ALL BUSINESS: Investors on losing end when capital raised

It's bad enough that investors in National City Corp. and Washington Mutual Inc. have seen their stock holdings plunge in value and dividends crimped because of the huge losses caused by the housing slump and credit crisis.

Now comes the next hit: Their ownership stakes are shrinking as companies use heavily discounted shares to woo new investors who often see immediate paper profits at existing shareholders' expense.

Don't get me wrong: financial firms are struggling and they need the money. Capital represents the assets left after subtracting liabilities. As the credit crisis has spread, it has become a crucial measurement of a firm's ability to weather potential losses.

Faced with a capital crunch, National City's executives said on April 21 that an investor group led by buyout firm Corsair Capital was putting $7 billion into the Cleveland, Ohio-based bank and mortgage lender.

Back when the housing market was strong, "National City overloaded on high risk real estate and deployed a lot of capital to buybacks and acquisitions," noted Goldman Sachs analyst Brian Foran. But now it has been stung by the surge in delinquencies in subprime and residential construction loans.

The company lost $171 million in the first quarter, and just slashed its 21-cent dividend down to just a penny a share.

National City agreed to let the Corsair-led investor group buy 126.2 million shares of common stock for $5 each a 40 percent discount to where shares were trading before the deal was announced. The lender will also raise $6.4 billion by selling preferred stock to the investor group that converts at the same price. Those investors will receive warrants with an exercise price of 115 percent of the company's average closing price for the five-trading-day period beginning April 21, with a cap of $8.50 per share.

By allowing all those new shares to come into the marketplace, the deal is about 70 percent dilutive to existing shareholders' ownership position, according to Goldman Sachs. That comes on top of the 80 percent plunge in the stock over the last year. On the flip side, the new investor group got a sweet deal, having already racked up paper profits topping $1 billion.

During a conference call with analysts discussing capital infusion, one question to management focused on why there wasn't a "a more palatable alternative." National City CEO Peter Raskind responded by saying there was a need to raise enough capital "to stabilize our debt ratings, beyond a shadow of a doubt," and he noted, that it had "counter-parties who were uncomfortable interacting with us. That had to stop."