There are a few hallmarks that define any bubble. One is the popular notion that making money is so easy. Another is the belief that anyone can do it. Yet another is the sense that even if things don't quite work out, there's little or no downside.
Yet when boom turns to bust, one outcome is always the same: fools who should have known better, saddled with large losses, desperately trying to pick up the pieces. In "How Safe Bank Tried Subprime And Got Singed," the Wall Street Journal reports on the fallout afflicting one institution that apparently saw only upside during the easy money days of recent years.
National City, in Move To Bolster Its Capital, Offers Cautionary Tale
Regional banks -- long known for their consistent if unspectacular growth in plain-vanilla loans and deposits -- are finding out the hard way that they should have stuck to their strengths during the housing bubble.
National City Corp., a Cleveland bank that barreled into originating subprime mortgages and the go-go Florida real-estate market, said it would slash its common-stock dividend by 49% and has hired an investment bank to advise it on ways to bolster capital levels now being sapped by souring loans.
The turnabout of fortune for the 15th-largest U.S. bank by stock-market value, with a reputation for Midwestern common sense, is a sign that the credit crisis is spreading deeper among traditional banks. National City had hoped that subprime loans and a larger geographic base would help it overcome slow growth closer to home, but the company now concedes that it made mistakes.
"We think the environment is uncertain enough that [the dividend cut and capital infusion are] the right thing to do," Peter E. Raskind, National City's chairman and chief executive officer, said in an interview. He became CEO in July and chairman last month, after running the bank's retail-banking and mortgage businesses.
Some of National City's nearest and fiercest rivals also made big bets across the U.S. -- and now are facing trouble, too. Among them: Fifth Third Bancorp of Cincinnati and KeyCorp of Cleveland, which pushed hard into once-booming Southern states but now are seeing their balance sheets clogged with bad residential and commercial real-estate loans. Such aggressive geographic expansions have "come back to bite all of them because of the downturn in real estate," said Robert J. Graves, co-head of the banking practice at law firm Jones Day.
National City's capitulation on its dividend is the latest sign of how hungry some of the best-known and most-established names in the U.S. banking industry are for capital infusions, from either investors or the sale of assets. Banks are often loath to reduce their dividends, but there may be no alternative, especially if loan woes continue to worsen.
Mr. Graves predicts that the dividend cut by National City could spur similar moves by other banks, since rivals can now say, "It's not just us; it's an industrywide problem."
The larger question is whether banks will hoard their capital, ratchet back lending and spread the credit crunch from Wall Street to Main Street. So far, lending standards haven't been tightened "appreciably, except for those on real-estate loans," according to the minutes of last month's Federal Open Market Committee meeting, released yesterday.
National City's dividend cut was widely expected, given the bank's dismal prognosis last month for the fourth quarter and its relatively thin loan-loss reserves. Until yesterday, National City's dividend yield of nearly 10% was much higher than the typical 4% to 6% at large U.S. banks. Yesterday, National City shares fell 5.3%, or 87 cents, to $15.59 in New York Stock Exchange composite trading at 4 p.m. National City shares are down 58% from a year ago.
Nancy Bush, an analyst at NAB Research in Aiken, S.C., said in a research note that she is "saddened to see a franchise that was once hallmarked by conservatism and Midwestern common sense" be forced to slash its dividend and scrounge for capital.
Betsy Graseck, a Morgan Stanley analyst who predicted last month that National City would cut its dividend in half, wrote that it will be 12 to 18 months "before credit trends stabilize in the loan books," which would ease pressure on bank dividends.
National City, with roughly 1,400 retail-banking branches in nine states, ventured into the business of making mortgages to borrowers with sketchy credit in 1999, when it bought a subprime lender called First Franklin Financial Cos. David Daberko, then National City's CEO, called the deal "a "superb opportunity to tap new revenue sources" in a high-growth business. By 2006, First Franklin was among the largest subprime originators.
At the same time, National City was eager to expand in Florida, a retirement haven for Midwestern snowbirds. The company spent about $2 billion to acquire community banks in West Palm Beach and Fort Pierce, giving the bank nearly 94 branches along Florida's southeastern coast, where housing prices skyrocketed. National City's own mortgage unit also expanded its loans to investors to buy real estate in Florida. Such loans are now souring at escalating rates.
Until recently, it seemed as if National City was early to recognize the looming subprime mine field. In December 2006, Merrill Lynch & Co. acquired First Franklin for $1.3 billion, a deal that has turned out to be a terrible one for Merrill, and National City quickly embarked on a roughly $3 billion stock buyback plan, paying as much as $38 a share.
"In hindsight, it was bad timing," said David Hilder, an analyst at Bear Stearns. "They went too far in buying back stock and didn't anticipate that loan losses would rise as much as they are now." National City also has had to write down the value of some First Franklin loans it kept.
National City no longer makes subprime loans, but its heavy exposure to the housing market as a traditional mortgage lender is clobbering the bank in places like the Midwest and Florida, which have some of the highest foreclosure rates in the country. Yesterday, National City said it would no longer use outside brokers to originate mortgages.
Mr. Raskind says National City "got very unlucky on timing" with the Florida purchases. Over time, though, "they will be good operations for us," he adds.
Ms. Bush says National City should seriously consider a "merger of equals" with KeyCorp, which became a major lender on commercial real-estate projects in frothy markets outside its 13-state branch network. Last month, KeyCorp said it will stop making loans to home builders beyond its home turf and warned of higher defaults on real-estate loans in California and Florida.
Mr. Raskind deflected speculation about any deals. "Our mentality now is, we've got important work to do to navigate through these challenges and rebuild profit and value," he says. KeyCorp had no comment on deal speculation.
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