Editor’s Note: We regret that a technical error cut off the last sentence in the feature story “Sinking of a Titan,” from our newly published 4th Quarter 2009 issue. We apologize for the error.
For the board of National City Corp., the end came with one final and startling plot twist. Heading into its last day as a truly independent entity, all was on track for the teetering Cleveland-based banking company to be acquired by U.S. Bancorp. Then, in a matter of hours, everything changed. PNC Financial Services Group, the big Pittsburgh bank, swooped in with a better offer and USB dropped out. The price: $5.9 billion-or about $2.23 per-share for most shareholders-a fraction of what the company had been valued at less than two years earlier, but better than any of the alternatives.
It was perhaps an apt way for what was the nation’s eighth-largest bank to die. The company’s sale, forced by regulators, marked one of the lowest points in the financial crisis, but it was years in the making. Nat City jumped feet-first into subprime and home-equity loans during the real estate boom, and couldn’t get out when things went bust. Directors signed off on ill-advised deals and they allowed capital to be managed in a way that, with hindsight, looks foolhardy.
Only six months earlier, $145 billion Nat City’s 12 directors believed they had ensured the company’s long-term survival with a $7 billion private-equity-led capital injection meant to provide a cushion against rising loan losses. In the end, however, liquidity concerns and market perceptions doomed the 163-year-old Cleveland institution.
What happened to Nat City should serve as a cautionary tale for any board that feels tempted to chase the latest bubble. Although not technically a failure, that’s what it was. Attempts to contact the board members have either gone unanswered or been met with polite declines. But a review of news reports, regulatory filings, and 3,000 pages of confidential board minutes, emails, courtroom depositions and other internal documents-part of a shareholder lawsuit that a Delaware judge ordered unsealed after a media challenge earlier this year-shows a board that worked feverishly throughout 2008 to keep Nat City afloat but got whipsawed by events both of its own making and beyond its control.
The group met frequently-often via phone-and relied on a host of outside experts. Along the way, the board weighed pursuing a “good bank/bad bank” strategy to isolate the troubled assets on Nat City’s balance sheet, sought salvation in the government’s Troubled Asset Relief Program, and flirted with some of the biggest banking companies on the continent, including Citigroup and Canada’s Bank of Montreal and ScotiaBank.
The suitors were noted in the minutes by code names, such as “Foxtrot,” “Sierra,” and “Whiskey,” to keep their identities secret-all of them seeking to capitalize on Nat City’s misfortune. Goldman Sachs & Co., the board’s primary financial adviser, even assigned a name to the ill-fated internal effort to keep the bank independent: Project Falcon.
Through it all, the board felt what Chairman and CEO Peter Raskind described in a lengthy deposition as “quite an intense sense of pressure” to try to balance multiple interests in a crisis environment. Just how well the directors did might be a matter of opinion, but the documents leave little doubt about the effort expended.
The story of Nat City’s demise begins during the go-go housing boom earlier this decade. Under then-CEO David Daberko, the company chased growth with some big bets. It bought brokered home-equity loans from third parties around the country and beefed up on subprime and residential construction loans. It also acquired two Florida banks-West Palm Beach-based Fidelity Bankshares and Harbor Florida Bancshares of Fort Pierce-and MAF Bancorp of Chicago, all at or near the peak of the market in 2006 and 2007. With hindsight, the pricing on those deals, at more than three times book value, looks ridiculous.
Making matters worse was the way Nat City managed capital. In February 2007, the first signs of the crisis emerged with the collapses of several small subprime lenders. It should have been a red flag to hunker down, analysts say. Instead, the board authorized a $3 billion stock repurchase in early 2008, and in July voted to bump the company’s quarterly dividend to 41 cents per-share from 39, draining the company’s coffers even more.
Having access to that capital could have enabled Nat City to better weather its coming loan troubles. “Of course, if we could go back and change things, we wouldn’t have done it,” Raskind said of the board’s decision to authorize the share dividend hike in a 2008 interview. “But it wasn’t so obvious at the time.”
In mid-January, Nat City reported a $333 million loss in the fourth quarter of 2007, compared with profits of $842 million a year earlier. The board moved proactively to preserve capital, slashing the dividend by 49%, to 21 cents per-share, and cutting about 2,000 jobs. But it wasn’t enough.
In March, investment bank Bear Stearns was forced to sell out to JPMorgan Chase & Co. for $2 per-share and falling housing prices began drawing comparisons to the Great Depression. Nat City, with its high proportion of real estate loans, looked poised to become the next victim.
Under pressure, directors weighed their options, considering lowball offers from crosstown rival KeyCorp, as well as USB, PNC, and Canada’s ScotiaBank, which offered more than $7 per share for the company but then dropped out of the bidding. They eventually settled on selling a 70% stake to an investor group led by Corsair Capital, a New York private equity firm, for $7 billion, or about $5 per share.
The money seemed destined to save the company, boosting its capital ratios to among the highest in the industry. Management played up the stabilizing effects of the injection to both investors and the board. The dividend was slashed again, to virtually nothing. Within months, however, liquidity concerns-mostly driven by external events-became an even bigger concern.
The July seizure of IndyMac Bank, replete with 24-hour news coverage of Depression-era depositor runs, sparked widespread unease. And then September came, with its rapid-fire succession of collapses: The government takeover of mortgage entities Fannie Mae and Freddie Mac; Merrill Lynch & Co.’s distressed sale to Bank of America Corp.; Lehman Brothers’ collapse; the government’s $85 billion rescue of American International Group; Wachovia’s forced sale to Wells Fargo & Co. and more.
When Washington Mutual Inc., the large Seattle thrift that also was a big real estate lender, was forced to sell to JPMorgan Chase & Co., Nat City suffered from guilt-by-association. Worried depositors and counterparties began to flee, and liquidity-not capital-became the overwhelming concern.
Raskind said in his deposition that he contacted numerous corporate CEOs and wealthy individuals, trying to get them to keep their money with his bank. “The most typical response was, ‘Gee, I’ve had a long relationship with your bank. I like your bank and when everything is fine, I’ll come back. But … right now I have to do what I have to do for safety’s sake,’” he recalled. “Even if it was based on rumors, … for their own peace of mind they would withdraw the dollars.”
Financial institution counterparties also got “squeamish about doing business with us,” Raskind recalled. There was so much “fear and uncertainty” among all financial companies regarding Nat City’s future that “the safest thing for counterparties to do, they felt, was to back away from doing business with us,” he said. It was “a perception issue, but it’s a perception that turn[ed] into reality.”
The market was spooked, as well-Nat City’s share price fell to as low as $1.36 in late September-and the board clearly felt flummoxed by the turn of events. Essentially, the company was caught in a “negative feedback loop,” according to Goldman partner John Mahoney, who was deposed as part of the lawsuit.
“[R]ating agencies would explicitly take into account stock price and liquidity in their rating and … downgrade the company, which in turn would negatively affect liquidity and the stock price, which would in turn potentially cause the rating agencies to take further action and so on.”
Faced with so many threats, the board hired Goldman in early October to help explore its broad strategic alternatives. Minutes also show representatives from three law firms, including one specifically representing the board-Cravath, Swaine & Moore LLP of New York-in regular attendance at board meetings.
Potential strategies included selling off pieces of the company-a task for which it turned separately to Morgan Stanley for assistance. One would-be buyer, for instance, was interested in Allegiant Asset Management, an institutional money management subsidiary, but that effort fell apart as the company’s woes increased.
The board also seriously pursued a “validating investment” from a big-name individual. “There was even an effort made to probe Warren Buffett,” Raskind said.
The September introduction of TARP presented another possible avenue of escape. The program’s original vision called for the government to purchase bad assets-an approach that seemed tailor-made for Nat City. Management lobbied Treasury and its regulators hard for inclusion in the program; the Comptroller’s office and the Federal Reserve returned the favor by, at times, sending representatives to sit in on board meetings.
Lurking just beneath the surface was the painful realization that Nat City might, indeed, need to be sold-perhaps quickly, in the fast, dirty Wachovia-esque style that no board likes to pursue but was becoming more commonplace. In this case, the rush was due not only to Nat City’s perilous position, but also to a coming change to purchase accounting rules, which would make a buyer’s mark to market on the company’s bad assets worth more if a deal was closed before January 1, 2009.
By early October, a list of potential partners was pulled together. Initially, the most promising candidate was Canada’s ScotiaBank (code name Sierra), which had shown strong interest when the board was exploring its alternatives in March and was “culturally aligned” with Nat City, Raskind said.
At one point, the two sides discussed ScotiaBank providing Nat City with a secured $5 billion “liquidity facility” with an 18-month term as a bridge to selling assets to TARP. Those discussions also included ScotiaBank investing $500 million for a minority stake and some warrants-a move that, it was hoped, would boost outsider confidence in the company.
Later, talk turned to a whole-bank acquisition, with the potential of a government “backstop of losses on the portfolio,” Raskind said. But a review of Nat City’s books left ScotiaBank’s team worried that even a small investment could leave it liable if Nat City’s condition got worse. On October 4, a Saturday, ScotiaBank CEO Rick Waugh called Raskind at home to say he was no longer interested.
KeyCorp (Kilo) and Fifth Third (Foxtrot) both were considered as merger, but not takeover, candidates. “The market capitalization of those two banks, relative to our market capitalization, didn’t position them to be [buyers],” Raskind said. Wells Fargo (Whiskey) was contacted, but the San Francisco company had its hands full with the Wachovia deal and talks apparently never progressed far.
BMO Financial Group, code-named “Bravo” in the board’s documents, was another possibility. The Montreal bank, recruited by Goldman, showed some preliminary interest in buying some of Nat City’s branch network, but the discussions “never took on a level of seriousness,” Raskind said. “We could discern no particular advantage” in a branch sale.
Banco Santander, the Spanish bank that has been building its U.S. footprint also was mentioned, though it doesn’t appear enough to merit a code name. Santander was in the process of purchasing Sovereign Bancorp in Wyomissing, Pennsylvania. “The feeling was that they were very likely to be preoccupied with that transaction,” Raskind said. Citigroup (Charlie), which had shown some interest in Nat City’s domestic deposit business back in March, also was contacted.
After ScotiaBank withdrew, the most likely buyers appeared to be Minneapolis-based U.S. Bancorp (code name Union) and PNC, which went by “Papa.” But on October 9, PNC CEO James Rohr called Raskind to say PNC was pulling out of the bidding, because “they couldn’t make the numbers work.” On Sunday morning, October 12, USB CEO Richard Davis called Raskind with the same message. “They were the final one to drop,” he recalled. “Now we have no one-no potential acquirer still in the picture.”
With no sale imminent, attention at that afternoon’s board meeting focused on saving Nat City as a standalone entity. Among the options considered was to try to sell the company’s bad assets-either to the government’s TARP program or on the open market. “We felt that clearly the most impactful thing we could do would be to sell distressed assets at that point, even at distressed prices, in order to manage the market’s perception of our risk,” Raskind recalled. Not surprisingly, Morgan Stanley, which was tasked with trying to find buyers, found the market for those assets to be “very, very thin.”
The next day, Treasury formally announced its intention to fundamentally transform TARP by using the $700 billion in funds to inject capital into healthy banks via the CPP. This was a blow: Selling bad assets to the government was now likely off the table, and early conversations with regulators and the Treasury provided a sense that Nat City’s participation in the CPP was doubtful.
In a phone conversation with Comptroller John Dugan on Tuesday, the 14th, Raskind tried to set up a meeting to discuss selling bad assets to TARP. Dugan said he’d be willing to have that discussion, but also pressed Raskind to pursue a sale. The asset-sale discussion never happened. Indeed, over the ensuing week, Dugan turned up the heat, reportedly telling Raskind several times that a sale was Nat City’s “only alternative.”
The good news was that the prospect of getting government capital had revived USB’s interest in doing a deal. In essence, the U.S. Treasury was willing to help finance a transaction. In a phone conversation, Davis offered Raskind $1.10 per-share for Nat City-less than half the price the stock was fetching on the market.
The next day, the offer was formalized in writing, along with an offer to appoint at least one Nat City director to USB’s board.
The board’s reaction to the offer, Raskind said, was mixed. On one hand, directors were happy someone was interested in a deal. “On the other hand, they were very disappointed with the value that was being offered.” After a long discussion, board members directed Raskind to try to negotiate better terms with USB, while Goldman and the other advisers began calling other banks looking for a more attractive deal.
“Were there other parties out there who might now have renewed interest … because of this new dynamic, the Capital Purchase Program?” Raskind recalled discussing.
Citi and Fifth Third were among the banks contacted, as was PNC. That Friday, the 17th, Raskind tried in a phone call to personally rekindle Rohr’s interest, noting that other banks were contemplating using government capital to help finance such deals. Rohr was reportedly intrigued, but remained noncommittal.
As the weekend dawned, Davis sent a letter outlining the structure of a deal that would be valued at roughly $2.5 billion-still around where the first offer had been.
In an executive session that night, the board met with its advisers. Directors bemoaned what they saw as bullying on the part of Dugan. They were clearly unhappy that the government was willing to provide another bank with the capital to acquire their institution. But advisers noted that the regulators were in the driver’s seat.
Crunch time was coming. TARP recipients would be named in the coming week, and if Nat City was off the list-an outcome that seemed more and more likely-the company could fail. “There was quite an intense sense of pressure to resolve our situation, understanding that at some point it was going to become clear to the market that there were some banks that were receiving capital and perhaps others that were not,” Raskind recalled, adding it was “a grave concern for us.”
At 1 o’clock on Sunday afternoon, October 19, the 12 directors gathered (three by phone) at the upscale Bertram Inn in Aurora, just southeast of Cleveland to commence the longest meeting in board history-one that would last nearly five days, be held in various places, endure numerous twists, and conclude in Nat City’s sale. Five Goldman investment bankers and 10 attorneys joined them.
As Raskind explained, the gathering was structured as one continuous meeting, as opposed to a series of separate sessions, for “technical reasons”-to avoid the need for giving notice of a new meeting. “We knew that we would need to meet with some frequency,” he said.
After conducting a review of the coming third-quarter earnings-the company would book a $729 million loss-the board began to delve into three potential strategies: Going it alone, possibly with government help; a long-shot government-assisted merger with Fifth Third; or a sale to USB.
None of the options was particularly appealing. Continuing on as an independent would require some creative financing and was looking more unlikely by the hour.
The prospects for selling assets privately were discussed, but didn’t look good. Goldman also talked about establishing a separate “bad bank” that would house troubled assets, but that would take regulatory concurrence.
As for gaining government help, Raskind believed-based on his ongoing discussions with, and a memorandum from, the OCC-that there was “substantial doubt” about whether Nat City would be allowed to participate in the CPP or a separate debt-guarantee program launched by the Federal Deposit Insurance Corp. The agencies had declined the board’s request for a sit-down meeting, and also had begun evaluating a potential downgrade of the company’s regulatory ratings.
One of the directors, Richard Thornburgh, 57, Corsair’s vice chairman and a former executive vice chairman for investment bank Credit Suisse First Boston, also talked with the OCC, according to the company’s filings. “He was … confirming for the board what was being told to us by our chairman,” recalled director Allen Koranda, MAF’s former CEO who had joined the board with the 2007 deal.
“We knew that the rating agencies were reviewing us for downgrade. And we knew that at some point the government would announce institutions who had received capital, and we likely wouldn’t be on that list,” he said in the deposition. As the parameters of TARP became more clear, the board was concerned that “the market would interpret our absence from that list as suggesting some very significant weaknesses” based on regulators’ assumed knowledge of the company.
Among the implications: greater deposit outflows, more counterparties unwilling to do business with Nat City, and the very real possibility that the Federal Home Loan Bank would yank $10 billion in funding, sparking “an immediate liquidity crisis.”
That left a business combination looking like the only viable alternative. Fifth Third was back in the mix as a merger partner-at least in the eyes of Nat City’s management and advisers. The idea hatched by Nat City’s team was for a complicated transaction that would involve accessing government capital, combining the two companies, and spinning off some of each bank’s problem assets into a “bad bank.”
Fifth Third’s team was cool to the idea, however, and with the clock ticking, and even if the Cincinnati company could be persuaded, there probably wasn’t enough time to execute a workable deal. By Tuesday evening, discussions with Fifth Third had died. “That option really never came to anything close to fruition,” Koranda said.
In short, while the board remained unhappy with USB’s offer, the combination of regulatory and execution risks, capital and liquidity requirements, and timing left it looking like the board’s only plausible avenue for escape.
Raskind’s primary task became squeezing as much as possible out of his counterpart, Davis-negotiations he called “very difficult and very painful.” He was pressing for about $2 per share, or about $4.6 billion, but was achieving only baby steps.
The board, meanwhile, began grappling with another issue. Corsair and two other investors who contributed to April’s $7 billion capital injection had negotiated “downside protection” that, in the event of a sale, guaranteed a minimum price for warrants they received into their agreements. Now, attorneys were reporting that there was “significant ambiguity”-about a $200 million difference-between the two sides over how those warrants should be valued.
On Thursday morning, one day before TARP recipients were supposed to be announced, the ball appeared to be rolling toward a USB deal. Raskind’s legwork had proven marginally successful, with a final offer valued at about $3.6 billion, or $1.75 per share. Then the chairman got a surprise call from PNC’s Rohr, saying that he was gathering his board that afternoon to discuss making a last-minute offer for Nat City.
Rohr’s preliminary verbal offer, about $2.15 per share, sounded more appealing than USB’s price, but Raskind was skeptical. He told Rohr that Nat City’s board was meeting that night to approve the USB transaction, so if he wanted to present a formal offer, he’d have to move quickly. “We were very much working against what we thought was-and believed to be-an imperative to complete the transaction by morning,” Raskind recounted in his deposition.
Rohr updated Raskind through the afternoon, and at 6 p.m. he made a formal verbal offer, along with the promise of a board seat for one Nat City director. Raskind still didn’t really believe it, and quickly asked for a marked-up purchase agreement. “We needed to be … as certain as we could be that the offer was bona fide,” he recalled.
Raskind, meanwhile, had established just how far Davis, indeed, was willing to go: When told about PNC’s better offer, USB’s CEO turned down a chance to match the terms. “They dropped out,” he said.
At 9:30 p.m. that evening, Nat City’s directors officially resumed their meeting at the Hyatt Hotel in downtown Cleveland and learned, for the first time of PNC’s new offer, which now was in writing. Raskind had been so skeptical about PNC’s intentions, he hadn’t even bothered telling his board members. “Literally, the board did not know of [PNC’s] interest until we arrived at the board meeting,” Koranda recalled. “Quite frankly, neither did most of the Goldman Sachs people. This really did come at the very end.”
The offer was “relatively simple,” Koranda recalled, “primarily because the deal was so fast-tracked.” Directors went over the preliminary purchase agreement with their outside advisers. Goldman had pulled together a packet of materials-including a recap of the past several weeks’ activities, a comparison of the proposed deal to other recent transactions, and a snapshot of PNC’s balance sheet and financial condition-for directors to review. It still wasn’t ideal, but the pricing “was higher than the $1.75 [per share] that U.S. Bank had been offering,” Koranda recalled.
Perhaps the most contentious part of those discussions centered on the Corsair warrants. PNC had made it clear that it didn’t want the issue hanging over the transaction. Thornburgh, the Corsair representative, left the meeting as the board weighed what to do, but it didn’t change the outcome. Nat City’s board had a gun to its head: The deadline for striking a deal was just hours away, and the $200 million gap was the key stumbling block. “Ultimately, the board essentially agreed to Corsair’s and other investors’ interpretation of the warrants,” Raskind said.
After the review, the board members dispatched Raskind to press Rohr for more money. The PNC CEO had flown into Cleveland with some members of his team after PNC’s board meeting, and was staying on another floor in the hotel. All Raskind needed to do was hop into an elevator for a face-to-face discussion.
A short while later, Raskind returned with another small increase in the price-an exchange ratio of .0392 PNC shares for each Nat City share, or about $2.23 for common owners after the Corsair warrants were taken into account. The deal included $5.5 billion in common stock and another $384 million in cash for warrant holders. PNC would receive $4 billion in additional TARP money for its efforts.
It was after midnight when the board voted unanimously to proceed with negotiations on a definitive agreement. The meeting adjourned temporarily, and directors retired to their rooms. “We thought it was a good price based upon what we had found in the market,” Koranda said. “To me, … the only thing that was really relevant was what the final price was going to be.”
The legal and investment banking teams, along with management, worked through the night hammering out the fine points and conducting a hurried due diligence. At 6 a.m., the board reconvened to go over a final analysis of the deal terms and review a fairness opinion, offered by Goldman. The discussions centered largely on Nat City’s financial condition, “the lack of alternative transactions and the very doubtful situation relating to the corporation’s participation in the TARP, the CPP, or the FDIC debt guarantee program,” according to the minutes.
“In light of the prevailing conditions and circumstances,” the minutes state, the advisers concluded “it would be reasonable for the board of directors to approve the proposed transaction with Papa.”
At 8:45 a.m., both boards unanimously approved the deal. And at 9:25 a.m., just five minutes before the market’s open, PNC’s acquisition of Nat City was announced, creating the nation’s fifth-largest bank. “This transaction is about two companies that fit well together in terms of geography, products, and services,” Raskind said in a news release, making no reference to the saga his board had just endured.
As it turned out, Treasury didn’t announce the TARP recipients that day after all, but it didn’t matter. Cleveland’s largest bank was no more. National City had been swallowed up by PNC.