It will never be as critical as a capital ratio or foretelling as a net chargeoff ratio, but to gauge PNC Financial Services Group Inc.'s progress with its National City Corp. acquisition, consider PNC's square footage per employee.
It seems like an unlikely ratio to draw concerns from PNC executives at the moment — until one considers what is at stake.
Four years ago PNC had about 280 square feet of space for each employee. As a result of a major cost-cutting initiative, that figure was cut to 230. But more efficient competitors make do with 180 square feet per employee, and that is where PNC wants to take Nat City, where the ratio is almost twice that.
"When we get it to 180" square feet, "that'll save us about $70 million on an annual basis," James E. Rohr, PNC's chairman and chief executive officer, said Thursday on a conference call with analysts.
And getting the ratio down would be one more way for the Pittsburgh company to build its case that acquiring Nat City was a smart decision.
Investors got their first look at the acquisition's benefits Thursday, when PNC reported a 38% increase in first-quarter earnings from a year earlier, to $530 million, or $1.03 a share. The increase spoke to the power of purchase accounting.
Taking on Nat City — a move that nearly doubled PNC's assets and catapulted it into a new weight class in the banking industry — was not without its drawbacks.
Nonperforming assets jumped 59.1% from a quarter earlier, to $3.5 billion at the end of the first quarter. The increase reflected both a deterioration in the economy and a review of Nat City's loan book, which already had been written down substantially by the time the acquisition closed.
"PNC's credit deterioration has been the worst among all the large banks for two quarters in a row now, and they pointed out that a good portion of the credit deterioration this quarter came from National City," said Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets, who has a "sector perform" rating on PNC shares. "Their assumptions at the time of the deal were not conservative enough to capture the rapidly rising NPAs that we saw this quarter."
Countering that, though, was a spike in net interest income that drove PNC's net interest margin up 72 basis points from a year earlier, to 3.81%, mainly as a result of purchase accounting — the same method that Wells Fargo & Co. used to structure its acquisition of Wachovia Corp.
"When you do a purchase deal and mark down the assets like Wells and PNC did, there is a very definite benefit to the buyer for the first 12 to 18 months," Cassidy said.
Gerald Hanweck, a finance professor at George Mason University's School of Management, said that once the accounting advantages are stripped away, banking companies that appear to be benefiting from acquisitions still have a lot left to prove.
"Those kinds of things have nice effects on the balance sheet and income statement, but they're really not cash flow, and that's what I'm looking for," Hanweck said. "You're going to accumulate lots of deposits" when making acquisitions. "Can you put them to better use, or are you just going to be funding legacy assets and loans?"
PNC reported net chargeoffs of $431 million. Its net chargeoff ratio fell 8 basis points from a quarter earlier, to 1.01% of average loans. The allowance for loan and lease losses climbed 10.3%, to $4.3 billion, or 2.51% of total loans.
The tangible common equity ratio increased 40 basis points from the fourth quarter, to 3.3%, while the Tier 1 risk-based capital ratio rose 50 basis points, to 10.2%.
"The good news is that PNC had the pre-provision earnings wherewithal to absorb a higher-than-expected provision and still beat estimates," R. Scott Siefers, an analyst with Sandler O'Neill & Partners LP, wrote in a note to clients. "However, the magnitude of deterioration in nonperformers (should it portend higher credit costs in coming quarters) may spook investors a bit."
That will make it all the more important for Rohr to show other ways in which the Nat City acquisition is paying off.
On Thursday he said the acquisition is exceeding his expectations and would be accretive for the full year. PNC already has implemented a standard loan approval process and a centralized loan and deposit pricing policy, he said. It is also migrating toward common compensation practices, eliminating duplicate contractors and preparing to get customers on board with the integration.
"The first wave of customer conversions is scheduled for the fourth quarter of this year, and that process will continue through 2010," Rohr said.
PNC said it has cut about 800 jobs and used its enhanced purchasing power to take advantage of bulk discounts from suppliers. None of that was unexpected.
What has surprised Rohr "has been the enthusiasm of the National City employees to embrace PNC and really to just get on with the integration," he said in response to an analyst question about the early integration process. "The 18 months before the acquisition was probably tough, and as a result they really see this as a tremendous opportunity to start over."
Albeit with a little less office space, perhaps.
