Why I Bought National City Corp Shares

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 |  About: National City Corp. (NCC)
by: Todd Sullivan

Bought shares of National City yesterday at $2. Here is why.

National City has said it has no exposure to adjustable rate mortgages and exposure to residential market is substantially less than Wachovia (NASDAQ:WB) and Washington Mutual (NYSE:WM).

Q2 results (ending 6/30) were as follows:

  • Net Loss of $1.8 Billion Driven By Actions to Increase Loss Reserves on Liquidating Loan Portfolios; Includes $1.1 Billion After-Tax Non-Cash Goodwill Charge Related to Previous Acquisitions — No Effect on Regulatory Capital;
  • Excluding Unusual and Non-Operating Items, Pre-Tax Pre-Provision Operating Earnings Were $610 Million, Up 19%;
  • Tier 1 Capital $7 Billion over Well Capitalized Minimum; 11.1 % Tier 1 Capital Ratio Highest of All Major U.S. Banks;
  • Net Charge-Offs of $740 Million, Predominantly in Liquidating Loan Portfolios Versus $1.6 Billion Provision for Loan Losses; Nonprime Delinquencies Down;
  • Solid Progress in Actively Managing Liquidating Loan Portfolios, Which are Isolated, Contained, and Performing in Line with Expectations;
  • Aggressively Re-Focusing on Core Businesses, Which Remain Profitable; Deposits Continue Solid Growth Trend;
  • Enhanced Leadership Team Intensely Focused on Managing Risk, Controlling Expenses and Improving Profitability.

Chairman, President and CEO Peter E. Raskind commented at the time:

"We believe we have clearly identified and segregated our portfolio of non-core assets and have much better visibility regarding loss estimates than we did earlier this year. As a result, we expect the provision for loan losses to decline in the second half of 2008. Our liquidating portfolios are isolated and contained, and are performing in line with expectations. More importantly, we are making progress in reducing the size of the liquidating portfolio and mitigating associated losses,” continued Raskind. “National City was among the first in our peer group to raise capital and build reserves. Our strong capital position not only enables us to fully address the ongoing challenges in the credit and housing markets, but also allows us to continue investing in and growing our core businesses, which continue to be profitable.

Here is the management discussion on Mortgages from the 8-K:

Mortgage-backed securities are collateralized primarily by prime residential mortgage loans. At June 30, 2008, approximately $124 million of the mortgage-backed portfolio represented securities collateralized by Alt-A first mortgage loans. Asset-backed securities are primarily collateralized by nonmortgage assets, principally bank and insurance company subordinated debt. The asset-backed portfolio also included $39 million of securities collateralized by home equity loans and lines to nonprime borrowers.

Management values the securities portfolio using observable market prices, when available, or a third-party pricing service or market-maker to determine fair value based on trade activity for the same or similar securities. At June 30, 2008, the securities portfolio had net unrealized losses of $119 million, comprised of gross unrealized gains of $113 million and gross unrealized losses of $232 million. Gross unrealized losses increased from $79 million at December 31, 2007 due to declines in the value of mortgage and asset-backed securities. During the first half of 2008, the value of these types of securities decreased due to an increase in credit spreads and a lack of liquidity in the capital markets. Total unrealized losses at June 30, 2008 on mortgage- and asset-backed securities collateralized by Alt-A first mortgage loans and nonprime home equity loans were $15 million and $4 million, respectively. The remainder of the losses related primarily to investment grade securities secured by prime residential first mortgage loans.

Management evaluates the available-for-sale securities portfolio for possible other-than-temporary impairment on a quarterly basis. During this review, management considers the severity and duration of the unrealized losses as well as its intent and ability to hold the securities until recovery, taking into consideration balance sheet management strategies and its view of the market. Management assesses the nature of unrealized losses taking into consideration factors such as changes in the risk-free interest rate, general credit spread trends, market supply and demand, creditworthiness of the issuer, credit enhancements and the quality of the underlying collateral. Other-than-temporary impairment losses of $29 million and $45 million were recognized on certain asset-backed securities and nonprime mortgage-backed securities during the second quarter and first half of 2008, respectively. There were no other-than-temporary impairment losses recognized in the second quarter or first half of 2007.

Excluding these impaired securities, there have been no recent credit downgrades of any mortgage or asset-backed securities with a material unrealized loss in the portfolio by either Standard & Poors or Moody’s Investors Service. For certain securities, management also reviewed the performance of the underlying collateral and considered the securitization structure, but did not find any indication of any security-specific credit concerns. Management believes the primary reason for the unrealized losses on securities is general credit spread trends caused by market concern over the credit quality of residential mortgages, an imbalance between market supply and demand for these securities, and in some instances, an increase in the risk-free interest rate at June 30, 2008 compared to the risk-free rate at the security’s acquisition date. Management has the intent and ability to hold these securities to recovery. Therefore, management concluded that none of the remaining unrealized losses on the securities in the available-for-sale portfolio represented an other-than-temporary impairment as of June 30, 2008.

Regarding credit risk:

During the second quarter of 2008, core commercial and retail credit quality was stable and loss rates remained low. Commercial real estate, in particular loans to residential real estate developers, has been affected by the continued weakness in the housing markets. Residential real estate and home equity lines of credit have also been adversely affected by declining housing values and pressures on consumers from rising fuel and food prices. Management expects that the weakness in the housing markets will continue to adversely affect the credit quality of the residential real estate portfolio through 2008 and into 2009.

During 2007 and 2008, the Corporation curtailed certain mortgage and home equity products and exited broker and correspondent origination channels. These portfolios of broker-sourced nonprime mortgage loans, broker-sourced home equity lines and loans, construction loans to individuals, and indirect automobile, marine and recreational vehicle loans are liquidating. Management has chosen to limit future lending to direct relationships with consumers. Mortgage offerings now consist substantially of loans that are readily salable to government sponsored entities. Home equity products are now limited to loans and lines originated throughout the bank branch network, which have historically been of high credit quality.

I spoke to a National City spokesperson today and gleaned the following information:

My concern about NCC was that a Washington Mutual (WM) or Wachovia (WB) scenario would unfold in which depositors withdrew funds and caused capital ratios to plummet, then forcing a liquidation. While not giving exact numbers, we get those 10/21 I believe, she did say that "National City has a stable, diverse and growing deposit base". In other words, a WaMu or Wachovia event at NCC just isn't happening.

I was also told, regarding the $20 billion "liquidation portfolio" referred to in Forbes that it was a portfolio the company would sell if an attractive offer came in but that 90% of the loans in it were performing (on time and full each month).

Regarding the Washington plan? It "could provide additional options for such disposition opportunities, however, we are not reliant upon a plan". Among all large US banks NCC is tops with an 11.1% Tier 1 Capital Ratio. Better than Wells Fargo (NYSE:WFC), JP Morgan (NYSE:JPM), and Citigroup (NYSE:C).

After the recent convertible conversion, NCC has 2.1 billion shares outstanding. What about earnings. NCC does not give guidance but if we got back before the housing boom sent earnings to about $2 billion a year, we can see from 1999 to 2002 (including the 2001 recession) NCC earned about $1.5 billion a year. That would give us roughly 75 cents a share at a PE of 12 and a price of $9 a share.

When? Who knows. It depends on what comes out of Washington, how it is implemented and how things shake out. It is clear though that NCC has ample earnings power once the present malaise is cleared. I think patience will be rewarded big here.

Most recent 8-K

Disclosure: Long WFC, NCC, C.