Restructuring Emerges from Dry Markets, Report Says

MBA (9/30/2008 ) Murray, Michael
In the weeks and months to come, the banking industry in the United States will experience more mergers and restructuring as liquidity remains dry, based on research from TowerGroup, Needham, Mass.

Jim Eckenrode, banking and payments research executive at TowerGroup, said lending markets are not completely dry, but TowerGroup’s reported that financial institutions would return to more traditional banking activities as capital holds back from the market, credit terms tighten and economic growth stalls.

“The credit markets are certainly very tight right now. That is more endemic at the moment,” Eckenrode said. “Obviously, some institutions are considered a greater counterparty risk than others. It makes it more difficult for them than for a firm that is perceived as being potentially healthier and less of a risk.”

The Dow Jones fell by 700 points following a House vote rejecting a $700 billion plan for the federal government to purchase “toxic” assets, including residential and commercial mortgage holdings, from financial institutions.

The House vote followed Citibank’s acquisition of Wachovia yesterday morning and a month of sales and failures by financial institutions—Fannie Mae and Freddie Mac brought into conservatorship by the federal government, Barclay’s purchase of AIG, bankruptcy by Lehman Brothers, Bank of America’s purchase of Merrill Lynch and JPMorgan Chase’s purchase of Washington Mutual Bank.

Eckenrode said commercial real estate assets would also have been covered by the $700 billion proposal as well as residential assets.

Michael Stoler, senior principal at a real estate investment firm, said $700 billion of purchased assets would not have alleviated liquidity issues for commercial real estate, as debt and equity remains frozen. Stoler said he spoke last week with real estate investment funds representing nearly $10 billion of equity that continues to sit on the sidelines.

“None of them is making an investment today. They are all waiting to see when the knife falls,” Stoler said. “They are waiting for the longer term. It is [smarter] to make no investment than to use your money. That’s equity investment.”

Stoler said lenders remained uncertain on pricing as cap rates rise and commercial real estate prices fall. "Lenders don’t know how to price things because they don’t know the cost of capital,” he said. “They don’t know how they are going to borrow money."

“That’s part of the problem at the moment for commercial enterprises of all sizes, trying to extend borrowing or borrow new money,” Eckenrode said. “Whether it’s commercial real estate or working capital, they are finding the same sorts of challenges that the banks are.”

“It’s a very, very difficult time, and we’re in it for a rather long time—18 months, and that’s the reality,” Stoler said.

Declining asset value and inability to raise capital through borrowing weakened financial institutions “driven by a crisis in confidence rather than any real loss of value,” Eckenrode said.

JPMorgan Chase’s acquisition included $19 billion in potential mortgage loan losses on Washington Mutual’s books, as told by Washington Mutual’s senior management in June. TowerGroup said Chase will look to raise an additional $10 billion of capital. While Chase’s loan loss provisions declined from the first to the second quarter of this year, WaMu’s provisions increased by nearly 79 percent to $5.9 billion.

TowerGroup said a new JPMorgan Chase will embark upon a two-year merger conversion process that “will result in a more effective technology footprint than that deployed by Washington Mutual.”

“In recognition of the decline in credit quality, the banks’ ability to cover those losses is really what’s going to identify the weak institutions versus the strong,” Eckenrode said.