Capital: New Wave of Mergers Looks Like Good News For Bank Bondholders

If banks continue to merge, their bondholders stand to make some nice profits.

"Generally speaking, in the land of corporate bonds, acquisitions are perceived to be negative because of a potential increase in leverage," said John Works, a fixed-income analyst at J.P. Morgan & Co.

But in the banking industry, transactions such as PNC Bank Corp.'s planned acquisition of Midlantic Corp., are usually done through stock poolings, which increase capital levels.

Higher capital levels often result in bond rating upgrades, a favorable event for both banks and their bondholders.

Better ratings reduce the cost of capital market access for banks, while the bonds themselves increase in value for the bondholders.

Indeed, Moody's Investors Service has been receptive to acquisitions, placing First Union Corp. on positive credit watch, in line for possible upgrading, as a result of its planned purchase of First Fidelity.

"That spells out the rating agency's posture on such acquisitions," said Mr. Works.

First Union bonds benefited from Moody's stance, with their spread tightening by approximately seven basis points, a few more than the market in general. Spreads are measured relative to comparable Treasury securities.

Clearly, said analysts, the fixed-income investor could gain from holding bank bonds from either the acquirer or the target.

Indeed, some analysts thought the bonds at various BBB-rated companies would tighten.

"There will be some halo effect," for other BBB-rated companies, said Matt Burnell, a fixed income analyst at Merrill Lynch & Co.

Other analysts said that acquisitions have decreased the number of BBB- rated companies, increasing the scarcity value, and boosting the price, of those bank bonds.

Lower-rated banks, for their part, might take advantage of the increasing appeal of their paper by coming to the market with new issues.

"The hint of a potential sale might make a bank's bonds trade through where its ratings are," said Michael Leit, a fixed-income analyst at Prudential Securities Inc..

But, analysts say, most of the BBB-rated companies that are the subject of takeover speculation do not have a strong need for cheap funds.

Part of the reason BBB companies sell to larger banks is because of a lack of revenue capability, said Mr. Leit.

Mr. Leit adds that banks will only raise the money cheaply if they can put the money to work.

Lower-rated companies in and of themselves are not necessarily great bargains for larger, higher-rated banks, said analysts.

Midlantic, for one, was a good buy because of its relatively high capital ratios and its strong core deposits, said analysts.

Midlantic's tangible equity-to-assets ratio was 9.68%. That is much higher than Amsouth Bancorp.'s 5.87%, Compass Bancshares' 6.31%, or Crestar Financial Corp.'s 7.27%.

For capital benefits alone, "There are no screaming buys," said Mr. Burnell.

Added Mr. Works, "I would never want to strictly recommend a BBB on takeover potential alone. A takeover could be a long time in coming."

Nonetheless, banks like Bank of Boston Corp. and Birmingham, Ala.-based Compass have tightened considerably in the last few months, boosted in large measure by takeover speculation.

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Goldman Sachs & Co. analyst Richard K. Strauss dropped H.F. Ahmanson & Co. from the firm's recommended list and replaced it with Countrywide Credit Industries Inc..

He said Countrywide would benefit from the current interest rate environment.

Mr. Strauss' new rating on Ahmanson is "moderate outperform."

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