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2009 is shaping up to be another painful year for the banking industry, reports dealReporter.
After the forced sales and government bailouts of the industry’s problem children, starting with Bear Stearns in March and ending with a government guarantee in November on some of Citigroup’s (NYSE:C) loan losses, industry sources predicted the focus next year will turn from large money centers institutions towards regional and community banks.
While smaller institutions largely avoided playing with exotic instruments and subprime assets, they nevertheless have wide exposure to regional economies and a prolonged downturn could further weaken their commercial and consumer loan portfolios, industry sources said. Bankers expect loan charge offs to rise in the coming quarters, with one suggesting the trend could continue for all of 2009.
To cover higher credit costs and remain well capitalized, banks will need to raise additional common equity. This will be a difficult and perhaps in many cases impossible task, bankers said, since savvy institutional investors know the market is far from the bottom and will be unwilling to invest until then. In turn, there could be a wave of distressed auctions and then bank failures when few bidders turn up to buy undercapitalized institutions.
”The way we did this business for 15 years is gone,” a second banker said. ”It’s now a distressed type of recap where you may be getting 50% of book value.”
Already this year, many of the large capital raises and M&A deals have occurred below book, including Wachovia (NYSE:WB) and National City’s (NYSE:NCC) sales. Capital One Financial (NYSE:COF) bought Chevy Chase Bank at 0.64x tangible book in December.
Other institutions on bankers’ radars for possible distressed transactions, whether for capital raises or sales, range from Citizens Republic Bancorp (NASDAQ:CRBC) and Huntington Bancorp (NASDAQ:HBAN) in the Midwest to South Financial (NASDAQ:TSFG) and Colonial BancGroup (NYSE:CNB) in the Southeast.
For many institutions like these, though, bankers are skeptical the firms can find new investors or buyers. While large banks and firms forming bank holding companies want to pick up low cost deposits, they do not want to pick up potential black holes on the asset side. To induce deals, industry sources said the government may have to provide assistance.
”The good news for the regional banks is that their deposit bases will be very attractive to the new bank holding companies, but may not be attractive enough to overcome the fear about potential bad assets,” said Randall Guynn, head of Davis Polk & Wardwell’s financial institutions group. ”That’s why I think many otherwise desirable transactions will not happen in ’09 unless the government steps in and provides support for the good bank, bad bank structure.”
Under a traditional good/bad structure, a bank cleans up its balance sheet by moving its worst loans to a separate company that absorbs the assets’ future losses. The original bank then emerges as a healthier, deleveraged institution. When the FDIC takes over a failed bank it employs a similar strategy: the deposits and good assets are auctioned off, the FDIC holds on to the rest.
In the modified version, a purchasing institution moves all of the failed bank’s assets onto its balance sheet and the government agrees to cover losses on assets if they exceed a certain amount.
US Bancorp (NYSE:USB) used this structure last month to acquire Downey Savings & Loan and PFF Bank & Trust, two failed California thrifts auctioned off by the FDIC. Under the terms of the transaction, US Bancorp took on all of the assets of the thrifts, but the FDIC will cover losses on the portfolio that exceed USD 1.6bn. Bankers said they expect future deals to follow a similar pattern.
Along with covering loan losses connected to M&A deals, bankers said the government may have to step in to provide additional assistance to institutions next year if charge offs eat through the funds provided by the Treasury Department’s TARP capital purchase program (CPP).
Short of injecting pure common equity into institutions, a third industry banker suggested the government could agree to purchase assets from banks above the assets’ written down values. This would provide the banks with additional capital, but not require the government to take additional ownership stakes, something regulators have said they are loath to do.
So where then does this leave the humdrum M&A transaction of yesteryear? Few expect healthy deal activity before the end of next year. But when the economy does turn north and the rate of charge offs stabilizes, bankers said several transactions may happen in quick succession.
One large deal on the horizon may be the sale of Royal Bank of Scotland’s US subsidiary, RBS Citizens, a USD 130bn asset commercial bank based in Rhode Island. Last month, the British government effectively nationalized RBS after the firm’s rights issue failed. HM Treasury is expected to try to sell Citizens at some point in order to recover some of its investment in RBS.
However, industry sources said possible buyers for the bank - ranging from Toronto Dominion (TSE:TD) in Canada to Spain’s Santander Central Hispano - are not in a position to make large cash bids.
”Even the best banks out there cannot afford to do this deal now on a cash basis,” an industry executive said. Citizens’ fundamental value may be USD 15bn to 20bn, the executive said, but buyers in the short term might only be able to offer around USD 5bn, he estimated.
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