National City Corp. said today it has reached an agreement to sell its California sub-prime lending subsidiary, First Franklin Financial Corp., to Merrill Lynch & Co. for $1.3 billion.

Cleveland-based National City announced in July that it was looking to sell First Franklin as it moved into residential banking in Florida. National City announced an agreement to purchase Harbor Florida Bancshares, which through Harbor Federal Savings Bank has $3.2 billion of assets and 40 branches on Florida’s east coast.

The deal includes affiliated National City business units, National City Home Loan Services and NationPoint. Pittsburgh-based Home Loan services First Franklin and third-party loans, while NationPoint is engaged in direct-to-consumer mortgage lending out of Lake Forest, Calif.

National City said it also expects to sell $5.6 billion in First Franklin-originated loans to Merrill Lynch’s wholesale loan trading unit. If that sale goes through, National City would still hold about $10 billion in loans originated by First Franklin, nearly all of which have some form of credit risk protection through lender-paid mortgage insurance or a credit risk transfer agreement, the company said.

As rising interest rates and increased risks drive some consumer banks out of the mortgage lending industry, investment firms including Morgan Stanley, Barclays Plc and Deutsche Bank AG are buying into it, Bloomberg reports.

Morgan Stanley last month agreed to pay $706 million for residential lender Saxon Capital Inc.

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