The New Banking Order in the United States

By Scott B. MacDonald

NEW YORK (KWR) -- Although there appeared to be little momentum on the U.S. banking consolidation side following Bank of America's purchase of Fleet Boston, this changed with J.P. Morgan Chase/Bank One announcement of an agreement to merge on January 14, 2004. The two banks agreed to form a bank holding company with $1.1 trillion in assets. Following this news, Sovereign Bancorp announced it was acquiring Massachusetts-based Seacoast Financial Services for $11 billion. These acquisitions have brought the issue of bank consolidation back to the front burner. They have also made bank stocks much more interesting. Just when it looked like a boring year for the banking sector, the consolidation game picked up. It is about to accelerate.

What is evident is that there is a large gap in terms of the size of the nation's three major banks and the next tier of institutions. The actions of Bank of America and JPM are likely to force many bank management teams to reassess the banking environment and determine whether to expand business through organic growth or look for possible merger partners and acquisition targets. This is particularly true for Wells Fargo, Wachovia, US Bancorp, Fifth Third, Sun Trust, KeyCorp. and Bank of New York. In a sense, a failure to move is likely to invite a suitor - welcome or not.

Taking heed of the changing banking environment, two large southern regional banks, Union Planters and Regions, announced on January 24, that they were merging. Combined, the two companies would rank as one of the largest banks based in the Southeast, boasting just under $81 billion in assets and nearly $56 billion in deposits. This has left many investors and analysts looking at other southern banks, such as Sun Trust, BB&T, First Tennessee, and Colonial – among others.

* Source: MSN. Ranking based on market capital, not total capital.
** Federal Reserve, June 2003.

The most likely banks in play as possible acquisitions include: PNC, KeyCorp, which must expand or be bought) BB&T and National City. Beyond this group, Sovereign Bancorp, which has been in and out of talks with Royal Bank of Scotland and Comerica are also frequently mentioned. Another combination is Wells and Wachovia, which would create a coast-to-coast bank and propel the new institution into the same range of assets and market value as JPM-One. We also think that HSBC, Royal Bank of Scotland and ABN Amro all could become more active in 2004 and 2005 about expanding their U.S. operations. All three have U.S. holdings and would find any new acquisition an opportunity to broaden their retail, commercial and consumer footprints in the U.S. market.

As for the proposed merger of JPM and Bank One we think it makes considerable sense, especially since Bank One's more plain vanilla business is likely to reduce some of the volatility inherent in JPM's investment banking business. There is a strong possibility the combined bank will be rated Aa3/A+/AA- - if the combined management team is able to demonstrate a well-constructed integration plan. Both rating agencies have ratings for each bank, which are one notch apart. Fitch rates both banks at A+. S&P already put Bank One’s A rating on Credit Watch positive and affirmed JPM's A+ rating due to the "excellent fit" of the merger. The rating agency observes the merger addressing certain weaknesses in the franchises of the two banks - JPM achieves significant scale in branch banking, while Bank One gains a stronger corporate banking business. S&P sees the merger as upgrading the combined institution's national businesses. Fitch has put both banks on rating watch positive as it expects both banks will benefit from the greater balance in the businesses of the combined bank and its stronger branch network.

Moody’s has indicated it expects the merger to be net positive for JPM and has placed it on review for a possible upgrade. This positive view is based on Bank One’s substantial and more geographically diversified consumer and business banking base helping JPM’s more limited role as a New York metro area regional bank. Furthermore, the national lending businesses (credit cards, autos, mortgages, and student loans) are complementary. This bolsters JPM’s position as a universal bank that competes in the investment banking arena. Moody's noted this is a very large merger that entails considerable execution risk. Nonetheless, both predecessor firms have management teams that are experienced at acquisitions. Management is forecasting cost savings of $2.2 billion over three years and Moody's indicated it is reasonably confident that cost synergies can be achieved.

While we see 2004 as a year of consolidation for the U.S. banking sector, we would be cautious over whether the process is likely to continue into 2005. Not every bank is ready to be bought or acquired or wants to become a Citigroup or a JPM Morgan Chase. And considerations must be given to maintaining profitability and prudent banking practices. But there are enough banks that do want to grow and maintain their independence, which keeps the banking sector a place to watch in the U.S. stock market.