December 23, 2008
Research Associate: Binod Kr. Das, M.Com.
Editor: Madhurima Majumdar, CA
Sr. Editor: Ian Madsen, CFA; ; 1-800-767-3771 x9417
N. Canal Street, Suite 1101 Chicago, IL 60606
National City Corporation / (NCC-NYSE) / $1.65Note: FLASH REPORT; more details to come; changes are highlighted. Except where noted, and highlighted, no other sections of this report have been updated.
Reason for Report: FLASH UPDATE: NCC shareholders approve takeover by PNC
Previous Edition: 3Q08 Earnings Update, October 31, 2008.
Flash Update
On December 23, 2008,PNC Financial Services Group, Inc. (PNC) announced that its shareholders approved the proposed acquisition of National City Corporation. The deal is expected to close on December 31, 2008. PNC's $5.6 billion acquisition of struggling National City was approved by the U.S. Federal Reserve on December 16, 2008.
A more expanded account of analyst opinions will follow in the next update of NCC.
Portfolio Manager Executive Summary [Note: This section has NOT been updated]
National City Corp. headquartered in Cleveland, Ohio, ranks as the eighth largest depository institution in the U.S. by deposits, and the 13th largest by market cap. Primary businesses include wholesale banking, consumer and small business banking, trust and management services, item processing, and mortgage servicing. NCC operates 1,555 branches and 2,223 ATMs throughout Ohio, Michigan, Pennsylvania, Indiana, Illinois, Kentucky, Florida, Missouri, and Wisconsin.
62.0% of the firms in the Digest group assigned positive ratings to the stock and the rest 38.0% provided neutral ratings. Eleven brokerage firms provided target prices, and the firm providing the Digest low target price rated the stock Market Perform and did not provide a valuation metric. The firm providing the Digest high target prices rated the stock Overweight and valued the stock on 1.3x expected year-end tangible book estimate of $5.90.
Bears (Neutral or equivalent outlook) – eight firms or 62.0%: Target Price range: $2.00-$5.25. According to firms, NCC is among the most exposed tohigh risk real estate, and given press reports that the bank is for sale, the stock reflects valuation concerns following the BSC deal. However, they believe potential buyers are probably wary of acquiring NCC’s higher-than-average risk loan portfolio, also given that purchase accounting rules would require a buyer to mark NCC’s loan portfolio to market, which would probably increase the total cost of acquisition materially. Thus, firms believe there is a material risk that NCC will not find a buyer, and there is a good chance that any potential buyer would be unwilling to pay a large premium to NCC’s existing stock price. In light of the numerous issues surrounding NCC, analysts expect the stock price to remain volatile in the near future. Firms also increased their credit cost assumptions for both 2008 and 2009, in light of ongoing deterioration in the housing market and related areas of NCC's loan portfolio.
Bulls (Buy or equivalent outlook) – five firms or 38.0%: Target Price range: $5.50-$8.00. The firms, which are bullish on NCC, do not expect a liquidity crunch for three reasons: 1) NCC is mainly a deposit funded bank with $87.5 billion in core deposits, 2) management claims that they have a plan to provide the bank with ample liquidity even if NCC is unable to refinance maturing long-term debt throughout FY08, and 3) NCC appears to have ample collateral for Fed Funds and other short-term borrowing. Moreover, there are several capital raising alternatives beyond the sale of the company: (i) the Visa IPO plus the ability to sell the Visa stake to another bank, (ii) the common dividend, and (iii) the asset management business.
October 31, 2008
Recent Events[Note: This section has NOT been updated]
On October 29, 2008, NCC announced that it lowered its prime rate to 4.00% from 4.50%, effective immediately.
On October 24, 2008, NCC announced that it agreed to be acquired by PNC Financial Services Group Inc. (PNC) in a government-assisted deal for $2.23 per share or an aggregate amount of about $5.6 billion in PNC stock. PNC will pay 0.0392 shares for each NCC share plus $384 million in cash to certain warrant holders. The transaction is expected to close by December 31, 2008.
On October 21, 2008, NCC announced its 3Q08 financial results. Highlights are as follows:
- The Companyreported a net loss of $729.0 million versus a net loss of $19.0 million in 3Q07.
- GAAP loss per share was $5.86 versus loss per share of $0.03 in 3Q07.
On October 7, 2008, NCC announced the closing of the first sale of a condo unit in the new Book Cadillac Hotel. The 1,401 square foot unit sold for $463,550, which equates to $331 per square foot, a new appraisal benchmark for Detroit.
On October 2, 2008, NCC announced that a cash dividend will be paid on its common stock in the amount of $0.01 per share. In addition, a cash dividend will be paid on its Series F preferred stock in the amount of $0.6171875 per depositary share. All dividends will be distributed on November 3, 2008, to stockholders of record as of October 13, 2008.
Overview[Note: This section has NOT been updated]
Based in Cleveland, Ohio, National City Corporation (NCC) is one of the nation's largest financial holding companies. The company operates through an extensive banking network primarily in Ohio, Illinois, Indiana, Kentucky, Michigan, Missouri, Pennsylvania, and Florida and serves customers in selected markets nationally. Its core businesses include commercial and retail banking, mortgage financing and servicing, consumer finance, and asset management. Its operations are primarily conducted through 1,300 branch banking offices located within an eight-state footprint and 470 retail mortgage offices located throughout the United States. The company’s website is
Brokerage firms identified the following factors for evaluating the investment merits of NCC:
Key Positive Arguments / Key Negative ArgumentsFundamentals
- It is expected to produce better-than-average expense efficiency improvements that will support the continued improvement in ROE and EPS growth.
- The Best-in-Class program is expected to generate substantial expense savings, leading to positive operating leverage.
- The move toward the ‘originate and sell’ strategy is expected to help core deposit growth keep pace with loan generation and free up more capital.
- Credit quality trends are expected to remain benign going forward.
- Solid revenue synergies are likely from the two Florida acquisitions.
- A flattening yield curve environment could pressure the company’s net interest margin.
- Adverse operating environment for the mortgage business continues to weigh on NCC’s earnings, given the outsized influence of its mortgage banking revenue on the bottomline.
- NCC’s banking franchise is exclusively located in the economically challenged Midwest, which is a critical issue.
- NCC has little chance of generating hedging gains due to the flattening yield curve.
- The ‘originate-and-sell’ strategy and the mortgage business continue to add volatility to the company’s earnings stream.
- Analysts speculate earnings loss because of the First Franklin sale.
NCC operates on a calendar year basis.
October 31, 2008
Revenue[Note: This section has NOT been updated]
The tables are current as of 10/29/08.
Prior to the 3Q08 earnings release, the Zacks Digest average NII growth forecast was (6.8%) for 2008 and (2.4%) for 2009. The total non-interest income growth forecast was 15.3% for 2008 and (0.7%) for 2009. Following the 3Q08 earnings release, the forecasts for NII decreased to (7.7%) for 2008 and (6.4%) for 2009. The total non-interest income growth forecasts decreased to (3.4%) for 2008 and (0.9%) for 2009.
($ in million) / 3Q07A / 2007A / 2Q08A / 3Q08A / 4Q08E / 2008E / 1Q09E / 2009E / 2010ENet Interest Income (FTE) / 1,102 / 4,424 / 1,021 / 1,024 / 998 / 4,084 / 962 / 3,822 / 3,842
Provision for Credit Losses / 366 / 1,312 / 1,592 / 1,184 / 1,088 / 5,337 / 935 / 3,038 / 1,151
Core Non-Interest Income / 623 / 2,584 / 442 / 463 / 549 / 2,262 / 527 / 2,495 / 2,784
Securities Gains / 1 / 22 / (11) / (77) / NM / 341 / NM / NM / NM
Total Non-Interest Income / 624 / 2,606 / 431 / 386 / 549 / 2,517 / 527 / 2,495 / 2,784
Total Revenue / 1,726 / 7,030 / 1,452 / 1,410 / 1,547 / 6,601 / 1,489 / 6,318 / 5,666
Net Interest Margin / 3.43% / 3.49% / 2.98% / 2.98% / 2.96% / 3.01% / 2.92% / 2.92% / 2.95%
As per the company’s release, Tax-equivalent net interest income was $1.0 billion in 3Q08, almost equal to 2Q08, and down about 7% y-o-y. Net interest margin was 2.99% in 3Q08, up 2 basis points from 2Q08. Net interest margin was down 44 basis points y-o-y due to higher levels of nonperforming assets and higher funding costs. Average earning assets in 3Q08 were $136.8 billion, down slightly from 2Q08, and up 7% y-o-y. The y-o-y growth in average earning assets reflects higher balances of federal funds sold and short-term liquid investments.
Net Interest Income, as per the Zacks Digest model, was $1,024 million in 3Q08 versus $1,021 million in 2Q08 and $1,102 million in 3Q07. Net interest margin, as per the Zacks Digest model, was 2.98% versus 2.98% in 2Q08 and 3.43% in 3Q07.
($ in million) / 1Q07A / 2Q07A / 3Q07A / 4Q07A / 2007A / 1Q08A / 2Q08A / 3Q08AMortgage Banking Revenue / 107 / 206 / 85 / (34) / 363 / 106 / (141) / (57)
Deposit Service Charges / 204 / 223 / 229 / 248 / 905 / 230 / 259 / 274
Payment Processing Revenue / 0 / 0 / 0 / 0 / 0 / 0 / 0 / 0
Trust & Invest. Management Fees / 74 / 84 / 79 / 81 / 318 / 80 / 81 / 71
Card-Related Fees / 33 / 29 / 31 / 33 / 125 / 32 / 33 / 30
Brokerage Revenue / 40 / 55 / 41 / 53 / 189 / 48 / 48 / 40
Leasing Revenue / 55 / 45 / 42 / 36 / 178 / 35 / 34 / 31
Other Core Non-Interest Income / 81 / 124 / 117 / 185 / 506 / 92 / 129 / 75
Total Core Non-Interest Income / 594 / 766 / 623 / 602 / 2,584 / 623 / 442 / 463
Non-interest income, as reported by the company, was $386 million in 3Q08, down $45 million from 2Q08, and down $238 million from 3Q07.
Loan sale and servicing loss was $56 million in 3Q08, up $85 million from 2Q08, down $141 million from 3Q07. The net loss from loan sales and servicing arose from net mortgage servicing right (MSR) hedging losses. Net MSR hedging (losses)/gains were ($189) million in 3Q08 versus ($146) million in 2Q08 and $64 million in 3Q07. Loan sale revenue improved sequentially due to a lower provision for estimated recourse losses on potential mortgage loan repurchases.
Net security losses arose from other-than-temporary impairment of available for sale securities of $91 million in 3Q08 versus $29 million in 2Q08. No redemptions or impairments were recognized in 2007.
Deposit service fees were $273 million in 3Q08, up 5% from 2Q08 and up 19% from 3Q07. This growth reflects higher fee generating transaction volumes, as well as a larger number of deposit accounts.
Outlook
As per the Zacks Digest model, total revenue forecasts are $6,601 million for 2008, $6,318 million for 2009, and $5,666 million for 2010, reflecting y-o-y growth of (6.1%), (4.3%), and (10.3%), respectively.
Please refer to the separately published NCC spreadsheet for additional details and updated forecasts.
Margins[Note: This section has NOT been updated]
Prior to the 3Q08 earnings release, the Zacks Digest average pre-tax margin estimate was (37.2%) for 2008 and (10.0%) for 2009. Following the 3Q08 earnings release, the Zacks Digest average pre-tax margin estimates decreased to (58.5%) for 2008 and (27.9%) for 2009.
Margins (%) / 3Q07A / 2007A / 2Q08A / 3Q08A / 4Q08E / 2008E / 1Q09E / 2009E / 2010EPre-Tax Operating Margin / -2.3% / 5.8% / -92.1% / -78.7% / -53.3% / -58.5% / -49.2% / -27.9% / 15.3%
After-Tax Net Operating Margin / -1.1% / 4.5% / -47.6% / -51.7% / -36.8% / -64.2% / -34.1% / -18.8% / 9.4%
Efficiency Ratio / 80.9% / 75.5% / 82.4% / 94.7% / 82.9% / 77.7% / 86.4% / 79.8% / 80.8%
Non-interest expense was $1.3 billion in 3Q08, down $942 million from 2Q08, and down $61 million from 3Q07.
Salaries, benefits and other personnel costs decreased 9% sequentially and 12% y-o-y due to reductions in staffing, lower business volumes, and lower incentive compensation. Cost savings from reduced staffing levels in 2008 were partially offset by lower deferrals of loan origination costs, resulting from the adoption of fair value for certain loans held for sale at the beginning of 2008.
Impairment, fraud and other losses in 3Q08 included a provision of $87 million for Visa indemnification obligations, as well as an impairment loss of $28 million for real estate under development associated with a prior acquisition. In 2Q08, impairment, fraud and other losses included a goodwill impairment charge of $1.1 billion. 3Q07 included a provision of $157 million for Visa indemnification obligations, $44 million of asset impairments, and a $25 million litigation settlement.
Foreclosure costs increased to $122 million in 3Q08, up $61 million from 2Q08, and up $105 million from 3Q07. Larger fair value write-downs were recognized in 3Q08 based on more aggressive property disposition strategies. Foreclosure costs increased as compared to 3Q07 due to more loans in foreclosure and higher expected and realized losses associated with declining property values. The same factors accounted for the higher foreclosure costs on a year-to-date basis.
Outlook
In 3Q08, the company announced that it expects its Performance Improvement Initiative to result in annual savings of $500-$600 million by 2011. The company expects to realize $240 million of this reduction in 2009, and estimates associated charges to be in the range of $80 $100 million. Further, the company expects a reduction of approximately 4,000 positions or 14% of its total workforce, over the next three years.
The Zacks Digest average total non-interest expense y-o-y growth rate is (3.3%), (1.7%), and (9.1%) for 2008, 2009, and 2010, whereas the Zacks Digest average total revenue y-o-y growth for 2008, 2009, and 2010 is (6.1%), (4.3%), and (10.3%), respectively.
Please refer to the separately published NCC spreadsheet for additional detail and updated forecasts.
Earnings per Share[Note: This section has NOT been updated]
NCC reported a net loss of $729 million in 3Q08 versus a net loss of $1.8 billion in 2Q08, and a net loss of $19 million in 3Q07. GAAP EPS was ($5.86) versus ($2.45) in 2Q08 and ($0.03) in 3Q07. The 3Q08 loss is inclusive of a $4.4 billion one-time noncash preferred dividend recorded in September 2008 on convertible preferred stock issued as part of National City's $7 billion capital raise completed in April 2008.
Prior to the 3Q08 earnings release, the Zacks Digest average EPS forecast for 2008 was ($2.19) and ($0.22) for 2009. Following the 3Q08 earnings release, the Zacks Digest average EPS estimate decreased to ($3.02) for 2008 and ($0.55) for 2009.
EPS / 3Q07A / 2007A / 2Q08A / 3Q08A / 4Q08E / 2008E / 1Q09E / 2009E / 2010EGAAP EPS / ($0.03) / $0.51 / ($2.45) / ($5.86) / ($0.34) / ($7.47) / ($0.19) / ($0.50) / $0.23
Zacks Consensus / ($0.23) / ($4.50) / ($0.14) / ($0.41)
Digest High EPS / ($0.02) / $0.55 / ($0.95) / ($0.85) / ($0.20) / ($2.19) / ($0.25) / ($0.30) / $0.65
Digest Low EPS / ($0.03) / $0.54 / ($0.96) / ($0.85) / ($0.38) / ($3.39) / ($0.26) / ($0.85) / $0.10
Digest Average / ($0.03) / $0.54 / ($0.96) / ($0.85) / ($0.27) / ($3.02) / ($0.26) / ($0.55) / $0.38
Digest Avg. Y/Y
Growth / -103.4% / -85.4% / -259.1% / 48.9% / -656.5% / 75.8% / 81.9% / 168.8%
Digest Avg.
Sequential Growth / -104.8% / 9.2% / 11.4% / 68.1% / 6.0%
Operating EPS, as per the Zacks Digest model, was ($0.85) in 3Q08 versus ($0.96) in 2Q08 and ($0.03) in 3Q07.
Highlights from the above EPS table are as follows:
- 2008 forecasts (total 8) range from ($3.39) to ($2.19); the average is ($3.02).
- 2009 forecasts (total 8) range from ($0.85) to ($0.30); the average is ($0.55).
- 2010 forecasts (total 2) range from $0.10 to $0.65; the average is $0.38.
Please refer to the separately published NCC spreadsheet for additional details and updated forecasts.
Balance Sheet[Note: This section has NOT been updated]
($ in million) / 1Q07A / 2Q07A / 3Q07A / 4Q07A / 2007A / 1Q08A / 2Q08A / 3Q08AAverage Loans / 109,967 / 112,304 / 117,082 / 121,824 / 115,332 / 119,873 / 117,140 / 113,797
Average Securities / 7,704 / 7,143 / 7,835 / 8,826 / 7,880 / 8,588 / 8,491 / 9,582
Average Assets / 137,810 / 138,587 / 145,095 / 152,566 / 143,559 / 153,032 / 153,852 / 150,740
Average Deposits / 87,847 / 90,024 / 93,502 / 98,299 / 92,450 / 97,587 / 99,552 / 98,724
Average Equity / 14,398 / 12,231 / 12,636 / 13,554 / 13,200 / 13,411 / 17,455 / 17,618
Average portfolio loans as reported by the company were $111.7 billion in 3Q08, down $2.4 billion from 2Q08, and up $7.2 billion from 3Q07. Average loans held for sale were $2.1 billion in 3Q08, down almost $1 billion from 2Q08, and down $10.5 billion from 3Q07.
The average balance of the Core Portfolio was down slightly from 2Q08, but up $4.7 billion from 3Q07 primarily due to the September 2007 acquisition. The Exit Portfolio declined 2Q08 with ongoing pay downs and charge-offs. The Exit Portfolio balance increased from 3Q07 as residential construction and non-agency mortgage loans were added to this portfolio in 2008. Loans held for sale declined, compared to prior periods, reflecting the curtailment of non-agency mortgage-related products and wholesale channels. Late in 3Q08, the Corporation's $1.2 billion marine portfolio was transferred to held for sale. This reclassification did not have a significant impact on the average balances reported above.
Average total deposits as reported by the company were $98.7 billion in 3Q08, down less than $1 billion from 2Q08, and up $5.2 billion from 3Q07. Average core deposits, excluding mortgage escrow and custodial balances, were $83.3 billion in 3Q08, down $1.0 billion from 2Q08, and up $5.7 billion from 3Q07. New customers and accounts were added during 3Q08, which partially offset declines in deposit balances in excess of FDIC insurance limits. Compared to 3Q07, deposits have grown with continued household growth and expansion, as well as a September 2007 acquisition.
Please refer to the separately published NCC spreadsheet for additional detail and updated forecasts.
Target Price/Valuation[Note: This section has NOT been updated]
Of the 16firms covering the stock, 5 firms provided positive ratings, 8 gave neutral ratings and none rated the stock negatively. Two firms did not provide any rating on the stock. The Digest average target price is $4.73 ( $1.78 from the previous report; 104.7% upside from the current price), and lies within the Digest low target price of $2.00 (13.4% downside from the current price) (BMO Capital) and the Digest high target price of $8.00 (246.3% upside from the current price) (Barclays Capital).
The firm providing the Digest low target price rated the stock Market Perform and did not provide a valuation metric. The firm providing the Digest high target prices rated the stock Overweight and valued the stock on 1.3x expected year-end tangible book estimate of $5.90.
Rating Distribution
Positive / 38%Neutral / 62%
Negative / 0%
Average Target Price / $4.73
Digest High / $8.00
Digest Low / $2.00
Number of Analysts with target price/Total / 11/16
Risks to the price target include interest rate risk related to a flattening yield curve and net interest margin compression, downturn in the housing market, change in overall economic and loan growth, exposure to mortgage market, capital markets performance, credit risk, and regulatory risk.
Metrics detailing current management effectiveness are as follows:
Metrics (ttm) / Value / Industry / S&P 500Return on Assets (ROA) / (2.0%)↓ / 0.3%↑ / 8.1%
Return on Investments (ROI) / NM / 0.0% / 11.2%↑
Return on Equity (ROE) / (47.8%)↓ / 4.0%↑ / 20.4%↑
Capital Structure/Solvency/Cash Flow/Governance/Other[Note: This section has NOT been updated]
Capital
Total stockholders' equity was $17.2 billion at September 30, 2008, and tangible stockholders' equity was $12.5 billion, up $4.9 billion, compared to December 31, 2007. During 2Q08, the Corporation raised $7.0 billion of equity capital by issuing common stock, contingently convertible preferred shares and warrants. On September 15, 2008, stockholders approved the conversion of the contingently convertible preferred shares, and shortly thereafter, these shares were exchanged into approximately 1.3 billion common shares. This exchange had no effect on cash, total stockholders' equity or regulatory capital.
On September 22, 2008, NCC announced that, as the result of the recently approved conversion of its Series G Convertible Preferred stock, effective September 22, 2008, its outstanding common shares increased from 760 million to 2.1 billion, representing a market capitalization of approximately $11.8 billion, based on the $5.61 closing price of NCC's common stock on September 19, 2008.