For much of this year the nation's largest banking companies watched as mortgage and structured investment failures punched holes in their balance sheets and depleted capital, leading many industry observers to assume that the biggest would wind up on the defensive.
On one hand, that has proven true, with the likes of Wachovia Corp. and Washington Mutual Inc., beaten down by bad mortgages, disappearing in fire sales. But at the same time, four of the nation's largest remaining banking companies went on the offensive, making major deals and grabbing big swaths of share in critical markets.
JPMorgan Chase & Co. bought Bear Stearns Cos. and established a notable West Coast operation by buying Wamu's banking assets. Bank of America Corp. made a deal for Merrill Lynch & Co. Inc. and became the nation's largest mortgage originator with its acquisition of Countrywide Financial Corp. Wells Fargo & Co. bought Wachovia, moving into the Southeast, and U.S. Bancorp gained ground in Southern California by acquiring Downey Financial Corp.
Each of the four acquirers says it is capable of making more deals and poised to gain additional share.
The fifth member of the top five, Citigroup Inc., has struggled the most, posting four straight quarterly losses on its wide exposure to risky investments and loans. However, it also says it has the wherewithal to grow through deals, and in fact it made a run at Wachovia's banking operation before Wells swooped in with a higher bid.
The federal government clearly played as big a role as market forces in this evolution. Regulators encouraged the transformative deals by JPMorgan Chase and B of A, rationalizing that the best way to sort out some of the weakest in banking was to push them into the arms of the industry's stalwarts. Such support is not likely to dissipate in the first half of next year.
Of course, these companies vary in terms of financial health and preparedness for more deals, but with the government stamping each with the label of "too big to fail," their cumulative success in the year ahead, perhaps more than another other factor, will determine how quickly the financial sector emerges from the doldrums of the worst down cycle in a generation.
"My sense is that the government will, throughout 2009, continue to prop up the banks, particularly the largest ones it has clearly deemed too large to fail, because they are critical parts of the financial system," Mark Fitzgibbon, head of research at Sandler O'Neill & Partners LP, said in an interview last week. "And the health of the financial system — and its largest companies — is critical to the health of the overall economy."
But more consolidation at the top is not a sure thing, and neither is the successful integration of recent acquisitions, given the wild card of a deep consumer-led recession.
B of A views acquisitions as a core competency, though the $1.8 trillion-asset Charlotte company is a prime example of the challenges that lie ahead. Two large, complex integrations will not be easy for a company that has spent billions of dollars in recent years boosting its exposure to U.S. consumers, largely through its 2006 purchase of the card issuer MBNA Corp. and the July acquisition of Countrywide, analysts said.
Add to that the challenge of cutting costs — and up to 35,000 jobs — and reducing risk positions related to the Merrill purchase. In fact, Merrill may pose a particular challenge by combining its exposure to structured products and leveraged loans with what already existed at B of A, analysts said.
"It will be a delicate balancing act," Frank Barkocy, the director of research at Mendon Capital Advisors Corp., said in an interview last week.
JPMorgan Chase, too, finds its plate full.
James Dimon, the $2.25 trillion-asset New York company's chief executive, has said in recent weeks that integrating Bear Stearns has been more difficult — and more costly — than expected. And in announcing the Wamu deal in September, Mr. Dimon said his company would mark down the value of the acquired loan portfolio by $31 billion, though he has since cautioned that the markdowns could deepen if housing prices continue to decline.
However, Jason Goldberg, an analyst at Barclays Capital, said in an interview last week that next year's prospects for both B of A and JPMorgan Chase remain strong.
"The environment will remain challenging in 2009, but they should continue to take market share and be winners on the other side of this," Mr. Goldberg said.
Wells and U.S. Bancorp stand in relatively good stead with Wall Street, bolstering the odds of a favorable year for each. But analysts said the sector cannot afford to have these companies stumble.
U.S. Bancorp has its issues. It cautioned this month that it expects to report fourth-quarter chargeoffs of about $650 million. But Richard K. Davis, the $247 billion-asset company's CEO, said at a conference this month that he is "open" to deals, even major ones, at a time when prices are relatively cheap.
And analysts are anxious to hear if Mr. Davis provides any more hints about the type of target he prefers, saying the Minneapolis company, which has avoided many of the credit cycle's pitfalls, may be best positioned to make the next big deal.
Last month U.S. Bancorp bought the troubled thrift operations of both Downey and PFF Bancorp Inc. in Rancho Cucamonga, Calif., adding more than 200 branches and $12 billion of deposits in the Los Angeles area. But Mr. Davis said large-scale deals, even those that could expand his company's operations beyond the West and the Midwest, are a possibility.
The $622 billion-asset Wells has established a reputation as a careful integrator after acquiring a long string of small regional companies over the past several years, including the $1.4 billion-asset Century Bancshares Inc. of Dallas and the $1.7 billion-asset United Bancorp of Jackson, Wyo., last year.
Now, however, Wells has its first major deal to sort through in a decade; its acquisition of the $764 billion-asset Wachovia is set to close by yearend. There are big positives: Wells stands to gain about $400 billion of deposits and a major market share in the South and on the East Coast. But analysts are waiting for more specifics from the San Francisco company's executives about the depths of Wachovia's troubles and whether any of those problems could worsen beyond initial expectations.
Wells also is getting large brokerage and investment banking operations from Wachovia, and how each will be integrated remains unclear.
Unlike the major deals struck this year by JPMorgan Chase, Wells' $15 billion bid for Wachovia was not backed by the federal government. Wachovia was forced to find a buyer after its massive option adjustable-rate mortgage operation imploded. The Charlotte company's $500 billion home loan portfolio includes about $122 billion of option ARMs.
John G. Stumpf, Wells' CEO, said at a conference this month that economic conditions "can get considerably worse from here, and this is still the best deal I've ever seen."
Wall Street hopes he is dead on with that assessment. If there are unforeseen struggles, some analysts say, Wachovia's customer base could unravel before Wells even gets into the thick of its integration.
"The biggest issue for Wells Fargo is whether they can keep together Wachovia's very fragile deposit base," Nancy A. Bush, the president of NAB Research LLC, said in an interview last week. "That's no small task."
Citi has the highest hurdles to clear and poses perhaps the biggest threat to the system if it stumbles further.
Nobody expects good results when the $2 trillion-asset company issues its fourth-quarter earnings report next month, so it would be hard to surprise Wall Street this time around. But analysts say Vikram Pandit, Citi's CEO, is sure to come under intense fire in his second year at the helm if he does not find a way to position it for profitability in 2010 — while convincing investors that the New York company's global universal model is viable.
Mr. Pandit has made it clear that he has no intention of abandoning Citi's model, despite efforts to shed some foreign assets. But maintaining the far-flung structure is bound to remain difficult for Citi. As of the fourth quarter, it found itself operating in a global recession and under intense scrutiny from regulators after receiving $45 billion of taxpayer money through the Treasury Department's Troubled Asset Relief Program to prop up its capital.
Citi is using "Tarp capital to help expand the flow of credit in the U.S. economy," Mr. Pandit wrote in a memo to staff members last week. "We are increasing our lending and continue to make targeted consumer and commercial loans."
But analysts want to hear more specifics from Mr. Pandit: What more, specifically, is he looking to shed as his company attempts to unload $400 billion of assets before 2012? If he looks to make domestic deals to prop up U.S. deposits, what types of deals are a priority, and what will regulators allow? How can it get smaller and continue to take advantage of its global operation to generate cash?
"Citi's underlying strengths, its ability to generate revenue, is in fact its global presence — its ability to leverage its name, technology, and vast expertise across various markets globally," Roger Lister, the chief credit officer of the financial institutions group at DBRS Ltd., said in an interview last week.
"Its problem, simply, is that it has not managed as well as it could have. They haven't, overall, delivered up to the capabilities of the company," he said. "But being more visible, in the sense that you get organized and show people what changes, what improvements investors can expect over the next three months, six months, a year, and so on, that could convince the outside world — if you lay out a clear strategy and then show you can execute against it."
In that sense, Mr. Lister said, the largest companies, as a group, could bolster confidence in the system simply by serving up well-defined and understandable goals.
"Fact is, they are the leaders," he said.
Executives at the companies mentioned in this story declined interview requests.