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National City Corporation is a financial holding company operating primarily in Ohio, Florida, Illinois, Indiana, Michigan, Kentucky, Missouri, Pennsylvania and Wisconsin, In addition, NCC operates 410 retail mortgage offices throughout the United States.
National City Corporation (NCC) is one of the top 15 banks in the country, with more than 34,000 employees, approximately 1,440 branches, and more than 2,200 ATMs throughout the Midwest and Florida (as of September 30, 2007). Its retail and commercial banking franchise operates primarily in Ohio, Illinois, Indiana, Kentucky, Michigan, Missouri, Pennsylvania, and Florida, while its mortgage business (including conforming mortgages and home equity loans) is more national in scope. NCC acquired three banks in 2004 (Allegiant Bancorp, Provident Financial Group, and Wayne Bancorp), but then was relatively quiet on the acquisitions front until July 2006. In July 2006, NCC announced two bank deals (technically, thrifts), both in Florida, with combined assets of roughly $7 billion and a combined purchase price of roughly $2.1 billion. On the divestiture side, NCC sold National Processing (its 83%-owned payment processing subsidiary) to the Bank of America in October 2004, and in December 2006 sold off its national non-conforming mortgage business, First Franklin to Merrill Lynch.
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Business Segments
As of January 1, 2007, NCC reorganized its operations into the following five reportable segments: Retail Banking, Commercial Banking Regional, Commercial Banking National, Mortgage Banking, and Asset Management. Retail Banking specializes in providing retail and small business banking facilities, while Commercial Banking offers term loans, structured finance, syndicated loans, treasury management, and other similar services to large and middle-market businesses in the company's footprint (regional division) and outside (national division). Mortgage Banking, comprising NCM (National City Mortgage) and NHE (National Home Equity), originates home equity loans and residential mortgages both regionally and nationally. Asset Management provides investment management, custody, retirement planning, tax planning, brokerage, and other related financial advisory services to institutions and affluent clientele.
National City has a respectable mix of fee-income businesses, including trust and investment management, investment banking and brokerage, and a significant credit card portfolio. This diversifies NCC's revenue stream and enhances its ability to cross-sell products and services. On a core basis, we estimate that non-interest income equated to 41% of net revenue in 2006.
Financials
Real estate loans in all (consumer and commercial, including held-for-sale) accounted for 62.6% of total loans as of September 30, 2007, followed by commercial (30.2%), and consumer (7.2%). The securities portfolio was a conservative 6.1% of average earning assets in the third quarter. Non-interest-bearing and other low-cost deposits funded 40.4% of average earning assets in the quarter, with time deposits and borrowing funding 21.2% and 27.3%, respectively. As of September 30, 2007, NCC had $154.2 billion in total assets, $124.0 billion in loans, and $98.2 billion in deposits.
Trends and Forces
Acquisitions and Expansion
NCC continues to support its internal growth initiatives with strategic acquisitions (including Forbes First Financial, the two Florida thrifts, and more recently, MAF Bancorp) and prudent capital management. NCC repurchased 20.0 million shares in 2006, following 43.5 million repurchased in 2005. In 3Q07, NCC repurchased about 1.0 million shares (repurchases were somewhat stalled in the third quarter owing to the MAF acquisition), which brings the year-to-date 2007 total to about 86.0 million shares. However, in view of the current environment, the Management plans to allow its capital ratios to migrate towards the top end of their respective target ranges and as such we do not expect any significant repurchases in coming quarters. For Tier 1 capital, the expected range is 7 8% and for tangible common equity, the range is 5 6%.
NCC has been more active than most in repositioning its businesses to enhance its growth story. Sharpening its focus on traditional retail and commercial banking in faster-growing states, NCC made a couple of acquisitions to gain a foothold in the Florida market, while cutting its exposure to subprime origination and servicing with the sale of First Franklin. More recently, the acquisition of MAF Bancorp gives NCC access to Wisconsin market, while increasing its presence significantly in the fast-growing Chicago market.
On the expense side, management seems to have a renewed fervor for expense control. Its "Best In Class" initiative was expected to produce a $200 million pre-tax benefit in 2006 (though the actual success is hard to measure given all the moving pieces) and $750 million per year by 2008.
NCC initiated its retail banking footprint in Florida, with the acquisitions of Fidelity Bankshares, Inc (FFFL) and Harbor Florida Bancshares, Inc. (HARB). NCC now has a 94-branch network along Florida's east coast, with total assets of more than $7 billion. Given the relative growth rates of the Florida markets versus NCC's traditional Midwest markets, a move there likely makes sense over the long term. Near term, however, we note that pricing appeared somewhat high to us (roughly a 20% premium for each, relative to what we see as already-full, public-market values for bank and thrift stocks). We also note that competition in Florida is fierce, that expansion by numerous competitors makes the success of each new branch less certain, and ongoing turmoil in the real estate markets is likely to have a significant impact on operations there.
Buying MidAmerica Savings in the Chicago region and Fidelity Bankshares of southeast Florida gave the bank some terrible loans, but also a large Hispanic footprint which will be an important building block for future market penetration in Latino communities.
Mortgage Business
We view NCC's oversized mortgage business as one key culprit behind its woes. The effect of various costs and charges were previously estimated, which produce an after-tax loss in Mortgage Banking of $167.4 million in the third quarter. Based on the information available as of the mid-quarter publication, the company expects the loss to be around $200 million during 4Q07. We viewed the First Franklin sale positively in this regard, although we note that National City Mortgage has actually been more volatile than National Consumer Finance / First Franklin when viewed as a line of business. Recently NCC took some restructuring initiatives in its mortgage business which include suspending the originations of broker-sourced home equity loans, moving the non-saleable warehouse inventory into the loan portfolio and narrowing the product range to agency eligible first mortgages and high quality jumbo loans. The company expects a much lower level of mortgage originations (about $30 billion) in FY 2008 (versus about $44 million expected for FY07) as a result of the initiatives.
While hedging is an important aspect of such a business and it has added significantly to overall mortgage banking results in recent years, its impact is highly volatile under GAAP accounting, leading to wide swings in reported revenues and earnings. The year 2006 included $294 million of net hedging losses, compared to $285 million of gains in 2005. These volatile components have translated into a high degree of difficulty in forecasting earnings (and thus a wide range of estimates).
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