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Has The Government Picked The Survivors?

Posted: Sep 30, 2008 09:51 AM by Stephen Simpson

Tickers in this Article: C, WB, WFC, USB, STD, HBC, AIG, FHN, ZION, MTB

Investors woke up Monday morning to the news that Citigroup (NYSE:C) had reached an agreement to acquire the banking operations of Wachovia (NYSE:WB). While debt holders are no doubt relieved that Citigroup agreed to assume a lot of their obligations, equity shareholders are getting little more than a token payout for their stubs.

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At the risk of sounding snarky, my first thought on the deal goes something like this: if Citigroup is the cavalry, we are all in a lot of trouble. Looking a little deeper, though, I think it raises the question of whether the government has more or less designated the survivors of this banking crisis, Citigroup possibly being one of them.

Safe with the Citi
When it was all said and done, it seems to me that the battle for Wachovia may actually have been something more akin to "No, you go instead" among the would-be bidders. After all, Santander (NYSE:STD) and HSBC Holdings (NYSE:HBC) never seemed terribly interested, I never heard USBancorp (NYSE:USB) mentioned as a serious suitor, and Wells Fargo (NYSE:WFC) was apparently not interested in matching Citigroup's low bid. And remember, Citigroup was able to squeeze out some assistance in this bid, with the FDIC agreeing to take on any bad Wachovia loans in excess of $42 billion, in exchange for some warrants and preferred stock. (To learn more about mergers, read The Merger - What To Do When Companies Converge).

How, then, does Citigroup get to buy Wachovia when it was only a relatively short time ago that Citi itself seemed shaky? It seems apparent to me that the federal government has made an increasingly implicit (but not yet fully explicit) determination that a small group of larger banks will be allowed to play the role of buyer-of-last-resort. I doubt that the acquisitions of Merrill Lynch or Washington Mutual would have been permitted just a year or two ago, but now a lot of the anti-trust and regulatory oversight has been suspended in the name of keeping the whole system running. What's more, the government clearly extended some assistance to Citigroup in getting this deal done in a way that helps protect Citi's capital to some extent.

The trick, however, is how far does this coverage extend? The government determined (correctly, in my view) that AIG (NYSE:AIG) could not be allowed to collapse, but shareholders there are going to lose a big chunk of their equity. In contrast, Lehman Brothers was allowed to go under (maybe not the wrong decision, but not handled very elegantly) and Washington Mutual was sold in a fashion that effectively wiped out equity and debt investors.

Is Any Company Safe?
What happens, though, if it's Tennessee's First Horizon (NYSE:FHN), Utah's Zion's Bancorp (Nasdaq:ZION) or Buffalo's M&T Bank (NYSE:MTB)? Do they know the secret handshake and are they sitting inside the circle of friendship? I am not - repeat not - suggesting that any of those three are poised to fail, but my point is that we as investors are now flying blind. We know that there's this vaguely defined concept of "too big to fail", but we don't know which side of the fence most of these bank, brokerage or insurance companies are on today. Let's not forget that Wachovia and Washington Mutual were both among the ten largest banks in the country … and yet their shareholders are left with virtually nothing. (To learn more about deposit protection, read Bank Failure: Will Your Assets Be Protected?).

Looking at the situation, I've got the feeling that unless you're among the biggest of the big (and let's assume that banks like Bank of America (NYSE:BAC), USBancorp, and Wells Fargo are on that list), you're pretty much on your own and nothing is guaranteed.

Look Twice!
Now, there are plenty of banks large or small out there that will likely come through this crisis battered and bruised, but basically intact. There are others, though, that made aggressive lending decisions and are likely to find themselves pushed into shotgun marriages that leave shareholders feeling as though the banks effectively failed (even if that is not their official fate). With that in mind, anyone considering an investment in a bank stock today had best triple-check every single one of their assumptions and make sure that they're investing with a lion and not a wounded gazelle.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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