Issue of the week: A takeover wave in banking

The consolidation of the U.S. banking system was supposed to take years to accomplish. Instead, it’s unfolding “in a matter of weeks, with the U.S. government often acting as matchmaker,” said Robin Sidel and Damian Paletta in The Wall Street Journal. At the end of last year, the Big Three U.S. commercial banks—Bank of America, JPMorgan Chase, and Citigroup—collectively held 21.4 percent of U.S. bank deposits. Today, following the government-backed sales of Washington Mutual to JPMorgan and Wachovia to Citigroup, the Big Three together control 31.3 percent of deposits. Analysts say they’ll soon control more, as the Big Three shift their focus from giants such as WaMu to smaller targets. Earlier in this decade, many of the nation’s 8,000 small and midsize regional banks lent heavily to developers to build housing tracts, shopping malls, and office buildings. Now those new houses are going unsold, and the malls and office buildings are desperately seeking tenants, saddling the regionals with millions in bad loans and plunging share prices. And that’s an invitation to the big banks to swoop in. The result: fewer banks, and a concentration of banking deposits in fewer and fewer hands.

One deal in particular may set the pattern for future takeovers of troubled banks, said Henry Sender and Joanna Chung in the Financial Times. Citigroup’s $2.16 billion takeover of Wachovia last week probably wouldn’t have happened if the Federal Deposit Insurance Corp. hadn’t agreed to take on “much of the risk on Wachovia’s portfolio of toxic assets, in return for an ownership stake in the combined bank.” Citi will take any losses on $42 billion of Wachovia’s $312 billion loan portfolio. Any additional losses will be absorbed by the FDIC. By limiting the losses that Citi could suffer by acquiring its ailing competitor, the FDIC is tacitly encouraging similar deals. And it’s giving itself—and taxpayers—a chance to profit if the acquisition turns out well and boosts Citi’s earnings and stock price.

In the end, though, the reduction of the number of U.S. banks will cost Americans dearly, said Nancy Trejos in The Washington Post. With fewer banks competing to make loans, offer credit cards, and manage investments, “consumers can at some point expect to pay more for products and services.” Customers of banks that have been taken over should be on the lookout for changes in the terms of loans and credit card agreements.

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Consumers won’t like the reduced competition, but investors will, said Manuel Schiffres in Kiplinger’s Personal Finance. So says ace fund manager Ken Heebner, manager of the popular CGM Focus fund. Over the long term, less competition translates to bigger profits for banks that survive the shakeout. “You’re going to see profit margins reach levels they never reached before,” Heebner says. And in the short term, banks will get a boost to profits if the Federal Reserve cuts interest rates, as is widely expected. But to share in the prosperity, investors will need both capital and the courage to wade into today’s manic markets.