on the California banks involved should improve, according to Standard & Poor's Ratings Group. If First Bank System Inc. is the winner, Standard & Poor's would probably upgrade First Interstate immediately, since the Minneapolis-based banking company has a higher debt rating. On the other hand, if Wells Fargo & Co. wins, an upgrade would take more time as the rating agency waits for the bank to demonstrate the benefits of diversification and greater size. Wells now has the same debt rating as First Intestate. S&P said it didn't have a preference about the victor in the contest to buy First Interstate, which is based in Los Angeles. "The positives in each of the two cases are different," said Tanya S. Azarchs, a director at S&P. The hostile nature of the Wells Fargo bid does raise some red flags, said S&P. It could exacerbate the never-easy process of integrating two managements. Also, the potential for lower morale among disgruntled employees probably poses some "special problems" in the event of a Wells Fargo victory, said Ms. Azarchs. Nonetheless, if Wells Fargo prevails, there is still the potential for "rating changes in the positive direction down the road," said Ms. Azarchs. Ms. Azarchs said Wells Fargo would both become significantly more diversified after a First Interstate acquisition and gain a hefty amount of low-cost funds, the "crown jewel of First Interstate," she said. A bidding war, however, could conceivably give the rating agency pause. Ms. Azarchs said she wouldn't be terribly concerned if the bidding went somewhat higher, though if the bids become much more aggressive, "it'd definitely be a concern." If the evolving bidding war does not limit the financial flexibility of the ultimate victor, analysts predicted ratings upgrades as commercial banks strengthen their franchises in an increasingly competitive industry. "A broadly diversified franchise has greater strengths from a creditor's point of view," said Allerton G. Smith, a bank bond analyst at Donaldson Lufkin & Jenrette. The upgrades at several of the largest banks indicate that rating agencies definitely favor the larger company, said Mr. Smith. If Wells Fargo wins, Ms. Azarchs said, another ratings factor is that the San Francisco-based banking company already had "positive outlook" status before its announced intention to purchase First Interstate. The rating agency had placed the bank on positive outlook despite the lack of diversification because it recognized the "superior management" and "tremendous core profitability which has allowed them to cover any and all problems," said Ms. Azarchs. The agency always has had to balance Wells Fargo's positives against lower diversity and a tiering down to the subprime borrowers. Ms. Azarchs said that the rating agency could still upgrade the company to A-plus, even without an acquisition, if it became more comfortable with the bank's ability to contain credit losses. Ms. Azarchs cautioned that while the banking industry is benefiting from consolidation, the reasons for that consolidation bespeak the competitiveness and overcapacity of the industry. "The consolidation is not wholly positive," she said. "It's in the context of negative industry trends." Ms. Azarchs said that it's unlikely the new Chase Manhattan Corp., after its merger with Chemical Banking Corp., would receive further upgrades, because of revenue limitations. "We don't see the same kind of dynamic that occurred at the time of the (Chemical) merger with Manufacturers Hanover," said Ms. Azarchs. "We don't see those kinds of organic revenue generation." Ms. Azarchs said each of the companies has had pressure on its net interest margin.
Save $400 off your subscription. Special offer ends April 30, 2017.
No credit card required. Complete access to articles, breaking news and industry data.
Have an account? Sign In