Miserable prices stall mergers

Still waiting for all those megamergers to rock the financial services industry? Don’t hold your breath.

The final nail is being hammered today into the coffin of Depression Era rules that kept insurers, banks and brokerages from entering one another’s business. But analysts say miserable stock prices will stall mergers and acquisitions and only make U.S. companies more vulnerable to well-heeled foreign acquirers.

It’s a far cry from predictions that a flood of domestic deals would follow the demise of the Glass-Steagall Act of 1933. It was repealed last fall when the Gramm-Leach-Bliley Financial Services Modernization Act was signed into law.

“I think people had much higher hopes that the reform would be the watershed event that would cause all kinds of mergers,” says Anna Dopkin, a financial services analyst at T. Rowe Price Associates Inc. in Baltimore. “But financial stocks are on their backs right now. Mergers just aren’t happening.”

Moreover, the deals expected to be made in anticipation of unpopular accounting rule changes never materialized, and the proposals might end up being shelved.

Even the possibility that those changes still could take effect next January hasn’t been enough to cause companies to rush to the altar.

“We’ve discovered that a down stock market is a lot more powerful than the potential loss of [favorable] accounting rules,” says Jon Holtaway, a banking analyst with Danielson Associates in Rockville, Md.

With few exceptions, financial stocks are trading at 52-week lows, having dropped with the Dow Jones Industrial Average, off more than 10% since the New Year.

Bank of America Corp., for instance, hit a new low last week of $42.88, down 44% from its 52-week high of $76.38 last July. First Union Corp., too, is trading at $30, down 48% from its high of $57 last April.

With another boost in interest rates expected and investors avoiding anything non-tech, many financial stocks will likely continue to slump, especially banks and insurance companies.

“If you look at the rising interest rate environment as well as the lack of interest in value sectors, you have factors that have created a difficult environment for bank stocks in general,” says Jim Ackor, an analyst with brokerage Tucker Anthony in Portland, Maine.

The mid-January announcement by Charles Schwab Corp. that it would purchase U.S. Trust Corp. for $2.6 billion led some to believe that other companies would follow suit. Stock prices rose for other institutions in U.S. Trust’s league, but Schwab’s has been the only big deal since the demise of Glass-Steagall.

The stock situation doesn’t bode well for banks, considering they are the ones most in need of the new law.

Essentially, commercial banking is a low-margin business, while asset management and investment banking hold great appeal for banks.

Many brokerages, on the other hand, have secured federal thrift charters, which would allow them to enter commercial banking. (See related story, Page 7). And, many have set up their own trust departments and likely wouldn’t get into the low-margin business of insurance underwriting.

But, say analysts, once stock prices recover, deals will emerge.

“It’s not a question of if, it’s a question of when,” Mr. Ackor says. “With depressed stock prices, it’s difficult to get deals consummated. Acquirers, historically speaking, have used stock to make acquisitions.”

Raymond “Chip” Mason, chairman and CEO of Legg Mason Inc., says that although he remains committed to the Baltimore brokerage’s independence, megamergers elsewhere in the industry are inevitable.

“Everything is pointing toward bigger and bigger [companies]. I don’t see that trend reversing itself,” Mr. Mason says. “Banks feel as though they’ve got to enter [other] financial services businesses. I’m not sure it’s all going to work, but I think that’s what is going to happen.”

Analysts see much of that bigness emanating from overseas.

In addition to slumping domestic stock prices, deals like Deutsche Bank’s planned $30 billion acquisition of German rival Dresdner Bank AG suggest European conglomerates — both banking and insurance — are on a roll.

Deutsche Bank, for one, already had become a presence in the U.S. market through its 1999 acquisition of Bankers Trust, picking up Baltimore investment bank BT Alex. Brown in the deal.

“There are some big global insurance companies and banks that have decent currencies right now,” Ms. Dopkin points out. “And, they’re more willing to accept a lower return than some companies over here are.”

But if stock prices continue their slump, U.S. shareholders looking to be rescued may settle for a smaller premium if their company is bought.

“The good news is that when we start to see mergers occur in financial services, prices might come down,” Ms. Dopkin says. “It might be easier to make mergers work, as long as sellers bring down their expectations.”

Meanwhile, the changes to rules by the Financial Accounting Standards Board were expected to spur mergers among financial companies before the new rules took effect next January. Now, with the chance that those rules will be put on hold, the rush to complete mergers is unlikely.

Basically, financial companies prefer making deals under current pooling-of-interest accounting rules, which essentially allow two companies to combine their balance sheets.

Under the new purchase accounting rule, the buyer would have to charge goodwill — the market value — of the seller on its balance sheet. In big merger deals, goodwill in the billions of dollars could act as a drag on earnings.