Why I Am Long National City

PNC Financial’s (PNC) purchase of National City (NCC) is an absolute travesty for National City shareholders and for the banks that chose to forgo a purchase of the Ohio lender.  The company’s recent quarterly report was fairly positive in my opinion, as it showed a company that was well positioned to survive the current turmoil in the economy and the credit markets. 

Of all the majors, National City had the highest capital ratio, at 10.98% at the end of the September quarter.  While loan losses were and still are a concern, the firm’s relatively strong capital position had caused me to believe that it would likely be one of the banking industry’s survivors and likely one of the new mega-regional banks to come out of the industry’s consolidation.

Unlike Washington Mutual (WM) and Wachovia (WB), National City has not experienced any deposit outflows and is still flush with liquidity. In fact, National City’s deposits actually increased in the most recent quarter when compared to the year ago quarter.  When this is coupled with the bank’s relatively strong capital base and the company’s $3.8B in loan loss provisions to non-performing assets of only $3.5B, the choice to sell the bank becomes even more cloudy. 

Barring a run on the bank, National City could have continued on its own with current loss rates for another two years.  However, this would likely be a worst case scenario as loan loss provisions have already begun to decline at many of America’s banks, including National City, which saw loan loss provisions decline 25% from the preceding quarter.  

So why did National City sell?  Because it’s likely that it believed that it had no choice.  The Wall Street Journal does a wonderful job of providing a time line of the National City sale and does a good job of alluding to the possibility that National City may not have been able to participate in the government’s capital injection program.  The Wall Street Journal then alludes to the possibility that this caused the bank’s executives to fear that the company’s stock would collapse along with its deposit base as shareholders and customers scrambled to withdraw cash.

Unfortunately, the government’s forced sale of National City succeeds in showing the investment community that it is taking its role as king maker in the banking industry too far.  There are many other smaller regional banks in far worse positions that could have been dealt with first, including such abject failures as Downey Financial (DSL), Bank United (BKUNA), Flagstar (FBC), AmTrust Bank, Guaranty Financial (GFG) and Colonial BancGroup (CNB).  In forcing National City to sell itself, the government has shown the utterly arbitrary fashion by which it will decide who lives and who dies.  

Fortunately, for National City and its shareholders, the company was not seized and given that the stock is trading at nearly 20% below PNC Financial’s offering price, management should cancel the deal and attempt to go at it alone.  Given the bank’s large reserves and relatively healthy capital position, management would be negligent not to try, given the low offer from PNC Financial.  I would personally rather have the bank seized and take a total loss on my holdings then have it sold to PNC Financial at $2 dollars and change.  The bank’s large asset base, branch network, geographic concentration, Visa (V) stake, $6.6B in excess capital and $100B in deposits are diamonds in the rough and could, if nothing else, lead to a sale in several years for a much more significant sum than is currently being offered by PNC Financial.

In not purchasing National City, several banks are missing out on an acquisition that would be of tremendous benefit to their business models and their shareholders.   Should management not renege on the merger agreement, I would not be surprised to see U.S. Bancorp (USB), Regions Bank (RF), BB&T (BBT), TD Bank (TD) and Bank of the West  (owned by BNP Paribas (BNPQY.PK)) seriously look at National City.  This will be especially true if the volatility in the financial markets declines in the weeks ahead.    

The two most compelling names, of those listed above, are TD Bank and Bank of the West as it would provide these two companies with the opportunity for national expansion via the National City name.  Both BNP Paribas and Toronto Dominion have been looking at the U.S. for years and they would likely be able to pull off the acquisition without government assistance, which would be a boon for the Treasury Department.  Given the incredible attractiveness of National City at these price levels, these two international power houses could offer between $3 & $4 dollars a share in stock and still make their shareholders very happy in the years ahead. 

It is clear to me that the government’s botched involvement in National City is a sign of the dangers tied to the government’s bank bailout program.  Before mandating future sales, the Treasury and its agencies need to outline and publicly release the key metrics that have caused the government to request the bank’s sale.  

Disclosure: Long NCC @ 1.40 & Change.

Comments

[smpl5:]

I was in agreement with the ideas here, and was (and still am) long NCC. I believed that the stock's "fair" value was far above what PNC, apparently brokered by the Treasury, paid for it -- easily twice or three times the amount. Perhaps the shares in PNC that I will receive under the buyout will eventually result in a breakeven for me, I had far greater aspirations for this investment and believe that NCC management was on track to deliver.

I think this government intervention in markets was both inappropriate -- favoring one class of investors (bondholders) over another (shareholders) -- and imprudent. I had been planning additional investments in the financial services sector but will now be hesitant given the specter of further interventions like this.

2008 Oct 27 01:49 PM

[markdauvid:]

absolutely correct and it is unfortunate that the people that we call government overseers can't find their butts with both hands, a road map, and a gps. they have chosen to force the sale of a bank that can make it on its own for pennies just like citi wanted to buy wachovia. these dumbos are allowing fire sale prices on banks and the money in most cases is money from we the people. we the people are paying to make borrowing banks larger and i don't doubt larger salaries for their executives all paid for by we the people.

2008 Oct 27 04:50 PM

[mik123:]

I read today most analysts were shocked that National City sold when they didn't have to. All had much higher price targets. With all the recently passed legislation, there is 0% chance of failure. Then I read that GOP Rep. Steven LaTourette is seeking Treasury Department and congressional investigations into whether Comptroller of Currency John Dugan steered $7.7 billion of taxpayer bailout money to his former client. PNC, so it could buy National City Bank. LaTourette said Dugan represented PNC as an attorney until August 2005 before starting his current position as Comptroller of Currency. He may be back working for PNC in 2-3 weeks with a new administration due January. It was reported that a week before the PNC - National City deal ,Dugan called National City CEO Raskind and said he shouldn't expect rescue money. It was reported that Dugan was heavily involved in the sale and was pushing for a deal by last Friday. LaTourette, a member of the House Financial Services Committee, wrote a letter to Paulson and Barney Frank requesting a probe. He also expressed concern that the bailout stipulated that the treasury could only give a bank 3% of its risk-weighted assets and PNC received 6%. This sale was so hurried because the treasury would look bad if they handed money to everyone else today and it became public they said no to the nations 7th largest bank. There would be public outrage because the whole purpose of the 700 billion was to rescue the banks.That's what the public was sold. There are no top 35 banks left other than National City that analysts were projecting a loss for 2009. National Citys loss projection is small at -.34 cents or apx 700 million. You can get earnings by going to smartmoney.com and put the ticker symbol in and click on earnings projections. My biggest question is why Goldman Sachs is receiving 10 billion in rescue money when they have nothing to rescue other than their share price. The biggest mistake with the 700 billion rescue plan was not having a congressional oversight committee allocate the money.

2008 Oct 27 08:21 PM

[jsc173:]

My observation is you are not taking into consideration what you might not know. The regulators handcuff banks using confidential MOUs (Memoranda of Understanding). As will see if you look at the post mortem on IndyMac, the government imposed lots of controls on Indy, but those controls were kept secret. You will not receive the explanation you wish from the government.

My suspicion is there's a lot none of us know about NCC and may not know, even though the optics (capital ratios, etc.) don't look horrific.

However, much in the same way Citi's aborted attempt to acquire Wachovia wound up being a JPM acquisition, if what you say is really true -- NCC is a giveaway at $2.23 -- then a "white night" will rescue them from PNC at something north of $2.23.

Right?

2008 Oct 28 03:42 PM

[c smith:]

However, this would likely be a worst case scenario as loan loss provisions have already begun to decline at many of America’s banks, including National City, which saw loan loss provisions decline 25% from the preceding quarter.

So why did PNC mark the NCC loan book at levels $10 billion lower than NCC did just a week prior?

2008 Oct 28 04:34 PM

[gofigr:]

Apparently management agreed and why is nobody else seeing enogh value to step up as a whilte knight. Does NCC still have the option to even consider another offer. I sure hope so.

2008 Oct 30 08:34 AM

[Onegus:]

Not addressing it correctly, basically it’s a quick fix and for deal makers a dream come true.

PNC will see a run on assets after the merger, the loyalty will be lost in NCB regional market. Those asset accounts will migrate to KEY bank not all but much of them will.

The issue of bad paper will continue until at least thirty percent of the value of real property is lost. Who holds that new paper and what terms will they offer? More down better income to debt ratios? That and higher interest at lower market prices. Pay off you home and then begin to save.

A more efficient market, has a more streamlined approach banks that are regional actually valuing the properties conservatively. Building and encouraging personal financial well being in the region they serve. That’s the opposite of what is happening isn’t it?

It not about the paper, it what is behind the paper. That would be you and me and the communities that we exist in. Does the treasury consult the housing department? Oh no we could never have that level of synergistic planning in government. Why? Something about a deal maker and dreams of an Austin Martin Vanquish I suppose?

The bad mortgages are for nearly every home purchased since 2000, the values of some homes are twice what they are worth. The average home price has to cluster around the average household income. Housing has to align with income, one third of Americans have household incomes under twenty-five thousand.

If we survey graduates from architectural colleges we find none are interested in building affordably, the lower end market exists in federal subsidy and in blighted urban areas. That’s the base of housing the core of the rotten apple. The income as you progress from that of nothing to that of twenty five thousand, it occupies obsolete housing. We have recently artificially inflated that base. The homes value is at full compliance to codes and that is a variance ignored. The amount plus the costs to repairs and upgrade places many homes outside of the market that currently occupies them. These homes are also inefficient with little or no insulation and often have antiquated heating systems. The cost of heating these homes subsidized with energy assistance programs.

The lower the value of inner city property offer opportunity for improvement. The lower value plus costs up upgrading or in some instances demolition. The prices would meet the market at the level inherent in that as a definable function. The price to acquire, the price to upgrade and market for sale. That’s cost control the material and labor and for that to happen prices cannot be allowed to inflate.

The government is failing, it should regulate to insure the market meets demand at the lowest income, breakevens are set on real incomes. We screwed up on this because we are subsidizing losses not sustainability.

The attempts to force lending to those that do not have the financial wherewithal inflated the entire market. It is difficult to estimate but the variance between income and value could be as much as thirty percent, I suspect it is higher.

The income has to define the market and the effort to mix incomes destructive, low income has to be concentrated into high density, and bear costs in full. Modest, clean safe and affordable. The pricing set so that excess exists, an ability to save for the down payment of a home if so desired. Then the next tier, modest homes at affordable prices, these cannot be outdated dilapidated century homes. The levels have to be defined by income ranges.

Unfortunately math rules and if outside of limits as I believe we are, pursuing the current approach will never work, its an attempt maintain false value.

This goes so far beyond finance, we are actually running on finance and chasing the ultimate limit, that being the total devaluation of the dollar.

Long term urban development models, that apply what many have learned. It all begins with close in housing that is clean safe and affordable. With transit services that connect to commercial and industrial areas. The key is to offer it to those that can afford it prices that meet the market until the market is satisfied.

The only measure of wealth is capital, real savings. It should be obvious that the best move up the ladder the smartest and the brightest. The purpose of government is to regulate that to insure that the market is meet.

2008 Oct 31 01:00 AM