October 24, 2008 / 1:41 PM / 11 years ago

PNC to buy ailing National City for $5.6 billion

NEW YORK (Reuters) - PNC Financial Services Group Inc (PNC.N) agreed to buy ailing National City Corp NCC.N in a government-supported $5.6 billion deal to rescue the large Ohio lender and create the No. 5 U.S. bank by deposits.

A National City customer uses an ATM at a branch of the National City Corp bank in Strongsville, Ohio, October 21, 2008. REUTERS/Aaron Josefczyk

The transaction doubles PNC’s size and will provide it with a bigger branch network and a much larger base of deposits, which can provide cheap funding and increased financial stability.

The deal is the first since government officials signaled earlier this week that they would approve of banks using parts of a $250 billion U.S. Treasury Department capital infusion to acquire weaker rivals.

PNC expects some $20 billion of writedowns from National City’s loans, losses that dwarf the accounting value of the entire Cleveland-based bank. National City said earlier this week the company was recently worth $17.2 billion, based on shareholder equity on its balance sheet.

“That’s why you’ve been seeing financial institutions get pounded this year, because no one knows what their assets are worth,” said Steve Persky, chief executive of Dalton Investments in Los Angeles.

National City aggressively invested in its mortgage business beginning in the 1990s, a bet that paid off earlier this decade, but turned out to be perilous as the U.S. housing market cratered.

The company sold off its First Franklin Financial Corp subprime mortgage lending business in late 2006, but held on to billions of dollars of subprime mortgages. It was also too slow in shedding other bad mortgage assets.

National City also bought one Florida bank in 2006 and another in early 2007, just before that state’s real estate market headed south.

“They had way too many mortgage loans on their books and they wanted to unwind them, but it was such a big chunk of their balance sheet they couldn’t do it in time,” said Bill Fitzpatrick, an equity research analyst at Optique Capital Management in Milwaukee.

National City would join Bear Stearns Cos, Merrill Lynch, Sovereign Bancorp Inc SOV.N, Wachovia Corp WB.N and Washington Mutual Inc WAMUQ.PK among U.S. financial companies that have been or are being swallowed up by lenders considered healthier.

GOVERNMENT MONEY

PNC said its offer valued National City at $2.23 a share, roughly 19 percent below Thursday’s closing price. It will pay 0.0392 share for each National City share plus $384 million in cash to certain warrant holders.

In tandem with this deal, Pittsburgh-based PNC plans to sell $7.7 billion of preferred shares and warrants to the U.S. Treasury under the Troubled Assets Relief Program, making it the first regional bank to participate in the program.

The government said last week it was injecting $125 billion into nine large U.S. banks and planned to give another $125 billion to other banks.

A senior government regulatory official said on Monday that merger opportunities will be among the factors Treasury will consider in deciding which banks get government investments.

PNC shares closed up $2, or 3.5 percent, at $58.88, even as financial markets swooned amid renewed fear the global economic slowdown could get worse. National City stock dropped 68 cents, or 24.7 percent, to $2.07.

The stock of another hard-hit Ohio bank, Cincinnati’s Fifth Third Bancorp (FITB.O), sank 28.7 percent on questions about the strength of Ohio banks.

For months regulators have been pressuring a weakened National City to sell itself, people familiar with the matter said. National City in April received a $7 billion infusion from private equity firm Corsair Capital and other investors.

If the deal goes through, Corsair will at a minimum make back its $785 million investment because of an “antidilution provision” written into the original deal, plus taking into account warrants it holds, a source familiar with the situation said.

The private equity firm will receive cash and stock in the new firm and, if it decides to hang onto the investment, it could make money on the deal if the stock rises, the source said.

That is in contrast to Texas-based private equity firm TPG’s investment in Washington Mutual Inc. TPG lost $1.35 billion in a deal that saw the bank sold to JPMorgan Chase & Co

(JPM.N).

Lenders including Bank of Nova Scotia (BNS.TO) US Bancorp (USB.N) and PNC looked at National City, according to people familiar with the matter. US Bancorp and PNC were the final two bidders.

Regulators earlier this month told National City that the government would not provide it with additional capital, the Wall Street Journal reported. As the U.S. banking system struggles with bad assets, the government is taking a growing role in determining which banks survive and which must sell themselves.

BIG WRITEDOWNS SEEN

PNC said the deal, to be completed by the end of this year, would generate a 15 percent rate of return and boost per-share results in its second year. The bank will incur $2.3 billion of merger costs and $1.2 billion of other expenses.

The deal represents a shift for PNC, which for a long time has been boosting fee-based businesses such as asset and wealth management and reducing the proportion of earnings coming from lending businesses.

But the main rationale for this transaction was boosting deposit and branches, PNC Chief Executive James Rohr PNC said on a conference call, which typically help lending businesses.

The combined company will have 2,747 branches across the middle-Atlantic and Midwest regions, as well as some in Florida, creating the fourth-largest U.S. branch network. PNC had 1,177 branches on its own.

PNC will be helped by a new tax rule that allows it to take an immediate benefit from losses at National City instead of having to do so over multiple years. One analyst estimated that benefit could run into the billions of dollars for PNC.

The combined company will have about $180 billion of deposits, ranking fifth. National City branches will assume the PNC name. The combined headquarters will remain in Pittsburgh.

PNC may also issue $1 billion of common equity “in the foreseeable future,” but only after speaking with top shareholders, CEO Rohr said. He said Treasury’s offer to inject capital made the deal for National City attractive. With the new funds, the combined company’s Tier-1 capital ratio would be 10 percent.

National City posted a $729 million third-quarter loss this week, its fifth straight quarterly loss. Chief Executive Peter Raskind told Reuters on Tuesday that the economic environment “probably gets worse before it gets better.”

Raskind will join the combined bank’s board, along with one other National City director.

Typical mergers of large banks trigger antitrust provisions that require branch and business sales, but Rohr said PNC and National City have little overlap. The combined banks have $180 billion in deposits.

Citigroup, JPMorgan Chase & Co, and Sandler O’Neill advised PNC, while Goldman Sachs advised National City.

Slideshow (4 Images)

Jones Day and Sullivan & Cromwell were legal advisers to National City. Wachtell, Lipton, Rosen & Katz advised PNC.

(Additional reporting by Jonathan Stempel and Paritosh Bansal and Megan Davies in New York and David Lawder in Washington)

Editing by Steve Orlofsky, Andre Grenon and Bernard Orr

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