January 16, 2008 / 6:55 PM / 12 years ago

Wall Street taps cornerstone funds to bail out banks

NEW YORK (Reuters) - The snowballing mortgage crisis pummeling banks and brokers is also creating a rare opportunity for a select club of deep-pocketed investors.

A Citibank sign outside a branch in Tokyo, November 5, 2007. REUTERS/Toru Hanai

Credit losses approaching $100 billion across the banking industry have humbled titans such as Citigroup Inc (C.N) and Merrill Lynch & Co MER.N and put these lenders in the unusual position of soliciting billions of dollars. To get these deals done quickly, banks are turning to governments, U.S. pensions and mutual fund firms willing to wait years for a recovery.

For investors, the crisis created an opening to buy stakes in banks at prices not seen since the Latin American and commercial real estate crises of the early ‘90s humbled many of the largest U.S. financial companies.

“Financial institutions were a big driver of capital-raising activity last year, and that will continue in 2008,” said Thomas Fox, global co-head of UBS’ UBSN.VX equity capital markets.

Beyond banks that announced deals, he added, “there are as many as 10 other issuers assessing their options right now.”

UBS helped SLM Corp SLM.N, which is known as Sallie Mae, sell $3 billion of stock and convertible debt on the day after Christmas, historically a difficult time to do deals.

This and other recent transactions underscored the emergence of “cornerstone” investors that can quickly provide large sums of money for private placements, even in periods of market turmoil, Fox said.

Wall Street enjoyed a busy year for stock and other equity offerings in 2007, but topsy-turvy markets in recent weeks have chilled demand for public deals. Yet global commercial and investment banks are desperate for new cash to shore up balance sheets gutted by losses on mortgages and other debt.

That created an opening for state-owned “sovereign” wealth funds, such as China Investment Corp and Singapore’s Government Investment Corp. Over the past year, these funds around the world have aggressively started spending more of their estimated $2 trillion of cash.

“There is tremendous depth of liquidity in the market,” said Fox, whose bank led the industry last year in underwriting initial public offerings. “I don’t see much of a disruption. There is a new source of capital in the sovereigns.”

In recent weeks, these massive funds have shared the spotlight with lesser-known pension and mutual fund managers. These long-term investors are snapping up stock and convertible debt through private sales at not seen since the early 1990s.

On Tuesday, Citi said it had raised $12.5 billion from Singapore, former Chief Executive Sanford Weill, Saudi Prince Alwaleed bin Talal, Kuwait Investment Authority, money manager Capital Research & Management and the New Jersey Investment Division. The company also will sell $2 billion of convertible preferred securities to the public.

These sales come a month after Citi sold a 4.9 percent stake to Abu Dhabi’s investment arm for $7.5 billion. (Click on nN15540608RIC for recent sovereign investments in banks.)

Also on Tuesday, Merrill said it would issue $6.6 billion in convertible preferred stock to Korea Investment Corp, Kuwait and Japan’s Mizuho Financial Group Inc (8411.T).

Closer to home, Merrill sold smaller stakes to hedge fund TPG-Axon Capital, the state of New Jersey, Saudi conglomerate Olayan Group and mutual fund manager T. Rowe Price (TROW.O).

This was a second round for Merrill too, which last month sold $6.2 billion in stock to Singapore’s Temasek Holdings TEM.UL and Davis Selected Advisors, a U.S. asset manager.


Yet more deals are coming as the mortgage mess continues.

Lazard (LAZ.N) investment banker Gary Parr said more financial institutions needing to fill “capital holes” will announce offerings now that they’ve completed year-end financial reviews.

There are significant risks for these investors. Some market watchers do not expect banks to fully recover for months or even years. Merrill stock, for example, has slipped 2 percent since Temasek and Davis on December 24 agreed to pay $48 a share for their stakes.

Yet banks are offering generous terms as they buy breathing room.

Merrill for its second fund-raising round will issue convertible debt paying a 9 percent coupon. Citi last month issued convertible debt that pay 11 percent, while its more recent round of convertibles will pay 7 percent.

Similar investments in downtrodden banks have paid off in the past.

Alwaleed gained fame in 1991 when he invested $590 million for a 15 percent stake in a nearly insolvent Citicorp, an investment worth more than $5 billion now.

Likewise Japan’s Sumitomo Bank in 1986 invested $500 million in Goldman Sachs when it was a capital-constrained private partnership. That move generated a $1.9 billion gain.

Cornerstone investors now hope to match that success.

New Jersey’s investment division approached Merrill and Citigroup last week as those companies circled the globe looking for funds. Just a stone’s throw from Wall Street, the state’s $81 billion fund ponied up $700 million for the banks.

These deals offer an opportunity to increase exposure to “two of the strongest franchises in the global financial services marketplace,” the state said. They “provide for a significant current yield and the opportunity to benefit from potential appreciation in the underlying common stock.”

Editing by Lisa Von Ahn

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