Takeover by PNC Heralds Fall of a Cleveland Institution

By Michael A. Fletcher
Washington Post Staff Writer
Saturday, October 25, 2008

CLEVELAND -- This city's biggest bank and a bedrock institution decided it faced a choice a decade ago: Find a way to grow or risk takeover. National City chose growth, a path that ended yesterday when it agreed to sell itself to Pittsburgh's PNC.

When it abandoned the conservative philosophy that had sustained it through the Civil War and the Great Depression and expanded by wading into the subprime mortgage market, National City was a solid company, its shares selling in the $30 range. Yesterday, PNC Financial Services Group agreed to buy the bank for $5.2 billion in PNC stock, paying $2.23 per National City share, and $384 million in cash.

Cleveland is still home to another large regional lender, KeyCorp, but the loss of one such venerable institution was a blow to the city and is emblematic of the way the financial crisis is rippling through communities. Cleveland's prospects had soared with property values during the mortgage boom earlier this decade, then collapsed in the subprime meltdown.

Last year alone, 8,000 homes went into foreclosure in the city, whose population has shrunk below 450,000. With tax collections shriveling and a recession looming, the city is in its worst shape in years.

Mayor Frank G. Jackson (D) likened the impending departure of National City, with more than 7,000 employees in the region, to the loss of a steel mill or other major employer, as well as a stalwart corporate citizen that has been engaged in almost every philanthropic endeavor in the city.

"It's not good news for Cleveland," he said yesterday. "However, it is not news that we did not think may happen."

When National City was trying to figure out how to expand in the mid-1990s, Cleveland was dormant, its population sliding and its vital industries contracting. Banks were reluctant lenders, and in many neighborhoods, it was nearly impossible to get a mortgage.

At the time, the mortgage business accounted for only 5 percent of the bank's profit. All of that changed when National City decided to turbocharge its earnings by going deeper into the riskier parts of the mortgage business. The bank began working more closely with mortgage brokers to bring in more business from faster-growing parts of the country. In 1999, it bought the California-based subprime lender First Franklin. By 2003, the bank was the nation's sixth-largest mortgage lender, and home loans accounted for about half of its $2.1 billion in profit.

In Cleveland's old neighborhoods, property values began to soar. Wood-frame houses built nearly a century ago were fetching $70,000, $80,000 and even $90,000 -- multiples of their previous peaks. Tax revenue accelerated, punctuating Cleveland's claim as a comeback city. National City got in on what turned out to be a national boom, as it rapidly expanded its mortgage business into the fast-growing Sun Belt and ventured deeply into the subprime lending market. For a time, the strategy was wildly profitable, as the bank reported profit of more than $13 billion from 2000 to 2006.

And then the boom fizzled, leaving both the bank and its home town faltering. Overall, nearly 10 percent of the city's properties have gone into foreclosure.

National City has lost more than 80 percent of its market value this year. On Tuesday, chief executive Peter E. Raskind said 4,000 positions would be eliminated from its overall workforce of 29,000 over the next three years. The bank slashed 3,400 jobs a year earlier.

The cuts were announced as the bank posted a third-quarter loss of $729 million -- its fifth consecutive quarterly decline -- and executives set aside precious capital to cushion it against expected losses from its bulging portfolio of toxic loans.

John C. Dugan, the U.S. comptroller of the currency, whose office oversees National City, had told the company not to count on an investment from the government's $700 billion recovery package, according to people familiar with the matter. Instead, the government gave PNC $7.7 billion to help it buy National City. The Cleveland company, fearing it could not survive the stigma of the government's rejection, then agreed to the deal, said the sources, who spoke on condition of anonymity because they were not authorized to comment publicly.

If the government had agreed to invest in National City, "we would not be having this conversation," Jackson said.

Bill Mahnic, professor of banking and finance at Case Western Reserve University in Cleveland, predicted that PNC would lay off as many as one-third of the National City employees in its home city, particularly in senior management and processing and operations staff.

PNC hopes to complete the deal by the end of the year, and Jackson said it plans to announce any changes after that. "The negative impact will be on the uncertainty and the trauma that it brings to the life of the employees of National City," he said.

The bank's travails have hit hard in Cleveland. National City has been a mainstay of civic life, supporting cultural institutions and lending expertise to community development groups, as well as sponsoring events such as the city's annual Home and Garden Show, which calls itself the largest in North America. The bank has spent about $20 million a year on philanthropy.

Mahnic said PNC would probably support only a handful of those organizations. "PNC has a good record in altruism," he said, "but obviously not being headquartered here, they're going to cut back from the level that National City donated money to."

The combined company would be the fifth-largest U.S. bank in terms of deposits. PNC has been steadily expanding in the Washington area, acquiring Riggs Bank in 2005 and Baltimore-based Mercantile last year. Earlier this week, it said it would open 41 mini-branches and install 180 ATMs in Giant Food stores by the end of 2009.

Long before it jumped into the subprime market, National City had earned a reputation for funding small development projects and residential programs proposed by the city's many neighborhood community development groups. Its executives sat on boards, and the bank made unconventional loans available to residents who were carefully screened for their ability to pay.

"Their involvement at that level was very well thought through and conservatively underwritten," said Eric Hodderson, president of Neighborhood Progress Inc., a community development group. "They were a bank operating in a traditional framework."

National City was hardly the only mortgage outfit to invest heavily in subprime loans. All over Cleveland, lenders from across the country were pouring money into communities that not long before had complained about being redlined.

Much of that money, from National City and other banks, found its way to Slavic Village, the childhood home of Rep. Dennis J. Kucinich (D), which local officials call ground zero for the foreclosure crisis. For decades, the neighborhood, which abuts a steel mill in the city's southeast, was a struggling working-class community with an aging population and few new residents. But Slavic Village underwent a dramatic change beginning in the late 1990s as the tide of mortgage money flooded the area with new homeowners, lifting prices to unprecedented heights. Thousands of the neighborhood's small wooden homes turned over, with investors selling to new buyers at multiples of their purchase price, sometimes within months, and often after making only cosmetic repairs.

"The deals became toxic immediately," said City Council member Anthony Brancatelli, who for 17 years headed the Slavic Village Development Corp. "What should have been $20,000 or $30,000 homes became $80,000 or $90,000 homes with toxic loans."

The result has been a rush of foreclosures. The number of foreclosure sales in the five-square-mile neighborhood swelled from 114 in 2001 to 840 last year. In the first six months of this year, 316 Slavic Village properties have been through foreclosure, according to figures compiled by the development corporation.

The story has been repeated to varying degrees throughout Cleveland, and the result has been the virtual collapse of the city's housing market. Livable homes can be had for as little as $6,000 or $7,000, while many others have tumbled into complete disrepair, leaving city officials in a desperate battle against the resultant blight. In Slavic Village alone, more than 50 arson fires have been set this year, while many of the vacant homes are ravaged by scavengers, looking to cash in on the copper wiring and plumbing and aluminum siding that they sell as scrap metal. It is a stunning decline that is sure to shrink the city's property tax base for years to come.

Jackson, the mayor, said the collapse is rippling across the region, with declining property values hurting even residents of more affluent neighborhoods. "As people lose home equity, they are having problems upgrading cars and sending their children to college," he said. "All of these things are off the table for some people. When that happens, the demand for goods and services are negatively impacted."

Jackson, who said the city has avoided deficits only by making across-the-board spending cuts in the past two years, said he is looking to Washington for a stimulus package for cities. Such a plan is in the earliest discussion stages in Congress. "There has to be an infusion of federal dollars," he said.

As the city struggled, National City went into a furious scramble for life, seeking to free itself from its bad loans.

The bank sold its subprime unit, First Franklin, in 2006, though it has held on to some of the most questionable loans. Raskind took the top job in 2007 and has attempted to steer the teetering company to safer territory and return to the kind of community-based business that was once its hallmark. In April, the bank received a $7 billion private-equity investment, which helped build capital reserves.

But it was too late. Soon, the bank founded in Cleveland in 1845 is likely to disappear into PNC.

"Initially, you're going to be hurt," Mahnic said. "It takes you a while to heal. Cleveland will overcome this, and Cleveland will adjust, but it's going to take some time."

Staff writers Ylan Q. Mui and Binyamin Appelbaum contributed to this report.