By easing restrictions on commercial banks' investment banking activities, the Federal Reserve may have fueled talk about bank acquisitions of investment houses.
But one Wall Street analyst argued before the Fed's move Wednesday to ease restrictions on the activities of banks' section 20 subsidiaries (article on page 1) that such deals in the near term are anything but a sure bet.
"There's been a lot of hype," said industry analyst Raphael Soifer of Brown Brothers, Harriman & Co. "We're saying it's unlikely, because the economics don't justify it."
Mr. Soifer cited three investment banks as potential targets - Salomon Brothers Inc., Lehman Brothers Holdings Inc., and Donaldson, Lufkin & Jenrette.
Share prices of each set 52-week highs in early October, he pointed out. More notably, each of these investment houses' stock price is up more than 20% from a 52-week low reached less than three months earlier.
In a recent report titled "Global Investment Banking: the Fed Opens the Door," Mr. Soifer detailed hurdles to any deal linking a commercial and an investment bank.
Besides steep purchase prices, the barriers include thorny social issues associated with the different way commercial and investment bankers are compensated and the necessity of negotiating a friendly deal.
As an example of how obstructive the social issues can be, Mr. Soifer said a European banking company with a 10% cost of capital and a 20% return on equity that is willing to pay up to twice book value would not be able to offer more than 1 to 1.5 times book value because of the cost of covering long-term contracts for key employees.
"The acquirer would inevitably wind up paying for the firm's employees twice," he said. The commercial bank would pay, first, the purchase price and, second, the long-term contracts of various employees.
That could mean that more than half the total purchase price would wind up in the pockets of employees instead of shareholders.
Another industry watcher also has reservations. Katrina Blecher of Gruntal & Co., New York, said buying an investment bank could wind up hurting acquiring banks' efficiency ratios, a measure of management effectiveness watched carefully on Wall Street.
To reconcile the considerable differences between the salaries of commercial and investment bankers, a bank might have to raise the pay of its own employees or reduce that of the investment bankers, Ms. Blecher said.
The first option would hurt the bank's efficiency ratio by adding to the cost of producing each dollar of revenue. And the second would cause banks to lose many key employees for whose services they had just paid top dollar, she said.
As a result, acquiring brokerage houses would almost surely hurt commercial banks' stock price-to-earnings ratio, which is generally higher than the multiple for investment banks.
Furthermore, Ms. Blecher noted, foreign banks have had the opportunity to buy investment banks - and have passed. "It could have happened," she said, "but management doesn't seem that interested in buying brokerage firms."
Mr. Soifer raised the possibility that foreign banks might consider buying investment banks after a stock market correction.
"The most likely buyers of these companies are foreign banks," Mr. Soifer said. "European banks can afford to pay more than American banks, and they are strategically motivated."
Mr. Soifer said that likely foreign buyers might include ABN Amro, Barclays, National Westminster Bancorp., or even HSBC Holdings PLC.
But even though investment banks may not go on the auction block for a while, the Brown Brothers analyst emphasized that it is quite likely the first deal will create instant momentum.
"Once the first deal happens, the competitive landscape will change," Mr. Soifer said. "And at that point, the economics of scarcity value will take over and force others to make acquisitions."
Suddenly, a buying panic could begin. "If you count the American buyers, there might be 12 or 14 banks interested in only three realistic targets" - Lehman Brothers, DLJ, and Salomon Brothers - Mr. Soifer said.
Those three investment houses would give commercial banks instant credibility and revenue in various markets, he said, without being too large to digest.
Securities Data Co. ranked DLJ fourth among investment banks, with $505 million of underwriting revenue generated through the first nine months of 1996; Salomon sixth, with $377 million; and Lehman seventh, with $339 million.