Midwest Bank Shares Rise Despite Losses

KeyCorp ( KEY), National City ( NCC) and Fifth Third ( FITB) all posted losses for the third quarter as credit deterioration continued to hamstring the three Midwest regional banks.

All three stocks finished in the black Tuesday, after giving indications they would accept capital from the government being offered through the $700 billion financial rescue plan approved by Congress earlier this month.

Key, Nat City and Fifth Third discussed the progress they have made on reducing their balance sheets as they seek to preserve capital in the poor economic environment. All three banks said they were considering applying for some of the $250 billion in preferred equity investments the Treasury Department will make through the troubled asset relief program, or TARP. Large banks including Citigroup ( C), JPMorgan Chase ( JPM), Bank of America ( BAC) and Wells Fargo ( WFC) have already agreed to accept investments, whether they need capital or not.

Key shares finished $1.21, or 12.4% higher, to $10.95 and Nat City shares gained 7 cents, or 2.4%, to $2.99. Fifth Third closed up fractionally higher to $12.25.

KeyCorp

Key posted a loss of $36 million, or 10 cents a share, vs. a profit of $210 million, or 54 cents a share in the year-earlier quarter.

"We have experienced the most severe financial crisis any of us has known in our business lifetime," said Key CEO Henry Meyer. Key's Tier-1 capital ratio was 8.48% at the end of the third quarter.

Key added $133 million to its loan loss reserves, mostly for its loan exposure to residential construction. Key's allowance for losses totaled $1.6 billion, or roughly 2% of loans, at the end of the quarter.

Key has been particularly susceptible to souring loans made to the homebuilder segment of commercial real estate business, but the bank says it has been aggressively reducing its exposure.

At the end of the third quarter, total residential property exposure in commercial real estate, including loans held for sale, fell by $1.3 billion, or 34%, from a year earlier. The "majority" of the reduction came from "the weakest part of the portfolio," Meyer said on a conference call.

Over the past four years, the company has been reducing its exposure to certain non-core lending. The company sold its subprime mortgage portfolio, Champion Mortgage, in 2006. It also exited direct and indirect retail land floor plan lending on marine and recreational based vehicle products, and brokered home equity.

The company is also limiting student loans "to those backed by a government guarantee" Meyer said.

Key's loan portfolios in run off mode declined $600 million from June 30 to $9.8 billion, it said.

National City

National City swung to a net loss of $729 million as it continues to build its loan loss reserves. The Cleveland bank pared its loss by 60% from the second quarter, but it made a $19 million profit in the third quarter of last year.

National City's $5.86 diluted net loss per share includes a $4.4 billion, one-time, noncash preferred dividend recorded in September on convertible preferred stock related to its $7 billion capital raise completed in April. Without the dividend, the loss would have been 85 cents a share. National City's Tier-1 capital ratio was 10.98% at the end of the third quarter.

More than its other two Midwestern rivals, National City has gotten slammed by the residential housing meltdown. The company forayed into some of the more risky home loans such as broker-originated home equity and subprime mortgages, as well as troubled geographic areas such as Florida.

Last year, National City separated risky loans that it planned to run-off into a portfolio that it has since renamed to officially be called its exit portfolio.

The $21 billion portfolio consists of brokered home equity loans, subprime mortgages left on National City's balance sheet after the 2006 sale of First Franklin to Merrill Lynch ( MER), residential construction loans and dealer-originated automobile, marine and recreational vehicle loans.

National City has decreased its exit portfolio by a total of $8.4 billion, or 8%, it says. The loans that were run off represented 40% of total charge-offs, it said. The company added that the loan portfolio has been declining roughly $500 million a month.

In the third quarter, the company took a total of $1.2 billion provision for loan losses -- more than half of which was to build reserves against the separate portfolio.

The company says it continues to "actively manage down" its risk exposure to soured loans and "aggressively" pursue loss mitigation strategies.

The remainder of the exit portfolio "showed stable or improving trends," CEO Peter Raskind said in a statement. "We are actively managing down and mitigating losses from the exit portfolio and have the capital flexibility to consider a wide variety of alternatives for these loans."

Still National City's remaining $91 billion core loan portfolio is "showing greater deterioration than the 'exit portfolio' with nonperforming loans increasing 21% sequentially vs. the 11% increase in the 'exit portfolio'," according to a note by Stifel Nicolaus analyst Christopher Mutascio.

Net charge-offs for the core portfolio rose 39% from the prior quarter to $290 million and represented 1.27% of average loans versus 0.88%" in the second quarter, whereas charge-offs for the exit portfolio rose "modestly," Mutascio wrote.

Fifth Third

Fifth Third recorded a loss of $56 million, or 14 cents a share, down 72% from the year-earlier quarter, on the heels of higher credit costs, further writedowns and several one-time charges.

The Cincinnati-based bank had a Tier-1 capital ratio of 8.53% at the end of the quarter. Fifth Third is also finalizing plans to sell non-core assets as part of a capital preservation initiative.

The initiative, announced in June, increased the bank's Tier-1 capital target ratios to between 8% and 9%, reduced its dividend and issued $1.1 billion in Tier-1 securities. As part of the plan, Fifth Third said the sale of non-core assets will add $1 billion to capital "to provide for the possibility of a difficult 2009, a view that continues to seem likely to us."

The company said during the third quarter, it has made "significant progress in evaluating attractive structures, gauging significant interest on the part of potential investors and negotiating potential transactions."

While the company doesn't have any subprime mortgages, option adjustable-rate mortgages, credit default swaps and exposures to troubled counterparties, "we are not immune to disruptions in the capital markets and weakening economic conditions," chairman and CEO Kevin Kabat said. "Higher credit costs once again drove bottom line results that no one here is satisfied with. Nonperforming assets and net charge-offs continued to increase and remain disproportionately attributable to commercial and residential real estate loans, particularly in Florida and Eastern Michigan."

Fifth Third added a $941 million provision for loan losses. Net loans charged off totaled 2.17% of its $86 billion of average loans and leases in the quarter, up from 1.66% in the second quarter.

The company said it is considering whether to take part in the U.S. Treasury's capital plan.

"Regardless of our course of action, we will continue to evaluate our businesses from a strategic planning perspective and will make decisions in the context of what's best for our investors and customers," Kabat said. "We retain significant flexibility as we evaluate our businesses and opportunities that may present themselves in a significantly changing financial services landscape."

Fifth Third's credit quality weakened in the third quarter, "a trend we expect to continue over the next few quarters as management deals with credit challenges mainly stemming from its Michigan and Florida markets," writes Bob Patten, an analyst at Regions Financial's ( RF) Morgan Keegan.

"We anticipate that management will become more aggressive in executing loan sales once it receives some capital either through the TARP program or via the sale of noncore assets or both," Patten writes. "As a result, we do not rule out a quarter with significantly higher provisioning and charge-offs as management looks to move troubled loans off its balance sheet."

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