A Conversation With PNC’s William Demchak

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When Pittsburgh-based The PNC Financial Services Group, a $557.3 billion bank, sold its 22% stake in asset manager BlackRock during the height of the financial crisis for $14.4 billion, executives didn’t know what to do with the cash. Chairman and CEO William “Bill” Demchak explained on stage at Bank Director’s Acquire or Be Acquired conference Monday why he sold BlackRock and turned around and bought BBVA USA within six months. He also offers advice to bankers doing deals. This conversation with Editor-at-Large Jack Milligan has been edited for length and clarity.

BD: What was the decision-making process to sell PNC’s stake in BlackRock in May 2020 for $14.4 billion and use the proceeds to acquire BBVA USA for $11.6 billion in November 2020?
WD: Before the government put out all the fiscal support, you’ll remember that we didn’t know if the mortality rate [of coronavirus in 2020] would be 10% or 1%. All I could think was: Make sure the bank has the most capital, a fortress balance sheet and is the one to survive the day. That led to the decision to sell BlackRock.

So I figured how my options might play out. It wasn’t a certainty that we would find a target [to buy]. If I sold BlackRock, the bank would be absolutely fine, the shareholders would be mad at me because we’d have too much capital and no BlackRock anymore and I’d get fired. That was OK: The bank, our employees and our clients would be great. If it turned out that we had a recovery and managed to land an acquisition target, that was a home run. In the end, that’s what it was. But that six months in-between was really tough.

BD: How did you prepare the board for that decision?
WD: I remember one director said, “You don’t normally sell something until you have the thing you’re going to buy in the other hand,” which is absolutely correct. But we weren’t long from the financial crisis. The bank with the most capital wins every time. We had a big stack of capital in our BlackRock stake that wasn’t recognized. Cashing in those chips was the right decision.

BD: How was the acquisition received in Washington? Did you have any sense that regulatory attitudes toward large bank M&A were changing?
WD: Yes, although we probably didn’t realize how close we were. There’s been a sea change in Washington on large scale consolidation, as they looked at the risk of combining institutions, both theory and economic risk, but also community-based risk. And we made it through a window before that. Although I will say, we made it through the approval process without a single negative letter sent to the regulators.

BD: What did the BBVA USA acquisition do for PNC that you didn’t have before?
WD: Between BBVA and markets we opened up on our own, we went from being in probably 12 of the largest MSAs just a handful years ago to now being in the top 30. It’s remarkable the growth prospects of the markets that we’ve entered. Houston has gone from not being on our radar to being almost our third largest market. What we’ve seen in Colorado is just as tremendous.

BD: Do you foresee PNC doing another acquisition?
WD: I think we have to.

BD: And you think you will be allowed to?
WD: I don’t know. There’s a horrible joke: You’re in the woods and a bear’s chasing you and you’re lacing up your shoes. You can’t outrun the bear, but you don’t have to. You just have to outrun [the person you’re with]. And there’s a lot of banks in this room I can outrun. But the bear is going to get you eventually, if they don’t change the way they look at competition and the different risks in the banking system to allow banks to grow larger.

BD: Acting Comptroller of the Currency Michael Hsu recently gave a speech raising the issue of banks that he referred to as “too big to manage.” He said the OCC is beginning to work on a structure, almost a decision-making tree, of what the regulators could do to deal with a bank that they think is too big to manage. What’s your thoughts on that? Can a bank be too big to manage?
WD: I suppose anything can be too big to manage if you don’t have the right management team to help pay attention to stuff. … We’re a large bank, but we’re in the basic business, probably in the same business as [most of the bankers attending Acquire or Be Acquired]: We serve retail customers with deposits, savings, loans, traditional products. We serve corporate customers with treasury management, and lending products. … But we’re just doing what we’ve done for 165 years.

BD: What have you learned about M&A over the years that you think would be useful for this group to hear?
WD: In the simplest form, understand the reason you’re doing it. Have a clear purpose as to why, other than just trying to get larger. Make all the tough choices that you don’t want to make on people, on technology. Make the choices that are going to hurt today that pay dividends tomorrow. Under-promise, over-perform. Deals are tough. Integration of systems, particularly if both institutions have legacy tech, is really hard. You’ve got to go into it with your eyes wide open, so that whatever comes out of the other side is worth the pain you’re going to cause your employees and sometimes your shareholders.

How to Protect Against the Downside, Prepare for the Upside

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“If you’re left in a situation where you’re defending, where you’re shrinking your balance sheet, where you’re worried about your capital, where you’re continually cajoling shareholders, or clients to stick with you — you’re not focused on growing.”

Those are wise words from William Demchak, chief executive officer of PNC Financial Services Group. PNC is one of the largest banks in the U.S. and an OakNorth customer.

He said this in an interview with the Financial Times in May 2020 — a couple of months after the country had gone into lockdown under full force of the coronavirus pandemic. At the time, he was discussing PNC’s rationale for selling its stake in asset manager BlackRock, which was prompted in part by increasing concerns about the U.S. economy as a result of the Covid-19 pandemic.

But fast forward the clock two and a half years, and he could just as easily be speaking about the economic situation in the U.S. today. Increasing economic uncertainty and interest rates at their highest point since 2008, many commercial bankers are focused on protecting their downside risk. As a result, many are likely missing the upside opportunity.

Protecting Against Downside Risk

1. Granular data. Most banks tend to lump their borrowers into one of a dozen or so broad sectors: all restaurants, bars, hotels, golf clubs and spas, for example, will be classified as “hospitality and leisure.” This classification approach misses the fundamental differences between how these businesses operate and how their capital and operational expenditures may be impacted by changes in the economy. In order to quickly identify where the most vulnerable credits lie in their portfolio, banks need to get to much more granular industry view — even going as far down as 6-digit NAICS codes — in their analysis.

2. Forward-looking scenario analysis. Banks need to be able to run multiple macroeconomic scenarios on their loan book using forward-looking scenarios to explore how a borrower would perform at different financial and credit metric level. This gives them the ability to plan ahead for market changes such as rate rises and house price fluctuation by formulating targeted risk mitigation strategies that can reduce defaults and charge-offs and better manage capital requirements.

3. Proactive monitoring. Banks need to be able to identify potential credit issues faster and earlier, so they can take proactive steps to reduce the chances of negative outcomes during a downturn.

Effectively Navigating Upside Opportunities

1. Granular data. in an economic downturn, there are always winners and losers that emerge; more often than not, it’s specific businesses or sub-sectors rather than entire industries. As consumer confidence wanes and inflation tightens purse strings, it’s likely that budget retailers and discount stores will see increased demand while their high-end alternatives experience the opposite. Both are classified as “retail” but will have dramatically different experiences in an economic downturn. Banks need the right data and tools to identify businesses that may need additional capital to make it through the economic cycle from the businesses that need additional investment capital to pursue potential growth opportunities arising in it.

2. Forward-looking scenario analysis. Banks need to be able to create configurable scenarios that reflect their internal economic outlook by adjusting macroeconomic variables, such as interest rates and inflation, among others. This means they can make more informed decisions about high risk, high opportunity industries and borrowers in their loan book and adjust their activities accordingly.

3. Proactive monitoring. In times of turmoil, most banks tend to segment their portfolio from highest to lowest exposure, starting with their largest and working their way down. Not only is this approach incredibly time consuming, it also means a lot of team time is spent running analysis on credits that don’t end up presenting a credit issue. Banks need to be able to segment credits on a high to low risk spectrum within a matter of hours, so they can identify the credits that require intensive versus light touch reviews, freeing up resources to pursue new loan origination.

Pandemic Offers Strong Banks a Shot at Transformative Deals

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It’s a rule of banking that an economic crisis always creates winners and losers. The losers are the banks that run out of capital or liquidity (or both), and either fail or are forced to sell at fire-sale prices. The winners are the strong banks that scoop them up at a discount.

And in the recent history of such deals, many of them have been transformative.

The bank M&A market through the first six months of 2020 has been moribund – just 50 deals compared to 259 last year and 254 in 2018, according to S&P Global Market Intelligence. But some banks inevitably get into trouble during a recession, and you had better believe that well-capitalized banks will be waiting to pounce when they do.

One of them could be PNC Financial Services Group. In an interview for my story in the third quarter issue of Bank Director magazine – “Surviving the Pandemic” – Chairman and CEO William Demchak said the $459 billion bank would be on the lookout for opportunistic deals during the downturn. In May, PNC sold its 22% stake in the investment management firm BlackRock for $14.4 billion. Some of that money will be used to armor the bank’s balance sheet against possible losses in the event of a deep recession, but could also fund an acquisition.

PNC has done this before. In 2008, the bank acquired National City Corp., which had suffered big losses on subprime mortgages. And three years later, PNC acquired the U.S. retail business of Royal Bank of Canada, which was slow to recover from the collapse of the subprime mortgage market.

Together, these deals were transformational: National City gave PNC more scale, while Royal Bank’s U.S. operation extended the Pittsburgh-based bank’s franchise into the southeast.

“We’re more than prepared to do it,” Demchak told me in an interview in late May. “And when you have a safety buffer of capital in your pocket, you can do so with a little more resolve than you otherwise might. The National City acquisition was not for the faint of heart in terms of where we were [in 2008] on a capital basis.”

One of the most profound examples of winners profiting at the expense of the losers occurred in Texas during the late 1980s. From 1980 through 1989, 425 Texas banks failed — including the state’s seven largest banks.

The root cause of the Texas banking crisis was the collapse of the global oil market, and later, the state’s commercial real estate market.

The first big Texas bank to go was actually Houston-based Texas Commerce, which was acquired in 1986 by Chemical Bank in New York. Texas Commerce had to seek out a merger partner after absorbing heavy loan losses from oil and commercial real estate. Through a series of acquisitions, Chemical would later become part of JPMorgan Chase & Co.

Two years later, Charlotte, North Carolina-based NCNB Corp. acquired Dallas-based First Republicbank Corp. after it failed. At the time, NCNB was an aggressive regional bank that had expanded throughout the southeast, but the Texas acquisition gave it national prominence. In 1991, CEO Hugh McColl changed NCNB’s name to NationsBank; in 1998, he acquired Bank of America Corp. and adopted that name.

And in 1989, a third failed Texas bank: Dallas-based MCorp was acquired by Bank One in Columbus, Ohio. Bank One was another regional acquirer that rose to national prominence after it broke into the Texas market. Banc One would also become part of JPMorgan through a merger in 2004.

You can bet your ten-gallon hat these Texas deals were transformative. Today, JPMorgan Chase and Bank of America, respectively, are the state’s two largest banks and control over 36% of its consumer deposit market, according to the Federal Deposit Insurance Corp. Given the size of the state’s economy, Texas is an important component in their nationwide franchises. 

Indeed, the history of banking in the United States is littered with examples of where strong banks were able to grow by acquiring weak or failed banks during an economic downturn. This phenomenon of Darwinian banking occurred again during the subprime lending crisis when JPMorgan Chase acquired Washington Mutual, Wells Fargo & Co. bought out Wachovia Corp. and Bank of America took over Merrill Lynch.

Each deal was transformative for the acquirer. Buying Washington Mutual extended JPMorgan Chase’s footprint to the West Coast. The Wachovia deal extended Wells Fargo’s footprint to the East Coast. And the Merrill Lynch acquisition gave Bank of America the country’s premier retail broker.

If the current recession becomes severe, there’s a good chance we’ll see more transformative deals where the winners profit at the expense of the losers.