Friday, October 24, 2008

PNC and NCC Deal Could Signal More Bank Mergers

Among the mess that is the global financial markets this morning there is some very positive and indicative news. PNC Financial Services (NYSE:PNC) agreed to purchase National City Corp (NYSE:NCC) in a stock deal. Along with the merger announcement PNC revealed that it will issue $7.7 billion in preferred stock to the US Treasury under the TARP.


This deal makes PNC one of the first banks to choose to participate in the TARP and could provide a model for how banks intend to use the program. Instead of making loans with the money, PNC has elected to purchase a weaker rival and increase its capital base. This is a first step in repairing the global financial markets and will likely be followed by other deals.


In fact, the government may actually encourage more mergers. A Wall Street Journal report on October 21, 2008 (“US Rescue Fund is Likely to Foster Bank Takeovers,” WSJ 10/21/08) quoted a government official saying, “If a healthy institution is making an acquisition, we would look very favorably on that.”


This government encouragement and available capital has not been lost on healthy bank CEO’s. On BB&T Corp’s (NYSE:BBT) Q3 earnings conference call, the CEO John Allison said in reference to the TARP, “We think there are going to be some acquisition opportunities, either now or in the future, and this is a relatively inexpensive way to raise capital.”


The market has rewarded PNC for this move, as it is one of the only financials that is up on the day. Again, a very interesting occurrence as acquirers usually fall on the deal announcement and the acquiree rises. The PNC bid for NCC was 7% below yesterday’s close, which explains the sell off in NCC. However, the rise in PNC is a canary in the coal mine that may signal that in this wave of bank mergers the acquirer will be rewarded.


There are two ways to play this theme of bank consolidation. First, one can sift through every regional bank and determine weak and strong. Typically the value player would look to buy the potential acquiree, however, based on the pricing of this deal and on how the market reacted it makes sense to purchase the stronger banks.


The second and more efficient way to play the theme is to purchase the Regional Bank HOLDRS ETF (AMEX:RKH). This ETF holds both the strong and the weak banks and provides an opportunity to participate in any deal among these players.


Regional Bank HOLDRs Composition

Company

Symbol

Current Weighting

Bank of America

BAC

7.17%

BB&T Corporation

BBT

3.59%

Bank of New York

BK

4.72%

Comerica

CMA

1.46%

Fifth Third Bancorp

FITB

1.61%

JPMorgan Chase

JPM

18.98%

KeyCorp

KEY

1.52%

Marshall & Ilsley

MI

1.13%

National City

NCC

0.46%

Northern Trust

NTRS

4.02%

PiperJaffray

PJC

0.21%

PNC Financial

PNC

6.18%

Regions Financial

RF

1.08%

Synovus Financial

SNV

0.81%

SunTrust Banks

STI

3.66%

State Street Corp

STT

4.36%

US Bancorp

USB

19.00%

Wachovia

WB

2.76%

Wells Fargo

WFC

17.27%

Source: www.holdrs.com


Since the components are market weighted the stronger banks will have a higher weighting as market players sift through the ruble and bid up the stronger companies.


The price action of the ETF suggests that market participants have similar thoughts. Earlier this month, during the equity market sell-off, RKH did not make a new low. This is significant given the fact it is loaded with financials and several of the companies reported substantial losses. Even with futures limit down this morning the ETF held above the October 10 low.



Source: BigCharts


The market weakness is providing one of those rare low risk entry points into RKH. As the weeks progress we will most likely see more mergers and more uses of the TARP in this manner.


Disclosure: I have a long position in RKH.



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