PNC Deal for Nat City Could Set Trend

PNC Financial Services' ( PNC) acquisition of struggling National City ( NCC) could mark the first in another run of deals for regional banks.

PNC on Friday said it agreed to buy National City for $5.6 billion in cash and stock, after receiving a $7.7 billion preferred equity investment from the federal government. With almost two dozen other regional banks expected to also receive government investments, the money will be there to make deals.

"I expect more consolidation," says Roger Cominsky, a partner in Hiscock & Barclay's financial institutions and lending practice area. "The Treasury is using the $250 billion to prop up the capital of the surviving banks. Those banks are going to be under immense pressure to acquire the sick, but not dead banks."

Additionally, the Federal Deposit Insurance Corp. "has a vested interest in seeing more consolidation because that lessens the risk of the insurance fund," Cominsky adds. "So you will probably see more consolidation over the next few weeks or months."

National City's $180 billion in deposits is essentially off the radar screen for the FDIC, Cominsky says.

Pittsburgh-based PNC agreed to pay $2.23 a share for Nat City and will also pay $384 million in cash to certain warrant holders. National City shareholders will be entitled to 0.0392 share of PNC common stock for each share of the Cleveland-based bank, the companies said.

PNC's government investment comes from the Treasury's $250 billion bank investment initiative under the troubled asset relief program, or TARP.

PNC estimates its Tier-1 capital ratio will be 10% after the equity injection.

The acquisition price is roughly 19% below National City's closing price on Thursday. Nat City shares fell as much as 36% as the market opened reflecting investors' disappointment with the price PNC is willing to pay for the bank. PNC shares rose 4%.

PNC is no stranger to troubled institutions. It bought scandal-tarred Riggs National in 2005 and a take-under of Yardville National Bank last year.

The deal comes on the heels as several other troubled institutions recently taken over. Earlier this month Wells Fargo ( WFC) won a battle with Citigroup ( C) for the right to buy Wachovia ( WB) for $15 billion. Last month, in a federally assisted deal, JPMorgan Chase ( JPM) acquired Washington Mutual, while Merrill Lynch ( MER) agreed to sell itself to Bank of America ( BAC).

Fixed income analysts at CreditSights suggested that given the attractive terms of the government's equity plan, large regional banks could be seen as the next acquirers.

" This deal is the first one announced which will receive the benefit of the Treasury's capital purchase plan to help fund the deal," the analysts wrote in a note. "We feel this indicates that the various Treasury programs will provide more opportunities for M&A transactions in the banking sector. Up to now, it appeared that stronger institutions were very reluctant to wade into troubled banks situations, as they did not want to take on the target's riskier loan exposures."

"We continue to feel that some stronger regionals such as U.S. Bancorp ( USB) and BB&T ( BBT) could explore larger merger transactions in order to pick up weaker rivals with a government assist," CreditSights said.

Weaker banks include Zions ( ZION), First Horizon ( FHN) and Huntington Bancshares ( HBAN), according to CreditSights.

Cominsky suggested that even the large national banks, busy with recently completed or soon-to-be closed deals, could even begin shopping again.

"You'd be surprised," he says. " These banks got to be as big as they are by doing a series of acquisitions. They know what they are doing. They have teams in place. They're looking at the marketplace. ... If they can get a capital injection and deposit base ... then it's a win-win."

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. Many of those loans have since been put into a separate portfolio which the bank was in the process of winding down.

Earlier this week, National City reported a third-quarter loss of $729 million, or $5.86 a share, as it continued to build its loan loss reserves last quarter. The company had 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.

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

Still it comes as no surprise that the bank decided to sell. National City had been rumored to be looking for a buyer as early as this spring, but after no buyer appeared, instead underwent a $7 billion capital injection from Corsair Capital and other institutional investors. The stock is down 83% this year.

National City also acknowledged earlier this year that it was operating under so-called memoranda of understanding with the Federal Reserve on April 29 and with the Office of the Comptroller of the Currency on May 5. It's likely that regulators forced the bank to sell itself, given its troubled state.

A call and an email to National City inquiring whether the bank was still under the regulatory scrutiny were not returned. Both the Fed and the OCC declined to comment for the article.

PNC's fair value adjustments and provisions for future losses of Nat City's current loan portfolio will bring the cumulative impairment of these loans to approximately 17.5%, or $19.9 billion, far worse than what Nat City predicted just a few days earlier, according to analysts. PNC says it will "accelerate the liquidation" of noncore and impaired loans.

"The higher-than-expected estimated lifetime losses of National City's loan portfolio does not bode well for future asset quality trends for the regional banks, particularly those losses in the residential construction and non-conforming mortgage/home equity areas," writes Terry McEvoy, an analyst at Oppenheimer, in a note Friday.

"The hardest question to answer is why did National City sell today at a perceived depressed price given their recent financial results, industry-leading capital levels and stable deposit trends? One might assume that they would not have qualified for TARP capital in the face of rising credit costs," McEvoy writes.

The Wall Street Journal reported on Friday that the government rejected Nat City's application for funds, forcing them into the sale.

PNC chairman and CEO James Rohr made it clear on a conference call that National City's deposit base was a primary reason for the bank to agree to the deal.

"PNC will be building a deposit franchise that will be the fifth largest in the U.S.," Rohr said on the call. "In the current environment, we see deposits as an important factor in determining long-term strength."

"The core asset of the banking business is the checking account," Rohr said later on the call. The banking industry "has been able to go through many cycles and many mistakes, frankly, because of that core deposit base. National City has a wonderful core deposit franchise."

Rohr wouldn't answer a question addressing whether the deal was forced, but did say as of Thursday night, that there was a "competing bid" from another firm. The Journal identified the other bidder as U.S. Bancorp.

He says PNC likely won't participate in other acquisitions in the near future.

"With regards to acquisitions, I think we've got our hands full," Rohr said during the call. "You never say never, but we don't have a bunch of extra people looking for new deals."

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