This guest commentary was written by Christopher Whalen. It was originally posted on The Institutional Risk Analyst. This piece does not necessarily reflect the opinion of Hedgeye.
In this issue of The Institutional Risk Analyst, we take a look at the recently announced purchases of the US assets of Banco Bilbao Vizcaya Argentaria, S.A. (BBVA) by PNC Financial (PNC), one of the better performing large bank holding companies (BHCs) in Peer Group 1.
But first, to address some reader comments about our last post, yes, we do feature things other than banks and finance in The IRA. Geopolitics is a major component of risk, as is corruption and war crimes.
Americans understand these things in binary, Cold War terms, but the nuances are far more profound. Long-time readers of The IRA know we are not shy about exploring the darker corners of the global political economy.
To be blunt, Americans don’t like to be reminded of the cost of Empire, including the cost to other nations of the "special" role of the dollar. Nations from China to Argentina finance their activities in dollars, and are short the reserve currency. Any wonder why inflation and debt defaults affect so many smaller nations?
And Americans don’t like to hear of the cost in blood and lives of ill-conceived big power games, as in the case of President Barack Obama and Hillary Clinton in Syria, but this story goes back centuries. As we told one reader, go live in Syria or Lebanon for a year. If you survive the US funded terrorists, Syrian Army attacks, Russian bombing and Turkish atrocities, then we'll talk.
The greenback became heir to the Pound Sterling at some point between the end of WWI and when Anthony Eden retreated West of Suez in 1956. Amid the dollar imperium that followed WWII, various foreign corporations attempted to gain footholds in the US, usually via acquisitions. But the big corporations and banks that financed WWII and defeated fascism in Germany and then communism in the Soviet bloc are formidable competitors.
The Dutch are perhaps the most successful and longest-lived direct foreign investors in the US, and also among the quietest. Other nations, Japan, Germany and France most notably, have entered and exited sectors such as automobiles, banking and retail with great frequency.
America’s rough and tumble market, even with accumulating layers of socialist regulation, is still the envy of the world. But sadly, America is not an easy market to penetrate successfully.
The record of foreign banks entering the US market is not very impressive. BBVA first entered the US in 1970 with the creation of a US BHC. In 1995, BBVA acquired Southwest Bancshares and by then had changed the name of the US operation to Compass Bancshares. The institutional history of BBVA US is available here.
The first thing to notice is that BBVA US is a decidedly mediocre performer. By acquiring the $100 billion asset BHC, PNC is doing the Federal Reserve Board and other regulators a favor. Whether or not the transaction will be accretive to PNC shareholders is another matter. And of course, the “progressive” politicians in Washington will demand a gratuity in the name of “consumer protection.”
Based upon net income, BBVA US has ranked in the bottom quartile of Peer Group 1 for the past five years. Indeed, BBVA US reported a $2.4 billion loss at the end of Q2 2020. Today BBVA US is comprised of 44 affiliates, including a state-chartered member bank based in Birmingham, AL, and a broker-dealer.
PNC, on the other hand, is an above peer performer that reported record results in Q2 2020 after the sale of its shares in Black Rock (BLK) closed in May 2020. PNC has less credit exposure than many banks in Peer Group 1 with just 55% of total assets in loans. The 10th largest bank in the US, PNC has strong capital and lower double leverage at the parent level than most large banks as a result of the proceeds of the BLK share sale.
PNC has a lower gross loan yield than its peers, but makes up for this with good operating efficiency and a larger portion of income from non-interest income. The bank’s efficiency ratio was 63% at the end of Q2 2020, roughly in the 60% percentile of Peer Group 1. The operating expenses of PNC are 20bp below the average for its large bank asset peers.
So why is PNC buying BBVA US? The Wall Street Journal reports that the parent BBVA decided to sell because of scale and capital constraints. “The problem for BBVA was that while it grew in the U.S. over a 15-year period, particularly in the Southwest, it didn’t get big enough that it made sense to stay in the country.” Indeed, as with many other foreign banks in the past several decades, BBVA was forced to capture its investment in the US to support the bank’s capital position back home.
So why is PNC buying this modest franchise? First, the purchase price of $11.6 billion is just a slight premium to tangible book for BBVA US as calculated by the FFIEC. Second, the acquisition expands PNC’s footprint into Texas, where BBVA had assembled a modest market share. And third, BBVA brings $80 billion in core deposits to PNC’s $330 billion in core deposit base, adding further strength to the bank’s funding profile and making it roughly the same size as U.S. Bancorp (USB).
If the past is any guide, we expect PNC to absorb the deposits of BBVA USA and gradually reduce assets to drive operating efficiency and overall asset and equity returns. Both PNC and its closest asset peer USB have shown great discipline in the past in terms of maintain a certain asset size.
But more than anything else, this transaction illustrates the intense competition for funding in today’s market.
As our friend Joe Garrett of Garret McAuley & Co told his clients recently: “Gathering assets is relatively easy. Getting deposits is extraordinarily difficult.” Even in the age of QE and zero returns on risk free assets c/o the Federal Open Market Committee, dollar funding remains scarce.
ABOUT CHRISTOPHER WHALEN
Christopher Whalen is the author of the book Ford Men and chairman of Whalen Global Advisors. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington.
This piece does not necessarily reflect the opinion of Hedgeye.
