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Sunday, October 26, 2008

breakingviews | PNC/National City

breakingviews | PNC/National City

Flexible Tarp

Context News

PNC Financial is buying National City for $5.2bn, or $2.23 a share – 52 cents below Thursday’s close. It’s an all-stock deal, with National City shareholders receiving 0.0392 share of PNC common stock for each National City share held, based on PNC’s closing price on Thursday of $56.88 a share.

The bank is also paying $384m to cover price resets that accompanied the warrants National City granted to Corsair and other large shareholders when they invested in the bank earlier in the year. PNC is financing the transaction by issuing $7.7bn of preferred stock and warrants to the US Treasury under the Troubled Asset Relief Programme.

PNC expects $1.2bn of cost synergies – 10% of the combined firm’s cost base – and $2.3bn or merger costs.

PNC/National City: PNC Financial’s US Treasury-assisted $5.6bn takeover of struggling National City looks like a smart purchase for both the Pennsylvania bank’s shareholders and its target’s bondholders – PNC is assuming the Cleveland-based bank's debts. But the deal leaves some other regional banks looking exposed.

Let’s start with the good news. PNC is getting its hands on almost $100bn of relatively sticky retail deposits for just $5.6bn – less on a simple pro rata basis than Wells Fargo is paying for Wachovia's customer money or JPMorgan for Washington Mutual's. The new PNC will also boast a Tier 1 capital ratio of around 10%.

And shareholders aren’t being immediately diluted. PNC is funding the deal by issuing $7.7bn of preferred shares and related warrants to the US Treasury under the Troubled Asset Relief Programme - the maximum 3% of the two companies’ combined risk-weighted assets allowed under the plan. And the deal roughly balances out that extra slug of equity investment thanks to $1.2bn in estimated annual savings which, once taxed and put on an earnings multiple of 10, are worth about $7.4bn.

Admittedly, Treasury Secretary Hank Paulson won’t get the immediate boost to bank lending he wanted from injecting Tarp capital. But he will have found a comfortable home for another shell-shocked institution – and this time without relying on one of the systemically critical megabanks.

So far so good. But the deal puts the spotlight on rival regional banks. PNC reckons Nat City’s portfolio of dodgy loans, mostly real estate-related, will lose half its value over time - roughly double the figure Nat City’s executives estimated when they released earnings just three days earlier.

It’s in PNC’s interests to take big losses now. But the discrepancy calls into question valuation assumptions across the sector. That’s happened before, but this time there’s a deadline looming: banks have three weeks left to tap the Tarp for capital, and only those considered going concerns are supposed to get it. Investors punished some bank stocks after the PNC deal was announced - Fifth Third and Regions Financial, for instance. Such banks now appear to be on notice to act fast, or risk being left out in the cold.

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