Under the government's plan to acquire stakes in banking companies, strong institutions will have added cash to acquire weaker ones, and as the stock prices of so many targets plunge, dealmaking may get even easier.
"Market caps have already come down significantly, and between now and next year there could be more noise and unhappy news that could cause the market to be even lower than we see it today," Gary Townsend, the chief executive of Hill-Townsend Capital LLC, said Thursday.
Most of the consolidation is likely to be done at the hands of the largest banking companies, which are splitting $125 billion among them. But the government has given smaller firms until Nov. 14 to apply for another $125 billion of capital that may be used to fund new lending or to make acquisitions.
The Capital Purchase Program is offering banks from 1% to 3% of their risk-weighted assets. For SunTrust Banks Inc., that would be $1.6 billion to $4.9 billion.
Analysts expect the merger and acquisition picture to clarify once the Treasury Department starts announcing which banks will get investments — and by definition which will not. Banks that are denied could face significant stock shocks and deposit losses, the analysts said.
Bob Hughes, a KBW Inc. analyst, said during M&T Bank Corp.'s third-quarter earnings conference call this week: "I'm guessing that at some point in November we'll see some increased separation between the wheat and the chaff, and there's going to be some companies that are not qualified for capital injections."
Michael O'Boyle, an investment banker at Sterne, Agee & Leach Co., said a number of banking companies with more than $10 billion of assets and market caps already below $4 billion could become "easily digestible" for those who received government capital.
"They will deploy the money quickly and be able to take out the weaker ones that don't qualify," he said in an interview. "I believe that is how the capital program is ultimately going to work."
James Wells, SunTrust's CEO, said when his company reported earnings Thursday that it could use the funds either for organic growth or the "potential purchase of different assets."
Henry L. Meyer 3rd, the chairman and CEO at KeyCorp, said capital infusions could make M&A more likely by adjusting price-to-equity ratios across the industry to levels that are conducive for deals.
Mr. Meyer said this week during his Cleveland company's earnings call that it plans to apply for $1.1 billion to $3.3 billion of capital. In the near term acquisitions may be limited to "troubled institutions" until the environment stabilizes.
Cam Fine, the president and CEO of the Independent Community Bankers of America, said its members plan to use the funds to increase lending, not to make deals.
"I've been sent dozens and dozens of e-mails from banks who are interested in this program, and not one single one has indicated they are interested because they want to acquire another bank," he said. "My gut feeling is this would be more of a regional and midsize and large program to acquire other banks."
Donald Powell, a former Federal Deposit Insurance Corp. chairman, said in an interview that the capital plan favors large banks. "It bothers me greatly that you don't reward the guys who played clean."
He also said he would like banks to use the funds for lending and not acquisitions. "I would hope that at the end of the day that they would use the capital to expand in their markets. I don't think this capital should be opportunistic, or that regulators should urge it to be used for acquisitions. It also bothers me that we're picking winners and losers here."
But former Comptroller of the Currency Robert Clarke, now a senior partner at Bracewell & Giuliani LLP, said he believes community banks, which have faced challenges raising capital, might use the government capital to fund acquisitions.
"We are getting a lot of inquiries from community banks that have no problem themselves but thinking maybe they should take advantage of this … and buy someone."
Other observers said M&A is not the answer.
"At some level they'd be better off dumping the bad asset into Treasury and freeing up their own capital," said Laurence Platt, a partner at K&L Gates LLP. "If what's dragging down these institutions is troubled assets, presumably the fire sale would improve their financial prospect such that they would not need a merger. At the end of the day, it all comes down to what is the need."
Chris Whalen, managing director at Lord, Whalen LLC's Institutional Risk Analytics, was even more blunt.
"It's a really bad idea to slam these banks together. They have issues, and going through a merger is a big distraction," he said. "Putting two bad banks together or putting two weak banks together with a little bit of incremental capital doesn't fix the problem. At best, you're buying time. If you look at the history of regulatory mergers, they're pretty dismal," he added.