October 15, 2008 / 4:58 PM / 11 years ago

U.S. plan may slow fire sales but spur bank mergers

NEW YORK (Reuters) - A U.S. government plan to inject capital directly into banks could slow the recent spate of distressed sales but is likely to set the stage for a new wave of bank mergers.

Wells Fargo CEO John Stumpf (L) presents Wachovia CEO Robert Steel with a gift during a news conference with Wachoiva employees at the Wachovia corporate headquarters in Charlotte, North Carolina, October 15, 2008. REUTERS/Chris Keane

U.S. officials announced a plan on Tuesday to inject $250 billion into the troubled banking industry by acquiring preferred stock and warrants in a number of banks.

Half that amount will go to nine banks: Citigroup Inc (C.N), JPMorgan Chase (JPM.N), Morgan Stanley (MS.N), Goldman Sachs Group (GS.N), Bank of America Corp (BAC.N), Merrill Lynch & Co MER.N, Wells Fargo & Co (WFC.N), State Street Corp (STT.N) and Bank of New York Mellon (BK.N).

The rest of the money will be offered to an as yet undetermined number of smaller banks and thrifts across the country.

A direct injection of capital could keep more banks from failing, giving them the option to seek deals on better terms than distressed sales like the takeover of Washington Mutual Inc’s banking assets WAMUQ.PK by JPMorgan and the sale of Wachovia Corp WB.N to Wells Fargo, experts said.

But depending on how the government decides to invest the money, it could divide the industry into haves and have nots, with banks that get government support better off than those that do not, leading to a wave of consolidation as stronger banks take over weaker competitors, they said.

“It creates the prospect of the government acting as a source of strength to banks that would otherwise be forced into mergers,” said James Murray, head of Houlihan Lokey’s financial institutions group. “In the longer run, it probably is going to act as a catalyst for mergers.”


The government has been taking a series of steps in recent weeks to encourage consolidation as it tries to strengthen the troubled banking sector.

Regulators have been aggressively pushing for sales of institutions that have run into trouble, sometimes offering guarantees on troubled assets to encourage potential buyers.

In another move that could encourage takeovers of distressed banks, the Internal Revenue Service, the federal government agency that collects taxes, recently allowed buyers to reap immediate tax benefits from targets’ loan losses and bad debts, rather than forcing them to realize those benefits over several years.

The government’s bailout package totals $700 billion and also includes a plan to take toxic assets off the books of financial institutions under the so-called Troubled Asset Relief Program (TARP).

“Through the TARP, there is in place a mechanism to take away some uncertainty on asset prices, which is one of the issues limiting bank consolidation,” said Brian Sterling, co-head of the investment banking group at Sandler O’Neill. “It appears to us that the government is trying to encourage consolidation in the sector.”

The latest plan came too late for banks like Wachovia and WaMu, which could have at least bought some time with a capital injection.

“If the government had invested in Wachovia and that investment had been sufficient to shore up its capital problem and stem depositors’ withdrawals, then perhaps that would have at least put Wachovia in a better position to decide its fate,” said Joseph Vitale, a partner at law firm Schulte Roth & Zabel.

“If you are not a recipient (of government aid), not only will it not help, but the existence of such a program may actually hurt your situation because there are other institutions — your competitors — that are receiving that benefit and you are not,” Vitale said.

Treasury Secretary Henry Paulson made a point of stressing the first nine firms to get capital were “healthy institutions.”

The government may want to let some weaker institutions fail, an analyst said.

“It would make little sense for the government to provide capital to poorly capitalized banks,” Ladenburg Thalmann analyst Richard Bove wrote in a research note.

Bove cited a government report dating back to the time of President George H.W. Bush, whose Treasury secretary, Nicholas Brady, argued for consolidation in the sector.

“Obviously, in choosing the (first nine) banks ... the Treasury Department is hewing to the policies enunciated in the Brady report,” Bove wrote. “It is forcing consolidation on the industry.”

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