the main reason as to my positive stance on the stock.
