Sovereign wealth funds are in the ascendancy, and bank capital ratios are deteriorating. Whether these forces unite in common purpose or merely stumble past each other depends on resolving complex political risks and aligning financial incentives.
Some of the largest banking companies in the world have already announced significant investments by these funds. The transactions are described by some observers as an elegant display of efficient global markets, in which abundant capital seeks out needy partners with deserving franchises and relatively healthy prospects. Others argue that the investments are less about financial return and more about political and economic influence.
But the funds’ sheer capital heft and a presumed preference for financial companies suggest that they will soon look further down the banking food chain to deploy their resources.
“They have trillions to invest, and they’ll run out of big banks to take a position in,” said D. Anthony Plath, a finance professor at the University of North Carolina at Charlotte. “Eventually what they will do is turn to second- and third-tier banks — as long as we have an unfettered market.”
Fueled largely by rising oil prices, developing economies, and a declining dollar, the 20 largest sovereign wealth funds are worth about $2 trillion, and growing rapidly. Merrill Lynch & Co. Inc. estimated in an October note to clients that the funds’ assets could reach $7.9 trillion by 2011. Standard Chartered Bank said in a report last month that they could total $13.4 trillion within a decade.
This year, state-owned funds have invested in Barclays PLC, HSBC Holdings PLC, and Standard Chartered. In November, Citigroup Inc. announced a $7.5 billion investment by Abu Dhabi Investment Authority. Last week, UBS AG announced an investment of almost $10 billion by the Government of Singapore Investment Corp. and a related investment of almost $2 billion by an “undisclosed strategic investor” in the Middle East.
The rash of investments in financial companies has drawn comparisons to Japanese investment in real estate during the 1980s — though most agree that those running today’s funds are more savvy and strategic.
“The shift in world wealth favors the emerging markets and the Middle East,” said Robert Albertson, the chief strategist at Sandler O’Neill & Partners LP. The foreign funds “have a hard-core focus on financial opportunities that make sense,” along with “a history of keeping a better perspective” of how the economic cycles play out — unlike the Japanese “who really bought in at the peak.”
Banking companies — and the dollar — are hardly peaking. With capital ratios falling at several large U.S. banking companies amid the mortgage and capital markets crises, Mr. Albertson and others expect more foreign funds to make deals similar to Abu Dhabi’s with Citi, particularly if large regional banks face their own crunches.
“This trend will go beyond the largest names,” he said. “There are a lot of companies that aren’t giants that will be willing to seek partners to help them get through to the next economic cycle.”
Few of the funds have clearly articulated their investment strategies — only four of the world’s 10-largest such funds even publish annual financial statements — so their intentions for the U.S. market are murky.
Huw van Steenis, an analyst at Morgan Stanley, estimated that sovereign wealth funds have invested more than $40 billion in western financial companies this year. He told the Financial Times last month that he expects a “rich seam” of sovereign wealth funds to take substantial stakes in financial companies because the sector was their “No. 1 focus.”
Kenneth Chen, the Qatar Investment Authority’s head of strategic and private equity, was quoted by Reuters as saying “tremendous opportunities” exist in the U.S. financial sector and that 2008 “is going to be an interesting year.”
Not everyone is convinced that foreign funds are poised to swoop in and launch a buying spree for stakes in U.S. financial services companies.
Douglas Smith, the chief economist for the Americas at Standard Chartered, said few large banks appear to be in dire need of capital, the Citigroup investment notwithstanding.
“When you look at the other large banks, they are not at risk,” he said in a Wednesday interview. “But of course that could change.”
Executives at the country’s largest banking companies have either expressed satisfaction with their current capital ratios or confidence in raising them without selling straight equity.
James Dimon, the chairman and CEO of JPMorgan Chase & Co., said at a Nov. 13 conference that his $1.5 trillion-asset company “has the wherewithal” to absorb billions of dollars on its balance sheet. “We have an awful lot of liquidity, and we have maintained it right throughout,” he said. The bank’s capital ratios are “particularly well-positioned.”
G. Kennedy Thompson, the CEO at Wachovia Corp., said at a conference Wednesday that current market conditions would lead to some capital erosion — which it could shore up, if necessary, with preferred stock to avoid diluting current shareholders.
Bank of America Corp. CEO Kenneth D. Lewis, speaking at the same conference, warned that his $1.6 trillion-asset company would fall below its 8% targeted Tier 1 capital ratio due to “disappointing” fourth-quarter earnings but would restore the ratio by halting repurchases and possibly monetizing a portion of its minority stake in China Construction Bank.
But plenty of U.S. banking companies may be large enough to support investments worth making.
“I think there is going to be a fair amount of interest from sovereign vehicles,” and “what is different is that the U.S. banks are now looking at them as a source of capital,” said Randall Guynn, who heads the financial institutions group at Davis Polk & Wardwell. “They will want to make sizable investments to make it worth their while to pay attention to it.”
Prof. Plath draws the line at about $50 billion of assets — which covers roughly 25 to 30 banking companies in the United States.
“Until there is diversification and scale in the model,” he said, those companies “don’t have much in penetration in the industry” and probably would not attract much attention.
Beyond judging the appetite of sovereign wealth funds for U.S. banking companies, few observers fail to point out the maelstrom of criticism that greeted Dubai Ports World’s early 2006 announcement that it had obtained the management contracts for six major U.S. ports. The fund eventually sold the rights amid the political backlash.
The Treasury Department has so far adopted a more accommodating tone about foreign investments than countries such as China, Canada, Russia, and Germany, which either restrict or are seeking to restrict foreign investment in domestic banks.
Treasury Department Deputy Secretary Robert Kimmitt said during the U.S.-GCC Investment Forum in Bahrain on Dec. 4 that sovereign wealth funds “may be considered a force for financial stability,” though he acknowledged that “large, concentrated, and often nontransparent positions in financial markets” could give rise to “legitimate security concerns.”
At issue is whether these concerns — possibly conflated with thunderings by politicians opposing foreign investment — will keep the funds away from U.S. companies.
“I hope what doesn’t happen is some sort of political protectionism,” Mr. Albertson said. “What we really need right now is to restore confidence in capital markets and liquidity.”
