Published: May 7, 2009
For America’s regional banks, it’s merger time. With the results of the stress tests now public, it’s clear that none of the country’s largest financial institutions will fail. Those that need capital will find it, even if it takes de facto nationalization. But that doesn’t mean the banking system is robust.
A handful of regional institutions received the equivalent of barely passing grades — including SunTrust, Regions Financial, KeyCorp and Fifth Third. These banks have more than $500 billion of assets among them. Even if they can raise the extra capital that regulators say they need, they may not be in a position to act as engines of credit creation — a requirement for their local economies to pull out of the recession.
Moreover, if they can’t raise private money over the next six months, they may need to have the government take significant, or even majority, stakes in them.
One risk is that they will stagger along, zombielike, for years. There’s an alternative: Let the strong eat the weak.
A core group of relatively robust regional banks has also emerged from the Treasury’s examinations, including U.S. Bancorp and BB&T, as well as PNC Financial, which has to raise a relatively modest $600 million.
An alternative to propping up troubled banks with new capital is to actively encourage a wave of consolidation.
This approach would make life simpler for the government should the banks fail to raise private capital. Rather than taking controlling positions in many midsize banks, the government could take smaller stakes (or none at all) in fewer, larger banks that in turn use the capital to buy troubled rivals.
By encouraging, for instance, the acquisition of SunTrust by BB&T, the takeover of KeyCorp by U.S. Bancorp and the purchase of Regions by PNC, the government would foster the creation of three new heavyweights better equipped to compete with JPMorgan Chase, Wells Fargo and Bank of America. These three went from big to megabanks by acquiring troubled rivals like Washington Mutual, Wachovia and Countrywide early in the banking crisis, in deals blessed by regulators.
In theory, this approach would also streamline and improve regulation. Instead of scattering oversight among six institutions, the government could focus on three.
By favoring more of the banks that fared best in the crisis and not just the very biggest, it rewards those executives whose teams proved better at risk management, like Richard Davis, chief of U.S. Bancorp.
Finally, the enormous savings that would come from cutting overlapping operations, extra branches and redundant workers would accrue to shareholders and add to the capital cushions. Last year Fifth Third, SunTrust, KeyCorp and Regions had combined noninterest expenses of $18.5 billion. As a general rule of thumb, knowledgeable bank acquirers aim to save about one-third of these costs. Gentlemen, start your M.& A. spreadsheets.
Boon for Underwriters
Banks must raise $75 billion of equity over the next six months. That sounds bad, but on Wall Street it may be cause for some celebration. That’s because the underwriters who sell all of that stock can charge fees of as much as $3 billion for doing so.
In the grand scheme of a $75 billion capital shortfall, it’s a pittance. But on the equity capital markets desks of the big investment banks, it would be a bonanza. Dealogic estimates it could add up to 12 times the amount they’ve earned so far this year.
Underemployed bankers at Merrill Lynch may finally have a reason to applaud their new bosses’ missteps. Merrill’s new owner, Bank of America, needs the biggest capital infusion of all — $34 billion.
Of course, the lead manager on a bank’s stock offering is often the bank itself, which is motivated not to ratchet up fees. And many of the banks that the government has ordered to raise more capital may do so by swapping existing preferred shares for common stock. But with most bank stocks trading at decent premiums to the prices at which they would have to convert the government’s preferred stock, it’s a fair bet the next six months will be happier for the underwriters of Wall Street.
ROB COX and DWIGHT CASS