Oct. 24 (Bloomberg) -- PNC Financial Services Group Inc., Pennsylvania's biggest bank, plans to buy National City Corp. for about $5.2 billion in stock after receiving U.S. Treasury funds.

PNC will pay $2.23 a share, 19 percent less than National City's closing price yesterday, to create the fifth-largest U.S. bank by deposits, the Pittsburgh-based lender said today in a statement. The $7.7 billion of Treasury funding, part of the government's $250 billion plan to recapitalize banks, ``put this transaction on a very solid footing,'' PNC said.

National City, once among the nation's top 10 subprime lenders, joins Washington Mutual Inc. and Wachovia Corp. in submitting to takeovers after losses tied to failed home loans. Cleveland-based National City lost more than $3 billion during the past five quarters, and its stock plunged 87 percent this year. PNC is still profitable.

``It certainly beats having these troubled banks end up being taken over by the government,'' said David Havens, a credit desk analyst at UBS AG in Stamford, Connecticut. ``It's better for just about everybody that you have a private-market solution and the government facilitating to make sure it happens.''

The capital injection is the first in phase two of the $250 billion program for financial companies, a person familiar with the matter said. An initial $125 billion was allocated to nine of the largest U.S. banks.

Bad Loans

PNC expects merger-related costs of $2.3 billion and said the deal would add to earnings in 2010. Cumulative impairments from loans in National City's portfolio will be about $20 billion, PNC said in a presentation on its Web site. The combined bank will cut $1.2 billion in costs.

PNC advanced $2 to $58.88 at 4 p.m. in New York Stock Exchange composite trading. National City, Ohio's largest bank, slipped 68 cents, or 25 percent, to $2.07. National City stockholders will get 0.0392 PNC share for each of their own. PNC will pay $384 million in cash to holders of warrants.

``A big thing that we're buying here is a very, very large deposit franchise with a very, very large and loyal customer base,'' PNC Chief Executive Officer James Rohr, 60, said on a conference call. ``If you look at the business over decades and decades, the banking industry has been able to go through many, many cycles and many, many mistakes, quite frankly, because of that core deposit franchise.''

Ohio, Michigan

National City had more than 1,400 branches in nine states including Ohio, Michigan and Pennsylvania as of June 30. The bank said Oct. 21 that total average deposits in the third quarter declined by less than $1 billion from the second quarter to $98.7 billion, and increased $5.2 billion from the same period a year earlier. The lender said new customers partly offset withdrawals from accounts that exceeded federal deposit insurance limits.

The combined bank will have about 2,750 branches, mostly in the U.S. Midwest and Mid-Atlantic regions, and some will be closed, PNC said. The deal is expected to be completed by the end of this year

By using stock for the purchase instead of cash, PNC may be able to use the government money to boost its Tier 1 ratio, a measure of a lender's ability to absorb losses. The ratio at the combined bank will be about 10 percent, compared with PNC's 8.2 as of Sept. 30.

Federal Help

Neel Kashkari, the Treasury official running the federal rescue program on an interim basis, told lawmakers yesterday that the department supported lenders using funds from the $700 billion bailout law for mergers.

``We have to be very careful about not discouraging prudent acquisitions because that can actually help us get through these troubled times that we're in right now,'' Kashkari said at a Senate Banking Committee hearing in Washington.

National City earlier this week posted a $729 million third-quarter loss and said it would cut 4,000 jobs over a three year period. CEO Peter Raskind, 51, said in an interview Oct. 21 that the bank was ``quite interested'' in the government's program and ``didn't feel we were in a position where we needed additional capital.''

National City had more than tripled its loan loss provision to $1.18 billion. PNC posted a 39 percent profit decline in the third quarter and its shares dropped about 13 percent this year through yesterday.

``PNC seems to have not strayed from the traditional blocking and tackling of the commercial-banking business,'' Havens said. ``They have a real clean portfolio that's not bogged down by the sort of things that have troubled some of their peers.''

Subprime Loans

National City sold its subprime loan unit, First Franklin Financial, at the end of 2006 to Merrill Lynch & Co., where it contributed to a record loss at the New York-based securities firm. National City kept some of the loans made by First Franklin, saddling it with losses.

National City also made ill-timed acquisitions in Florida at the height of the housing boom. The lender acquired Fidelity Bankshares Inc. for $1 billion and Harbor Florida Bancshares for $1.1 billion in deals struck in 2006. Florida had the second- highest foreclosure rate last month, and Ohio was also in the top 10, data compiled by research firm RealtyTrac Inc. show.

PNC's credit rating may be lowered because the ``transaction materially increases PNC's exposure to residential mortgage-related loans in some of the weaker banking markets in the Midwest and Florida,'' Standard & Poor's said today in a statement.

Corsair Capital

Corsair Capital LLC, which owns about 7.8 percent of outstanding National City common shares after leading investors in injecting $7 billion earlier this year, will support the deal, PNC's statement said. Due to a non-dilution clause in its deal, Corsair will recoup all of its $785 million initial investment and may be eligible for a cash payment from the National City warrants it holds.

Raskind will become a vice chairman at PNC.

PNC was assisted by Citigroup Inc., JPMorgan Chase & Co. and Sandler O'Neill & Partners. Wachtell, Lipton Rosen & Katz gave legal advice.

Goldman Sachs Group Inc. was National City's banker and Sullivan and Cromwell and Jones Day were its legal advisers. Cravath, Swaine & Moore LLP advised National City's board.

Wells Fargo & Co. said this month it will buy Wachovia Corp. for about $14.4 billion, creating the largest U.S. bank by branches. The deal is expected to be completed by yearend.

To contact the reporter on this story: Linda Shen in New York at Lshen21@bloomberg.net

Last Updated: October 24, 2008 16:34 EDT