National City Just a Victim of Its Industry

Gary Townsend is way too tough on National City’s (NCC) top management and the capital allocation decisions it made last year, in my view. Oh, sure, if the company knew then what it knows now, it wouldn’t have done a big share buyback in early 2007.

But it turns out—surprise!—the company isn’t clairvoyant. Rather, it relied on the best information it had at the time. One such piece of information, about which there was universal agreement back then, was that the company was overcapitalized following the $1.3 billion sale of its First Franklin subprime lending unit in late 2006. After the deal closed, National City saw it had an above-average capital ratio but only modest prospects for loan growth. It was widely applauded, then, when it responded to its dilemma by announcing $2.9 billion share repurchase via Dutch auction.

The argument that this was a bad management decision depends on an almost willful amnesia. There simply was no controversy over the buybacks at the time. Gary certainly didn’t criticize them. (In fact, if I remember correctly, he upgraded National City’s stock after the details of its Dutch auction were announced.)

What’s more, the company’s operating performance in 2006 was strong. For the full year, National City earned $2.3 billion in net income and generated an ROE of 18%. Its year-end capital-to-assets ratio rose to 10.4% from 8.9% the prior year.

To say now that the company shouldn’t have bought back stock because it was about to be engulfed by a credit crunch of historic proportions, that basically no one saw coming, is not very convincing, to say the least.

I also don’t agree with Gary’s criticism of management’s decision to raise the common stock dividend in 2007. The company wouldn’t make the same decision now, sure. Even so, common dividends paid in 2007 came to $970 million, just $50 million more than the company paid out in 2006. Given that National City’s capital base is $13.4 billion, I don’t think the $50 million in higher dividends paid in 2007is a real factor in the company’s currently stressed condition.

National City is by no means the only company that’s been turned upside down by the meltdown in the subprime mortgage market. If anything, it prepared for the collapse much better than most lenders did. (For one thing, the company was able to sell its subprime business for a meaningful amount of money; most of its competitors either had to shutter their lending units, or went bankrupt.) To single out National City for mismanaging problems that beset the entire industry strikes me as a serious mis-remembering of the record.

Tom Brown is head of BankStocks.com.

Comments

[DSX Lover]

I agree with most of this issues except for the Buyback.NCC is selling for .39 cents on Book. Where do you Townsend gets the 6.53% Tier one capital, if the Bank had 13.4 Billion in Capital over 150 Billion in assets, thats way more than 6.53%, and it will have a huge profit in Q1, because it has a $406 Million profit for 1/3 of its stake in VISA. The other 2/3 of its stake will be unrealized, and is worth more because VISA shares are up. The Buybacks were stupid, but the dividends were not, all these Banks paying high dividends were paying about 50% of earnings, while growing at lower levels, so those dividends were sustainable, as long as the asset quality did not deteriorate. NCC, FITB, WM, C, WB have had horrible risk management, in the other hand, RF, USB have high dividend yields, and asset qualitiy is still excellent for USB, and manageable for RF, I would like to see when CMA reports on Thursday, how are their assets, because after today's reports of USB, and RF, the credit conditions, are manageable by most financial institutions. NCC is worth more than the $7.5 it closed for yesterday, Is is not the same JUNK as WAMU, NCC has a strong franchise, and corporate clients, unlike WAMU who only has mortgages, as earning assets, and horrible credit risk management.

[Weejen]

Oh so true. Banks as a whole have been beaten down too far. They aren't going away anytime soon. They will find a way to make more "fees" on each and every transaction, just like the airlines are (ie., charging for that second bag). Todays "investors" are not the steady eddie investors of the past. Remember, you're supposed to be investing for the LONG TERM. For most of todays investors that means between 3 days and 3 months. The bank sector is a fantastic sector to place a "portion" of your overall portfolio. I certainly have. Check back on the financial stocks in 3 to 4 years and you will wonder why you didn't have more money in them.

[valueguy123]

I am a long term investor, but being a long term investor does not mean I need to own bad companies for a long period of time. I never owned NCC and never will. My guess is they will share the same fate of Bear Stearns which is a takeunder. I will stick to the quality bank names like HCBK, WFC, JPM etc.

[DSX Lover]

HCBK-overpriced, horrible ROE, excessive conservatism. 29.8 P/E
SHORT HCBK go long any other of the below book banks, you will become millionare, its not too hard to figure it out.

[DSX Lover]

HBCK great employment of Capital, keep buying back stock at 29 P/E.

[stonebluff]

It is idiotic for a banking institution EVER to buy its own shares at 5 times tangible book. I wrote NCC in protest at the time and got a "board in its infinite wisdom" reply. NCC was not alone, of course. Banks should by law be prohibited from buyingback their stock above tangible book without regulators permission and options of bank employees should never be exercisable at a price below book (I don't say tangible book here). This crisis would be minute by comparison had this rule been in place. They should take a bank like WFSL as their model.