Dealmakers Awaiting Regulatory Clarity, Market Rebound: Morgan Stanley Exec

Investment banker Jonathan Pruzan offers a clear-cut prescription for what ails bank M&A.

Europe has to solve its debt problems, and investors must stop selling off financial stocks for the turnaround in bank deals to begin.

U.S. regulators also need to make some merger-friendly decisions about bank capital and liquidity, too, according to the managing director and co-head of Morgan Stanley's global financial institutions group.

"Until the uncertainty lifts and valuations firm up a little bit, I think we're in for a slow period of domestic consolidation," Pruzan said.

Pruzan, 43, is a 17-year veteran of Morgan Stanley. He was named co-head of its banking practice at the end of 2009. Morgan Stanley had advised on two U.S. bank M&A deals worth $10 billion through June 30, making it No. 8 in number of deals and No. 2 in of deal values, according to SNL Financial.

His team is among the three teams advising Capital One Financial Corp. in its proposed takeover of ING Group's U.S. online bank, a deal some critics fear will create another too-big-to-fail bank.

The following is an edited transcript of an interview with Pruzan last week.

What are some of the regulatory hurdles to bank mergers right now?
JONATHAN PRUZAN: There are parts of Dodd-Frank that haven't been implemented. The [systemically important financial institutions rules] and some of the capital changes haven't been implemented. We're seeing the regulatory process versus historical precedent taking longer, usually by about 30 days. But also given some of the uncertainties about capital, there has been no clear framework for the approval process. We're seeing in some of these recently announced deals some things that we haven't really seen in the past.

Clearly the too-big-to-fail doctrine is going to be an overlay to some of these types of transactions. I think when you get bigger deals, it's going to require some level of extra scrutiny. And I think that uncertainty is going to give people pause until they really know what the framework and the criteria are going to be for approving transactions.

Will the extra scrutiny Capital One is facing in its takeover of ING Direct make other big acquirers think twice about doing a deal?
I think the outcome will determine whether people are willing to do transactions. If they feel like there is a regulatory framework and an understanding of how to get a deal approved, and they have a real good strategic opportunity, then I think they would obviously try and pursue that. If there is a view that deals of this nature are unapprovable, that will obviously put a significant damper on consolidation.

What is your basic outlook for bank mergers in this down market?
I think everyone has been talking about significant consolidation in the financial sector for quite some time. We've seen a few waves certainly in the last 10 to 15 years. I think the only certainty today is uncertainty. There are so many uncertain things in this environment. I think it's going to be difficult to see significant transactions. You've got an economic outlook that's uncertain. You have a sovereign debt situation that is uncertain. You have regulatory framework that is uncertain. You have Basel III implementation and liquidity requirements that still haven't been sorted out. You have the mortgage exposure and how the mortgage settlements of some of these litigation issues get sorted out. Until that uncertainty lifts, you're going to see limited M&A activity.

Another key is that a lot of that uncertainty is leading to very depressed valuations. The combination of the uncertainty and the low valuations means there's going to be a slow level of activity certainly in the U.S. You will continue to see activity maybe from the deleveraging and some of the asset disposition and sales coming out of Europe. Until the uncertainty lifts and valuations firm up a little bit, I think we're in for a slow period of domestic consolidation.

What would an industry consolidation look like without big mergers?
There are several megabanks in terms of the size of their balance sheets. If you put them off to the side, the next level of banks doesn't come close to them from a size perspective. We have a transaction that's been announced which was about $70 billion of assets. The vast majority of the banks are under $70 billion in assets. If deals get approved, we would expect consolidation to occur. It'll be among these sort of mid-cap or next-level of institutions.

We've seen historically significant consolidation waves. I think from 2004 to 2006 — we saw 250 bank deals greater than $100 million. In the last three years, we've seen 25. …[F]or all the reasons you read about — the profitability pressures, the pressure on revenues the incremental costs of regulation and just overcapacity —we would expect there to be continued consolidation. But the industry itself has gotten a lot more concentrated. Do I expect 250, $100 million deals? No. There's been a lot that's already happened, but can you see a wave of transactions where a dozen, two dozen over a short period of time happen? Sure.