PNC Considers Selling BlackRock Stake

NEW YORK ( TheStreet) -- Shares of BlackRock ( BLK) have returned a whopping 42% this year through Tuesday's close of $291.69, and that's a very big deal for PNC Financial Services Group ( PNC).

PNC of Pittsburgh "owned approximately 36 million common stock equivalent shares of BlackRock equity" as of March 31, according to the bank's 10-Q filing, with a carrying value of $5.6 billion. PNC "accounts for its investment in BlackRock under the equity method of accounting," according to the filing, "exclusive of a related deferred tax liability of $1.9 billion at both March 31, 2013." The bank's voting interest in BlackRock common shares is about 21%.

But the market value of PNC's common stake in BlackRock was $9.2 billion as of March 31, and the value of the BlackRock stake rose to more than $10.5 billion as of Tuesday's close.

PNC is leaving a lot of money on the table. Then again, because of the accounting treatment, the BlackRock stake added $138 million in revenue and $108 million in net income to PNC's first-quarter results.

"Obviously the BlackRock state for PNC has been a long-term, very valuable relationship," PNC Chief Financial Officer Rick Johnson said at a conference on Tuesday, according to a transcript provided by Thomson Reuters, adding that "clearly the value of what we hold is worth a lot more and sits on our books today."

"At some point we have to clearly recognize that value and do something, and when we do it, I think we would like to do it in the most tax-efficient manner possible," Johnson said. He hinted that it could take some time for a sale to be made, as "there's still a lot of regulation left to be determined, both from a PNC and a BlackRock side to decide how both companies move forward in this environment."

PNC's first-quarter net income attributable to common shareholders was $938 million, or $1.76 a share, increasing from $766 million, or $1.44 a share, during the first quarter of 2012. The bank's first-quarter return on average assets (ROA) was 1.34%, improving from 1.16% a year earlier, while its return on average common equity (ROCE) was 10.68%, improving from 9.41% during the first quarter of 2012.

That is a respectable ROCE in the current environment, however, it pales when compared to U.S. Bancorp ( USB) of Minneapolis, the shining star among large regional banks, with a first-quarter ROA of 1.65% and ROCE of 16.0%. Wells Fargo ( WFC) has a national footprint, but is often thrown in for comparison to the large regionals, and reported a first-quarter ROA of 1.45% and a return on average common equity of 14.16%, according to Thomson Reuters Bank Insight.

Johnson on Tuesday discussed how the company is seeking to improve its efficiency ratio, which it reported to be 63% during the first quarter. "That's not good enough, and I think we get that," he said. "A lot of that is because of the bets we have on the table, the majority of those bets, the investments that were made and how long it's going to take to get a return on those, and that's one of the reasons we focus so hard on expenses."

The efficiency ratio is, essentially, the number of pennies of expenses incurred for each dollar of revenue; lower is better. U.S. Bancorp's first-quarter efficiency ratio was 50.7%, while Wells Fargo reported an efficiency ratio of 58.3%.

When discussing PNC's efforts to improve the efficiency ratio, Johnson said, "I think we need to be in the high 50s." He threw a big bone to investors when he said "the business model will generate over time mid-teen return on tangible equity."

Johnson plans to step down from his chief financial officer role in the third quarter, with PNC veteran Robert Reilly slated to take over the position. In April, William Demchak took over as PNC's CEO, with former CEO James Rohr taking the position of executive chairman, with plans to retire in 2014.

Atlantic Equities analyst Richard Staite rates PNC "overweight," with a price target of $76. Staite discussed Johnson's comments on a possible sale of the BlackRock stake and efficiency improvements in a note to clients on Wednesday, writing that "we welcome such comments and see them as an indication that new management is more focused on driving shareholder returns."

"We have long argued that PNC should be able to generate higher profitability out of its existing franchise," Staite wrote, adding that "there might be room to surprise on the upside" as the company works to cut costs over the next several quarters.

Staite also said that "previously there was no indication that PNC would consider selling the 22% stake it owns in BLK," underscoring a big change in plans by the bank's new management team. But the analyst underscored the complications of a sale: "We think that exiting the stake would add shareholder value but a simple sale might trigger a large tax bill and it is unclear if the surplus capital could be immediately returned to shareholders. PNC would need to think hard about the best way to structure an exit."

Oppenheimer analyst Terry McEvoy rates PNC "outperform," and in a note to clients on Wednesday wrote, "We recently raised our price target to $78 to reflect higher bank stock valuations and the increase in market value of BLK, which at current prices would add roughly $6/sh to tangible book value if sold."

"In 2012, PNC recorded $395M in net earnings related to BlackRock, accounting for approximately 13% of the company's total net income. We estimate this translates into a high teens ROE on the investment today, a greater rate of return than PNC's core banking business," McEvoy wrote.

While saying the estimates were "purely an exercise," McEvoy wrote that "if PNC sold its entire BlackRock stake today, we estimate after-tax proceeds of approximately $6.8B. Assuming regulatory approval, PNC could theoretically repurchase 96M shares of its common stock." When factoring in the decline in earnings from the BlackRock stake, as well as a lower share count after the buybacks, McEvoy estimates that his 2014 earnings-per-share estimate for PNC would increase by 2.5%. The analyst currently estimates PNC will earn $6.60 a share this year, with EPS growing to $6.70 in 2014.

PNC's shares closed at $72.20 Tuesday, returning 25% this year, following a 4% return during 2012. The shares trade for 1.4 times tangible book value, according to Thomson Reuters Bank Insight, and for 10.5 times the consensus 2014 EPS estimate of $6.88, among analysts polled by Thomson Reuters.

Based on a quarterly payout of 44 cents, the shares have a dividend yield of 2.44%.

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.