Feds Brokered PNC's Deal for National City

The deal is the strongest indication to date of the federal government's determination to rid the industry of weak banks by pairing them with healthy buyers, which will get capital infusions to help them absorb the bad loans and other problems they are inheriting from acquired banks.

Playing a key role in the PNC-National City deal was Comptroller of the Currency John Dugan, who asked National City earlier this month to find a buyer and made it clear the government was unwilling to prop up the Cleveland-based company with new capital. Dugan also steered National City to Minneapolis-based U.S. Bancorp before PNC emerged as the winning bidder.

(This story and related background material will be available on The Wall Street Journal Web site, WSJ.com.)

"An M&A deal is your only alternative," Dugan told National City Chief Executive Officer Peter Raskind on more than one occasion, according to people familiar with the situation.

National City said Raskind couldn't be reached for comment. PNC said it knew nothing about the discussions between National City and the OCC. U.S. Bancorp had no comment.

Spokespeople for the OCC and Treasury were not immediately available for comment Friday.

The deal is yet another sign of how U.S. government is flexing its muscles during a period of wrenching upheaval for the banking industry. In the past two weeks, scores of banks nationwide have reported third-quarter results that highlight the cascading series of problems dogging the sector.

Pittsburgh-based PNC, which has largely sidestepped the problems afflicting many of its peers, delivered a formal offer Thursday only after it was clear government assistance would be forthcoming. PNC will sell $7.7 billion of preferred shares and warrants to the Treasury to finance the stock-and-cash transaction, which it valued at $5.6 billion. If shareholders approve, the deal would close by the end of the year, with each National City shareholder receiving 0.0392 shares of PNC.

The deal would give PNC $180 billion in deposits, fifth-highest in the U.S., and 2,747 branches across the Midwest, Mid Atlantic and Southeast, good for fourth-largest in the U.S. behind Wells Fargo & Co. (WFC), Bank of America Corp. (BAC) and JPMorgan Chase & Co. (JPM). The headquarters of the combined will be in Pittsburgh, and Raskind will become a vice chairman of PNC.

In a sign of how weak National City was before agreeing to the sale, PNC expects to mark down the value of National City's assets by $19.9 billion, or 17.5% of National City's loan balance.

The same problems that afflicting National City are spreading to the rest of the industry as defaults pile up not only in residential real-estate, which is where the current crisis originated last year, but also in credit cards and auto loans, as well as commercial real estate. Many banks are seeing surging problems on business loans. Of particular concern are loans to finance strip malls, gas stations and other retail businesses that are struggling to stay afloat as the economy weakens and consumers pull back on spending.

"This is the sector that we are watching very, very closely," said Joanne Kim, chief executive of Wilshire Bancorp Inc., during an Oct. 21 conference call. Los Angeles-based Wilshire, with $2.4 billion in assets and 20 branches, specializes in serving the Korean-American market.

Compounding the problems, it is getting more expensive for banks to attract deposits. Deposits are the lifeblood of banks, providing a low-cost source of financing for their basic lending businesses. Customers, fretting about the safety of their deposits amid the industry shakeout, are increasingly yanking their money out of institutions that they view as unstable.

That became the undoing of National City, prompting the OCC to intervene.

Even banks that aren't in dire straits are offering ever-higher interest rates on savings accounts and certificates of deposit.

"The competitive environment has become fierce," said Kevin Kabat, the CEO of Cincinnati-based Fifth Third Bancorp (FITB), on an Oct. 21 conference call. "We've never seen anything like it in my 25-year career, and we've had to respond, as have all competitors."

Banks derive much of their profits from the difference -- or "spread" -- between the rates at which they lend money and the rates they pay for deposits. As a result, the deposit-pricing war is flattening industry profit margins.

The National City deal would come as a big relief to Corsair Capital, which led a $6 billion capital infusion into National City in April. Corsair's $785 million investment gave the New York-based private-equity firm a 7.8% stake in the bank and a seat on its board.

If the deal receives shareholder approval, Corsair will be made whole on its investment despite it being struck at $5 a share. Corsair negotiated protections into its deal, including an anti-dilution feature that will issue new shares to Corsair at a discount to compensate it for a deal struck at a lower price. Corsair also holds warrants in National City that would entitle it to an additional cash payment.

"Corsair believes that in light of today's environment surrounding the banking industry, the decision by the NCC Board to enter into the proposed transaction with PNC is appropriate," said a Corsair spokesman.

The deal will allow Corsair to avoid the fate of TPG, the buyout firm that lost its entire $1.35 billion investment in Washington Mutual Inc. (WAMUQ) in just five months after regulators seized the thrift-holding company's banking operations.

TPG and Corsair's investments, both made in April, were the first of what was expected to be a wave of private investment into banks. But the extent of the banking crisis and now the government's rescue efforts have halted these capital infusions.

PNC shares recently rose nearly 1% to $57 while those of National City fell 28% to $2.

-- Dan Fitzpatrick, David Enrich, Damian Paletta and Robin Sidel, The Wall Street Journal

(Peter Lattman contributed to this report.)