FDIC-Brokered Bank Deals Set To Surge

(Reuters) – Merger and acquisition activity may have dried up in the banking space, but the appetite for deals brokered by a top banking regulator is increasing as more and more weak banks succumb to the deepening recession.

With bank failures expected to rise further, experts say healthier banks could start to look aggressively at acquiring weaker ones as early as the second half of this year, in deals assisted by their regulator, the Federal Deposit Insurance Corp (FDIC).

“For sure there’s going to be more bank failures, more FDIC receiverships and so more opportunities for healthy banks to acquire these insolvent banks in assisted transactions,” Lawrence White, an economics professor at New York University’s Stern School of Business, said by phone.

Experts believe there will be no dearth of such opportunities for banks and see 100 to 200 bank failures this year, up from 25 banks in 2008 and just three in 2007. So far this year 17 banks have failed.

“The FDIC is going to be making available for merger by the end of the year at least 100 banks and maybe more,” White said.

When a bank fails, the FDIC, which insures up to $250,000 per depositor, is named receiver and is responsible for liquidating its assets.

For banks that have been prudent in their lending and in the portfolios they maintained, an FDIC-assisted deal poses an attractive alternative to traditional acquisitions, as acquiring banks can pick up deposits at relatively low or zero premium and also be shielded from toxic assets.

FDIC spokesman David Barr said there was interest by banks in acquiring potential bank failures, but that the interest varied considerably.

“It all really is based on the franchise value of that troubled institution,” he added.

In recent weeks, community banks, including FirstMerit Corp (FMER.O) and First Midwest Bancorp Inc (FMBI.O), have said they were eyeing potential FDIC-assisted acquisitions.

“I think it would be tough to find a regional bank that would not have an interest in doing an FDIC-assisted deal,” Oppenheimer and Co analyst Terry McEvoy said.

But U.S. banks are not the only ones eyeing such deals. Foreign banks such as Canada’s Toronto-Dominion Bank (TD.TO) had earlier this month expressed interest in FDIC-assisted deals.

FDIC Chairman Sheila Bair has said the number of bank failures could increase and the agency has set aside $22 billion for expected payouts from its deposit insurance fund this year.

The regulator said its watch list had 252 problem banks, with combined assets of $159 billion, in the fourth quarter.

EASIEST TARGETS?

Small banks, which currently do not have access to capital markets and are constrained by revenue and geographic diversification, face the biggest challenges, making them the likeliest targets for FDIC-assisted acquisitions, analysts say.

“I think it’s mostly going to be smaller versions of IndyMac, Washington Mutual, PFF Bank and Trust — just guys who got in over their head in local lending on properties that are now way under water and are going to pay the price,” White said.

Washington Mutual, by far the largest U.S. bank failure, as well as failed California thrifts IndyMac Bancorp and PFF Bank all specialized in exotic mortgages, causing those banks to become insolvent as the housing crisis gained momentum and dragged the economy into recession.

Morgan Keegan and Co analyst Robert Patten estimated at least 500 to 1,000 banks, predominantly in the small-cap space, will need to be acquired over the next two to three years.

New York University’s White said, “Any place where there’s been a weak housing market and lots of foreclosures, there’s probably a local lending institution that is hurting and that’s where you’re going to see the FDIC action.”

CATCH-22

But in the end, for an FDIC-led deal to take place, much would depend on whether the healthy banks, which regulators look to as consolidators, can give up capital.

“While the Fed wants all these consolidators to start picking up their weaker sisters, these larger banks care for how they allocate their own capital because they are also working through a capital environment,” Patten said.”So we’re at this catch-22.”

Faced with mounting capital constraints, financial institutions around the world have unleashed a slew of measures to bulk up their capital, including cutting or eliminating dividend payments.

Oppenheimer’s McEvoy believes regional banks with strong capital levels are in a better position to do FDIC-assisted deals, and cited KeyCorp (KEY.N) and Comerica Inc (CMA.N) as good examples.

Analysts, however, agree that the larger banks will not be driving merger and acquisition activity in the sector, saying they have “enough on their plate right now.”

But other than JPMorgan Chase & Co (JPM.N), Citigroup Inc (C.N), Wells Fargo and Co (WFC.N) and Bank of America Corp (BAC.N), the rest are open game, analysts say.

By Tenzin Pema

(Editing by Anil D’Silva;)