With its latest deal — the disputed bid for LaSalle Bank Corp. — threatening yet again to push Bank of America Corp. over the national deposit cap, the Charlotte giant has returned to a strategy that many financial institutions would consider wasteful, if not heretical.
While B of A has been moving to expand geographically, it has been sacrificing market share in many of its current markets. Analysts generally supported that strategy when B of A added MBNA Corp. and its high-margin lending business, but some were less supportive when they learned about the deal for LaSalle, which has most of its operations in the highly competitive Midwestern cities of Chicago and Detroit.
B of A's earnings are not yet validating the strategy; its first-quarter results relied on several supplemental items to compensate for sluggish fundamentals.
Federal law bars banks from expanding by acquisition once they control 10% of the nation's deposits, but it does not limit internal growth. So, like a wrestler shedding a few pounds to make its weight class, B of A has been slowing its deposit growth to keep its share below the cap when it needs regulatory approval for another deal. But observers say once the weigh-in is past, or once the cap is lifted, B of A will have the infrastructure in place to bulk up quickly.
"Once they close on LaSalle, it will truly be all about organic growth," said Todd Hagerman, an analyst at Fox-Pitt, Kelton Inc. "It will put them in an enviable position to price aggressively when appropriate to build out deposit market share."
To maneuver around the cap, Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets, said BofA has been allowing "certain markets to lose deposit market share to gain in other markets where they think it is more important to be."
"They will allow certain deposits to run off, particularly time deposits, so that they are able to garner more valuable franchise deposits in an acquisition like LaSalle," he said. "It has always been their strategy that they can use their interest rates on those deposits as a lever to bleed deposits or increase them depending on if they have an acquisition."
B of A has lobbied Congress sporadically for a higher deposit cap. Late last year it recruited state banking groups for support. But after some negative publicity, Kenneth D. Lewis, the chairman, president, and chief executive, drew the $1.5 trillion-asset company back.
"We were out talking about it … a little more aggressively than I would have liked," he said during a Jan. 23 conference call to discuss fourth-quarter earnings. "I told our people to back off."
When the 10% cap was mandated in 1999, no bank was even close to the threshold. By mid-2003, B of A had the industry's biggest deposit share, 7.58%. Buying FleetBoston Financial Corp. pushed that figure to 9.62%, and buying MBNA would have pushed B of A over the limit, to 10.49%, when the deal was announced in March 2005.
Two years ago Mr. Lewis expressed concerns that deposit growth was outpacing loan growth. Today the opposite is true, but three deals threatened to put B of A over the 10% cap: the MBNA purchase, which closed in January of last year; the still-pending acquisition of U.S. Trust Corp. from Charles Schwab Corp.; and the agreement announced last week to buy LaSalle from ABN Amro Holding NV for $21 billion.
Though B of A claims it is not shedding deposits to stay under the cap and continue making deals, the numbers tell a different story. (See chart below.)
Richard Bove, an analyst at Punk, Ziegel & Co., wrote in a note to clients last week that the strategy is "stripping cash out of the business." He said B of A is losing ground in high-growth markets to expand into Midwestern ones "with relatively static population growth" and, in the case of Detroit, "severe economic problems."
Christopher Mutascio, an analyst at Stifel, Nicolaus & Co. Inc., said in an interview that he supports B of A's strategy, though it would take time for Mr. Lewis to be vindicated by an improved operating environment.
"We're really in the middle innings for this," Mr. Mutascio said. "I think it's rational, but … we'll have to wait until 2008, when the curve hopefully steepens."
B of A executives say that they will not pay aggressive rates for deposits, and that they prefer using the company's expansive branch network and broad product range to win customers.
Mr. Lewis stuck by that when asked about the possibility of shedding deposits to buy LaSalle. "All I would I say is we're confident that we can meet the requirements there, and we would not plan to change our retail deposit strategy," he said during his company's conference call on the deal last week.
Less than a week earlier, Joseph Price, B of A's chief financial officer, said during an earnings conference call that its deposit-gathering strategy was based on product offerings such as rewards for those who keep certain balances or risk-free certificates of deposit. "I don't want to signal a major shift in deposit strategies."
In the first quarter B of A did raise the average rate for its consumer CDs by 113 basis points from a year earlier, but that rate remains at least 100 basis points below the average in most major markets, according to data from Bankrate.com in North Palm Beach, Fla.
As a result, B of A has ceded share to rivals and newcomers in several of its well-established markets, according to June 30 data released last fall by the Federal Deposit Insurance Corp.
In Washington, its stake slid 1.1 percentage points from a year earlier, to 10.1%. Commerce Bancorp Inc. of Cherry Hill, N.J., which entered the Washington market in 2005, is among the companies that have slowly captured share there.
In San Francisco, B of A's lead over Wells Fargo & Co., Citigroup Inc., and Washington Mutual Inc. was trimmed after its market share slipped 1.1 percentage points, to 27.4%.
B of A has lost ground even in its hometown, where its share fell 3.5 percentage points, to 23.1%, as North Carolina competitors such as BB&T Corp. of Winston-Salem and RBC Centura Banks Inc., the Raleigh unit of Royal Bank of Canada, posted gains.
In Boston, B of A's share fell 1.7 percentage points, to 20.6%. That drop drew analysts' attention, since it paid a hefty 29% deposit premium for Fleet, according to SNL Financial LC in Charlottesville, Va.
Thomas Brown, the chairman of the New York hedge fund Second Curve Capital LLC, said he could understand the need to shed deposits to make deals "if they weren't paying a big premium for these deposits and then running them off."
Gary Townsend, an analyst at Friedman, Billings, Ramsey Group Inc., said the declining market shares reflect B of A's slower rate of growth. Its average deposits grew 6.4% last year, compared with 15% the year before and 36% in 2004.
"They know what the rules are, and they recognize that managing to the cap can be a problem," Mr. Townsend said in an interview. "That is obvious due to their lobbying behavior. They need regulatory relief."
Holding the line on deposit rates has not helped B of A's margin, which shrank 14 basis points from the fourth quarter, to 2.61%, the lowest among large U.S. banking companies except for Citi. In addition to deposit pricing, B of A attributed the narrowing spread to the sale of certain foreign businesses and trading account liabilities.
Analysts are watching its balance sheet, which has been significantly altered by its deposit strategy and the MBNA purchase. Since June 2005 the company's loan portfolio has grown 37%, far outpacing its 9% deposit growth. As a result, the loan-to-deposit ratio has grown from 83% in mid-2005 to 104% as of March 30.
Mr. Mutascio said that other banking companies are reporting a similar shift, including Wachovia Corp. and Wells Fargo. The true test for these large companies will be funding loan growth, he said.
Joe Morford, an analyst at Royal Bank of Canada's RBC Capital Markets, wrote in a note to clients last week that B of A "continues to struggle" with organic growth. He cited the deal for LaSalle and first-quarter earnings that relied more on supplemental items than on solid fundamentals.
While it appears easy to shed deposits, the current rate environment makes it more difficult and expensive to win them back, and B of A is preparing to expand in a high-priced deposit market by buying LaSalle.
In March the average six-month CD yield in Chicago was 3.95%, compared with 3.17% in New York, 3.67% in Los Angeles, and 3.69% in Atlanta, according to Bankrate.com. For that reason, analysts said, B of A is not likely to rebuild its deposit base until pricing comes down.
"It isn't something that they would have to do immediately," said Frank Barkocy, the director of research at Keefe Managers Inc. "They could wait until they're in a period of time that is better than today to be aggressive. With that in mind, I'm not overly concerned about the deposit loss."