Since the coronavirus pandemic first sent markets plunging, the $462 billion asset PNC Financial Services Group (PNC 3.21%) based in Pittsburgh has been looking to make a game-changing acquisition. The bank sold its $14 billion stake in the asset management firm BlackRock (BLK 1.95%) in May, and PNC's CEO Bill Demchak said publicly the main purpose of the sale was to build capital that could eventually be used for an opportunistic move in the harsh environment for banks.
But six months later, credit has held up better than expected, largely due to stimulus. Bank valuations have improved, and many bankers are now ruling out worst-case economic scenarios. While the banking environment has improved, Demchak does not appear to have changed his patient approach when it comes to looking at potential mergers and acquisitions (M&A).
The same philosophy
Since the beginning of the acquisition talks, Demchak has said he would like to buy another bank that helps the company build a national retail banking presence specializing in commercial and industrial (C&I) lending. A lot of investors have questioned why the bank doesn't consider buying a consumer finance or credit card company that could perhaps aid its net interest margin in the low-rate environment. Like most banks, PNC's net interest margin, the difference between what it makes on interest-earning assets such as loans and what it pays out on interest-earning liabilities such as deposits, has dropped significantly this year -- all the way to 2.39% at the end of the third quarter. While PNC does have a consumer loan portfolio with some credit card, automobile, and student loans, the bulk of it is standard residential mortgage and home equity loans.
At the Bank of America Future of Financials conference held earlier this month, Demchak said he doesn't see consumer finance as a strategic opportunity for PNC. "Most of the consumer finance businesses that ever show up on the market for sale are broken," he said. "Our ability to fix in scale a large broken consumer finance business -- you know maybe we can do it -- but I'd have a lot more confidence in our ability to fix a C&I franchise." Demchak added that while you never say never, over the course of time he doesn't view consumer finance as a great return on capital.
I think this is a fair argument. Demchak is essentially saying that he likes the business PNC runs right now and thinks it can generate good returns long term. While the low-rate environment and potential for lots of future loan losses from the pandemic does make things difficult for banks, the industry has really been operating in a low-rate environment since the Great Recession, and PNC has been able to generate solid returns on equity.
Not phased by rising valuations
Demchak also did not seem phased by the boost in bank valuations. The pandemic earlier this year pushed a lot of banks downward, ultimately trading at a substantial discount to tangible book value. This is one of the reasons PNC has been so eager to make a move, because in this kind of environment, acquirers wouldn't need to pay as high a premium for another bank. During the Great Recession, PNC purchased National City Corp. for $7 billion less than the bank's tangible book value, and the deal has been considered a major success for the bank.
In recent months, bank valuations have been coming back up. On the recent news from Pfizer (PFE 0.89%) of its early successful vaccine trials, bank stocks surged. While that's good for the sector, it makes acquisition targets more expensive. This could leave some asking if it's still worth it for PNC to make a big purchase, but Demchak did not seem worried about valuations.
"Notwithstanding that banking is going to be a tough environment for the next bunch of years, because of rates and credit costs and all of the stuff we know about, technology spend, I think there is going to be real separation between the winners and losers inside of that slow-growth environment," he said at the Bank of America conference. "We have the potential to be a winner in that space. We think we have the tools to do it, and in the process of doing that, be a much larger institution."
Plenty of opportunity
I think you can assume from all of Demchak's comments that PNC still has every intention of making a big acquisition. The bank will be patient, but once the market becomes more stable, expect PNC to make a move. Most banks have to want to be sold, so they probably want to wait until valuations come up a little before selling, especially when you see some light at the end of the tunnel. Demchak believes that even after things normalize, market conditions will not be easy for the banking sector because of low rates, the need to invest in technology, and potential loan losses. So, while PNC may not get the same deal that it did for National City, it could very well buy a bank for a lot cheaper than what it would have before the pandemic began.