Market:M&A May Not Materialize

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Without M&A as a positive catalyst, many regional banks may suffer, as investors' concerns about the health of their balance sheets mount

From Standard&oor's Equity Research. Now that JPMorgan Chase (JPM) is tied up with its pending purchase of Bear Stearns (BSC), and Bank of America (BAC) is slated to close on its acquisition of Countrywide Financial (CFC) in the third quarter of this year, will the financial giants have room to acquire others?

Standard&oor's doesn't think it's likely that these two financially-sound institutions will look to purchase smaller banks affected by the credit crisis. Ongoing concerns about the strength of many banks' balance sheets may also reduce the likelihood of mergers and acquisitions (M&A) in the banking industry.

According to data from the FDIC, fourth-quarter net income for the U.S. banking industry was the lowest amount reported since 1991. Loan loss provisions represented 11.6% of net operating revenues in 2007, the highest level for the industry since 1992. Additionally, net charge-offs nearly doubled to $16.2 billion in the fourth quarter of 2007 from $8.5 billion in the year-ago period. Net charge-offs of residential loans rose 144.2% and charge-offs on home equity lines of credit surged 378.4%.

However, some banks have fared better than others, and this raised hopes that the better capitalized banks would take advantage of the situation and make acquisitions of struggling regional banks and thrifts. Given the current market conditions, these potential deals could be done at a discount and might help to expand the acquiring banks' product portfolios or geographical diversity. Washington Mutual (WM), National City (NCC), BB&T (BBT), and SunTrust Banks (STI), among others, have been coping with the fallout from the mortgage crisis and could be prime targets for a larger bank with a strong capital position, S& thinks.

According to S& equity analyst Erik Oja, National City, BB&T, and SunTrust have indicated that they could be for sale as long as the buyer and price is right. But interest in them may be waning, since two of the big banks in the best position to do deals, in S&'s estimation, are now preoccupied with mergers.

Until JPMorgan's announced acquisition of Bear Stearns (sweetened to $10 a share on March 24 from $2 a share initially), the New York Times had reported that the bank could look to make an acquisition of a smaller, struggling regional bank to fill out its retail banking franchise. Despite the relatively small price tag on Bear, JPMorgan has put aside $6 billion to cover potential litigation costs associated with the acquisition and to cover expenses related to reducing Bear Stearns' balance sheet risk.

Although JPMorgan's capital may still be adequate (it has a Tier 1 capital ratio of about 8%) to pursue another acquisition, S& equity analyst Stuart Plesser believes that ⠠given the uncertainties of more securities writedowns from the Bear buyout, it is unlikely that JPMorgan will acquire anyone else in the near term.⠿

Similarly, Bank of America has already agreed to the acquisition of mortgage lender Countrywide. Although there are concerns about Countrywide's business, which could delay the transaction's close, Bank of America remains committed to a deal, which S& thinks likely precludes other acquisitions.

S& equity analysts Oja and Frank Braden both believe that acquisitions are likely to occur only when buyers have a good deal of confidence in the balance sheets of their potential targets. And Braden notes that the banks themselves aren't particularly confident in the strength of their balance sheets.

Some banks have tried to fix their financial situation, which, in certain cases, may alleviate concerns for acquirers. In Oja's estimation, Fulton Financial (FULT), Associated Bancorp (ASBC), and The South Financial Group (TSFG) have had success in restoring themselves to fiscal health.

And some smaller banks could be in a position to make an acquisition. Plesser notes that People's United Financial (PBCT) has about $2 billion in cash that could be used to purchase a struggling lender. Similarly, New York Community Bancorp (NYB) has been making smaller acquisitions and has the ability to continue to do so, according to Plesser.

Some larger banks have also made recent acquisitions. Oja notes PNC Financial (PNC) which snapped up troubled Pennsylvania bank Sterling Financial last year, and Canada's Toronto Dominion (TD) expects to close on its acquisition of Commerce Bancorp in the coming weeks.