National City Deal Could Snap Keycorp

The Wall Street Journal today reported that National City Corp. (NCC Quote - Cramer on NCC - Stock Picks) might be acquired by KeyCorp(KEY Quote - Cramer on KEY - Stock Picks). Both banks have their headquarters in Cleveland.

The combined bank holding company would "receive a capital infusion from private-equity behemoth Kohlberg Kravis Roberts & Co," the Journal's source also said. Neither holding company was willing to comment.

This would be a terrible deal for KeyCorp's shareholders, for several reasons.

KeyCorp, with total assets of $100 billion at the end of 2007, is considerably smaller than the $150 billion National City, and has weathered the mortgage crisis pretty well so far.

Market Not Banking On National City Deal

Here's a look at earnings performance for both companies:

While National City was a very strong earnings performer in 2006, it paid for its subprime sins with massive provisions for reserves in 2007, leading to an ROAA of 0.22%. While KeyCorp also suffered, it posted decent earnings for 2007.

While both companies have seen their asset quality tumble during the year, KeyCorp was clearly in a much stronger position at year-end, with nonperforming assets comprising 1.00% of total assets, reserves at a level exceeding total nonperformers, and capital ratios in a reasonably comfortable range. KeyCorp's net charge-offs (loan losses) for the year totaled $274 million, compared with $661 million for National City.

National City saw its level of nonperforming assets shoot up to 2.28% of total assets during 2007. After heavy provisioning for loan losses, reserves covered a decent 58.31% of nonperformers at year-end. The capital ratios were on the low side, considering National City's asset quality. To be well-capitalized under regulatory guidelines, a bank needs to maintain a leverage ratio of 5% and a risk-based capital ratio of 10%. National City's risk-based ratio slipped to just 10.27% at year-end.

Keycorp's $1.50 dividend represents a current yield of 6.80% on the company's common stock. While KeyCorp avoided a lot of the crummy residential loans that National City made or acquired, its dividend is under some pressure, with loan quality expected to continue to decline through 2008. It's hard to see how KeyCorp's shareholders could hope to retain the dividend after a merger.

A private equity capital infusion for the combined holding company would dilute KeyCorp's current shareholders. This, along with dividend and asset quality concerns about National City could cause flight from the stock if a deal were announced.

National City entered the Florida market at the peak of the mortgage cycle, with expensive acquisitions of Harbor Federal in Fort Pierce and Fidelity Federal in West Palm Beach. KeyCorp would now expand its presence Florida market at a difficult time.

The Journal article mentioned that the combined entity would be forced by regulators to sell overlapping branches. This means selling deposits and some loans, while of course keeping National City's bad loans.

Other possible acquirers for National City mentioned in various reports have included Wells Fargo (WFC Quote - Cramer on WFC - Stock Picks), PNC Financial Services (PNC Quote - Cramer on PNC - Stock Picks) and U.S. Bancorp (USB Quote - Cramer on USB - Stock Picks).