The Death of Investment Banks - MS and GS get full banking charters
NEW YORK -(Dow Jones)- Moves by Morgan Stanley (MS) and Goldman Sachs Group Inc. (GS) to become bank holding companies will close the window on the era of independent investment banks but open the door for them to a new breed of acquisitions.
Morgan Stanley and Goldman Sachs were both granted bank holding company status Sunday by the Federal Reserve. The status is supposed to include a five-day antitrust waiting period, but Monday the Fed said the transaction might done immediately.
The two banks managed to remain standing despite the financial crisis hitting a peak last week. Stock prices of Morgan Stanley and Goldman Sachs plunged early last week, but rebounded Friday on talks a government plan to buy troubled mortgage assets from financial firms in a bid to halt the spreading crisis on Wall Street.
“The main advantage investment banks will gain is flexibility - both on the liability side and on the asset size,” said Roger Lister, the chief credit officer of the U.S. Financial Institutions Group at the rating agency DBRS Inc.
While it makes it easier for investment banks to use deposits, it also makes it easier to moves assets from one part of the company to another. Both investment banks’ “goal is to reduce stress and wholesale funding,” said Lister.
The Federal Reserve Board has already eased restriction for bankers to use deposits to fund capital markets operations. After the previous weekend’s hectic negotiations between bankers, regulators, and Lehman Brothers Holdings Inc. ( LEH) and Merrill Lynch & Co. (MER), the Fed announced on Sept. 14 that it would allow “all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market.”
That removed one of the main restrictions regarding the use of deposits, and it makes it more attractive to generate more deposits. Though the exception to the Federal Reserve Act is set to expire on Jan. 30, the Fed said.
For now, that makes retail deposits even more valuable, and is a big incentive for the investment banks to either merge with a bank, or buy a bank. In fact, at least one investment banker, who declined to speak on the record, said buying or merging with a bank is likely to be the main reason for the change to bank holding company status.
“It will be a lot easier to make an acquisition, which the two firms [Morgan Stanley and Goldman Sachs] are immediately equipped to do, without having to go through the regulatory machine,” said Campbell Harvey, professor of finance at Duke University’s Fuqua School of Business.
Bank boards have looked with suspicion at potential non-bank buyer, this investment banker said. Capital One Financial Corp. (COF) also became a bank holding company once it had decided more than five years ago that it would want to buy a bank to fund its consumer loans with deposits.
In that sense, the change to holding company status would smooth even the negotiations Morgan Stanley is rumored to hold Wachovia Corp. (WB). The Charlotte-based company might have a much easier time negotiating with a partner now on an equal playing field from a regulatory perspective, the investment banker said.
Monday, Japanese bank Mitsubishi UFJ Financial Group Inc. (MTU) announced a strategic partnership with Morgan Stanley, and it is buying between a 10% to 20% stake in the firm, with intentions to spend a maximum of $8.4 billion.
However, even despite the capital infusion from Mitsubishi, a merger with Wachovia might be Morgan Stanley’s ultimate goal, the investment banker said.
The remaining investment banks might also look for banks to buy. However, they might have to look for a sizable target to generate the returns shareholder would demand for expanding into a new line of business. Running a retail bank is different from managing capital markets operation, though the investment banks could conceivably buy retail bank with a stable management and keep it in place. “Eight percent of the value of a retail bank is in its deposits,” said the investment banker.
Still, Lister of DBRS remained more skeptical. “The difficulty will be how to make money” from retail banking. “How do you leverage the business?” he asked. Capital One’s rational was to add its marketing skills to the banks it bought, and use the branches and new customers for its credit card business, in addition to the new businesses and the deposits. It remains to be seen how investment banks would add their skills to advance the retail bank they might buy, Lister said.
Banks have turned to foreign investors the past few weeks as they looked to raise capital, but many market participants felt that it was becoming more and more difficult for banks to secure capital, especially from overseas investors. Lehman Brothers, which recently filed for bankruptcy and sold its broker-dealer unit to Barclays PLC (BCS), was in talks with Korea Development Bank for a capital infusion, but the deal fell through.
However, the Mitsubishi partnership with Morgan Stanley might be a sign that the market is bottoming out, said Harvey of Duke University, adding that foreign investors may start looking again to the U.S. market for investment opportunities.
However, challenges will arise from becoming a bank holding company, such as the costs to comply with bank holding company rules and regulations, which will be extensive.
For one, Morgan Stanley and Goldman Sachs will need to drastically reduce leverage, and bring down the ratio to bank holding company range, said Harvey.
Banks’ capital is tightly regulated - so on July 31, Wells Fargo & Co.’s (WFC) leverage was 12.7 times, and even JPMorgan Chase & Co.’s (JPM) leverage was 13.3 times, despite its large investment banking unit. Morgan Stanley and Goldman Sachs leverage ratio is 33, and 28, respectively.
The two firms will also be subject to heightened scrutiny. Generally, investment banks have tried to avoid direct regulation from the Fed, but bank holding companies are subject to fairly specific hands on regulations from the government. Goldman Sachs and Morgan Stanley have been under the Securities and Exchange Commission watch, but will now need to comply with bank regulatory type standards, said V. Gerald Comizio, senior partner in the banking and financial practice at Paul Hasting. A challenge for the Federal Reserve will be coming up with a user friendly transition period, he said
(END) Dow Jones Newswires 09-22-08 1446ET Copyright (c) 2008 Dow Jones & Company, Inc.
