National City's Earnings: The Loss Was Expected

| About: National City (NCC)

Yes it is a loss, yes it was expected. What do we care about? Deposits are growing, Tier 1 remains high and operating income is up. (Click for Conference Call Transcript)

The Headlines:
• Net Loss of $729 Million Driven by Continued Actions to Build Reserves; Loan Loss Provision Declines 25% from Second Quarter

• Pre-Tax Pre-Provision Operating Earnings of $636 Million Up 17% Year-Over-Year

• Tier 1 Capital Ratio of 11% Among Highest of All Major U.S. Banks and $6.6 Billion Above Regulatory “Well-Capitalized” Minimum

• Retail Deposits Stable in Quarter and Grow Year-Over-Year, Reflecting Steady Household Growth and Expansion

• Net Charge-offs Flat with Second Quarter Excluding Writedowns from Reclassification of Marine Loans to Held for Sale

• $8.4 Billion of Exit Portfolio Loans, Representing 8% of Total Loans, Account for 40% of Total Charge-Offs; Remaining Exit Portfolio Shows Stable to Improving Trends

• Performance Improvement Initiative Targets Total Annual Savings of $500-$600 Million by 2011; $240 Million to be Realized in 2009

Details:

National City Corporation (NCC) reported a net loss for the third quarter of 2008 of $729 million, driven primarily by continued actions to build loan loss reserves. This compares to a net loss of $1.8 billion in the second quarter of 2008, and a net loss of $19 million in the third quarter a year ago. On a year-to-date basis, the net loss was $2.7 billion in 2008 compared to net income of $647 million in 2007.

Diluted net loss per common share was $5.86 for the third quarter of 2008 and $9.51 on a year-to-date basis, inclusive of a $4.4 billion one-time noncash preferred dividend recorded in September 2008 on convertible preferred stock issued as part of National City's $7 billion capital raise completed in April. The non cash dividend had no impact on total capital or net income. Excluding it, diluted net loss per common share would have been $.85 in the third quarter of 2008 and $3.60 on a year-to-date basis based on weighted average common shares outstanding of 877 million and 745 million, respectively. As of September 30, 2008, post conversion of preferred shares, the Corporation had approximately 2.0 billion common shares outstanding. Had those shares been outstanding from the beginning of the period, diluted net loss per common share would have been $.37 for the third quarter of 2008, exclusive of the noncash preferred dividend.

The provision for loan losses was $1.2 billion, down $408 million, or 25%, from the preceding quarter. Net charge-offs were $844 million in the third quarter of 2008, up $104 million from the preceding period due to $134 million of writedowns from reclassifications of loans to held for sale.

Pre-tax pre-provision operating earnings were $636 million in the third quarter of 2008, about equal to the preceding period, and up $93 million from the third quarter a year earlier. On a year-to-date basis, pre-tax pre-provision operating earnings were approximately $1.9 billion in both 2008 and 2007.

As of September 30, 2008, the Corporation’s Tier 1 risk-based capital ratio was 10.98%, $6.6 billion in excess of the well-capitalized minimum. Total risk-based capital was 14.86% and tangible equity to assets was 8.93% at September 30, 2008.

The "Exit Portfolio" is responsible for the majoirty of losses and it is shrinking:
The Corporation’s Exit Portfolio (formerly termed “Liquidating Portfolio”) was formed so that loans remaining from exited businesses and discontinued products could be managed separately from National City’s core retail banking, corporate banking and wealth management businesses. This $21 billion portfolio consists of broker-originated home equity loans, nonprime mortgages, non-agency mortgages, residential construction loans, and automobile, marine and recreational vehicle loans originated through dealers.

These loans, which are in run-off mode, have been declining about $500 million per month, and are actively managed to mitigate losses by a dedicated team headed by recently appointed Executive Vice President James LeKachman, an experienced risk management executive. Significant resources and talent are devoted to this effort, which includes ongoing evaluation of potential strategic alternatives. Undrawn home equity lines have declined $2.9 billion since year end.

“A limited number of segments within our Exit Portfolio generated the majority of net charge-offs for the quarter,” said Mr. Raskind. “Specifically, $8.4 billion of Exit Portfolio loans, representing 8% of the company’s total loans, accounted for 40% of total net charge-offs. The remainder of our Exit Portfolio showed stable or improving trends. Importantly, we have no exposure to Option ARM-type mortgages. We are actively managing down and mitigating losses from the Exit Portfolio and have the capital flexibility to consider a variety of alternatives for these loans.”

Loans 90 days past due were $1.1 billion at September 30, 2008, down somewhat from June 30, 2008, primarily due to a lower level of delinquent residential real estate loans within the Exit Portfolio. Average core deposits, excluding mortgage escrow and custodial balances, were $83.3 billion in the third quarter of 2008, up $5.7 billion compared to the third quarter a year ago.

So, has the reasoning for buying National City fallen? No. Remember we bought National City because its core business was stable and growing, was adequately reserved and the loan portfolio was, while challenging, not worsening.

We are NOT seeing a Wachovia (NASDAQ:WB) or WaMU (NYSE:WM) situation where we are having either a run on deposits or loan losses overwhelming the bank. What we do have is a stable bank in a miserable environment. Will they take money from the government? Will there be a buyer? I think the answer to both of those is maybe.

The real good news is that the bank has the option of governmentt money as back stop should it think it needs it. That being said, we know the bank will not go under and loan writedowns are not an infinite proposition. There is an end.

If the bank is still independent when that comes, substantial profits will come. My guess is though that once the Treasury begins handing out multi-billion dollar checks to banks, National City becomes part of another bank.


Disclosure: Long NCC