Banking Acquisitions during the Financial Crisis

I. Introduction

When the housing crisis was at its lowest point, entire neighborhoods were experiencing the possibility of foreclosure as residents defaulted on their mortgage payments. Foreclosures and consumer defaults have not only damaged the housing market but also have affected financial institutions. [1] The financial industry was hit particularly hard, especially leading subprime lending banking institutions. Washington Mutual, Freddie Mac, Wachovia, Bear Stearns, Countrywide and Merrill Lynch have been or are in the process of being acquired by big banks, strong enough to make the acquisition. [2] In this article, I will discuss the most recent acquisitions, Washington Mutual and Wachovia Corp., and analyze the benefits of this acquisition to the banking industry as well as the costs to consumers.

II. Background

Both Washington Mutual ("WaMu") and Wachovia Corp. ("Wachovia") suffered heavy losses after the housing market collapse. Wachovia and WaMu ranked first and second as the biggest providers of "option" adjustable rate mortgage loans ("ARM") [3] and WaMu ranked sixth among U.S. mortgage companies as the biggest subprime lender. [4] These subprime and adjustable rate mortgage loans were meant to aid individuals with poor credit scores to acquire mortgages. [5] Option ARM loans offered very low introductory payments and let borrowers defer some interest payments to a later period. [6] As borrowers became delinquent on their mortgages, both financial institutions suffered billions of dollars in losses. In July WaMu reported a $3 billion second-quarter loss. [7]

Furthermore, in 2006 Wachovia had made $23 billion acquisition of Golden West Financial, a large mortgage lender. [8] After the housing crisis, Wachovia's stock plummeted 93% in the past year as a result of the Golden Financial acquisition. [9] The Federal Deposit Insurance Corp ("FDIC") seized WaMu in September 2008. [10] JPMorgan Chase & Co. ("JPMorgan") then purchased WaMu from the FDIC. [11] Citigroup and Wells Fargo both made offers to Wachovia. [12] However, Wachovia made a deal with Wells Fargo for $15.1 billion. [13] Citigroup filed suit claiming that the Wells Fargo-Wachovia merger was "in clear breach of an exclusivity agreement between Citi and Wachovia." [14] Recently, Citigroup announced that it is no longer seeking the enjoinment of the Wells Fargo-Wachovia merger. [15]

III. Effects of the Acquisition

A. Survival of the Fittest Benefits the Banking Industry?

The financial crisis offers an opportunity for "U.S. large banks to get truly huge." [16] This is a once in a lifetime opportunity for banks to increase exponentially in size by buying up banks with billions of dollars in assets and thousands of branches. Although Wachovia has had suffered losses due to its bad mortgage debt, it is one of the largest banks in the U.S. with 3,300 branches in 21 states. [17] If Wells Fargo obtains Wachovia, it will create the "nation's premier coast-to-coast community banking presence" having banks in 39 states. [18] In addition, both Wachovia and WaMu offer an opportunity to get a large amount of cheap deposits. [19] During this financial crisis, these deposits are especially valuable. [20]

Jamie Dimon, chairmen and CEO of JPMorgan, has stated that their acquisition of WaMu "makes excellent strategic sense for [the] company" predicting that the acquisition would add 50 cents per share to JPMorgan's earnings in 2009 and achieving pretax savings of approximately $1.5 billion by 2010. [21] The acquisition expands JPMorgan's network reaching 42% of the U.S. population adding 5,400 branches in 23 states. [22] Through this acquisition JPMorgan became the second largest branch network in the nation. [23]

Furthermore, Wells Fargo has purchased this weakening financial establishment with no government assistance. [24] Taxpayer money will not be used to save this troubled bank. In addition, JPMorgan will be writing down WaMu's loan portfolio to about $31 billion [25] although it will not be acquiring senior unsecured and subordinated debt. [26] This trend to take the industry's assets away from weak management teams and put into the hands of capable managers through acquisition may help in stabilizing the banking market. [27]

B. Costs to Consumers

Federal regulators seem to be ignoring antitrust rules. [28] They even seem to be encouraging this climate forcing banks with thousands of branches and billions of dollars in deposits to sell at rock-bottom prices. WaMu, a bank of $307 billion in assets, was sold to JPMorgan for merely $1.9 billion. [29] Wachovia with assets of $813.4 billion and market capitalization of $33.5 billion was offered $2.2 billion by Citigroup before it was sold for $15 billion to Wachovia. [30] This monopolizing effect may hurt consumers. According to Sally Grenberg, executive director of the National Consumer League, "Whenever you have fewer businesses in an industry competing for consumers, they can inflate prices." [31] Therefore, this banking monopoly may result in higher fees on checking accounts to bounced checks as well as low interest-rate yields on deposit accounts. [32]

IV. Conclusion

As Wachovia and Washington Mutual are near collapse, their acquisition by Wells Fargo and JPMorgan are lifesavers to their customers and shareholders. Although their takeover by stronger and larger banking institutions may be necessary to stabilize the banking market, the long term effects of these acquisitions may be harmful. As financial institutions, like JPMorgan, Wells Fargo, and Bank of America become larger and monopolize the banking industry, this will cost consumers in the long-run through price inflation and low-interest yields. Only time will tell how these banking monopolies will affect the financial market.

[1] Sally Pitman, Arms, But no Legs to Stand On: "Subprime" Solutions Plague the Subprime Mortgage Crisis, 40 Tex. Tech. L. Rev. 1089, 1103 (2008).

[2] Id.

[3] The Rise, Fall, and Eventual Collapse of WaMu, Miami Daily Bus. Rev. 3, *at 2 (2008) [hereinafter Collapse of WaMu].  ARMs are a type of subprime mortgage loans. See Pittman, supra note 1, n. 7 (2008) ("An ARM is a loan with an interest rate that will readjust after a specific period of time").

[4] Collapse of WaMu, supra note 3.

[5] Id.

[6] Pittman, supra note 1.

[7] Collapse of WaMu, supra note 3.

[8] Dean Foust, Wachovia: One Thompson Deal Too Many, Business Week, June 2, 2008, http://www.businessweek.com/bwdaily/dnflash/content/jun2008/ db2008062_952319.htm

[9] Ben Steverman, Citi, Wells Fargo: Why the Wachovia Fight?, Business Week, Oct. 3, 2008, http://www.businessweek.com/investor/content/oct2008/ pi2008103_092589.htm

[10] Id.

[11] Id.

[12] Id.

[13] Id.

[14] Id.

[15] Press Release, Wells Fargo, Wells Fargo's Merger with Wachovia to Proceed as Whole Company Transaction with all of Wachovia's Banking Operations (Oct. 9, 2008).

[16] Steverman, supra note 9.

[17] Id.

[18] Press Release, Wells Fargo, supra note 15.

[19] Id.("The combined company will have $787 billion in deposits . . . [and] will be #1 in deposit market share in 17 of its 39 community banking states.") See also Press Release, JPMorgan, JPMorgan Chase Acquires the Deposits, Assets, and Certain Liabilities of Washington Mutual's Banking Operations (Sept. 25, 2008). JPMorgan's acquisition of WaMu has created the largest U.S. depository institution as JPMorgan now obtains over $900 billion of customer deposits. Id.

[20] Steverman, supra note 9.

[21] Press Release, JPMorgan, supra note 19; Collapse of WaMu, supra note 3.

[22] Id.

[23] Press Release, Wells Fargo, supra note 15.

[24] Press Release, JPMorgan, supra note 19.

[25] Collapse of WaMu, supra note 3.

[26] Press Release, JPMorgan, supra note 19.

[27] Foust, supra note 8.

[28] Steverman, supra note 9.

[29] Press Release, JPMorgan, supra note 19.

[30] Steverman, supra note 9.

[31] Kelli B. Grant, What Bank Acquisitions Mean for Customers,Smart Money, Sept. 26, 2008, http://www.smartmoney.com/deal-of-the-day/index.cfm?story=What-Bank-Acquisitions-Mean-For-Customers-.

[32] Remaking of the Banking Landscape Might Mean Higher Fees for Consumers,Boston Globe, Oct. 1, 2008, http://www.boston.com/business/personalfinance/articles/2008/10/01/ remaking_of_the_banking_landscape_might_mean_higher_fees_ for_consumers/,

Comments

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[Rachael]

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[Mergers and Acquisitions Attorney]

Marta, you did a very nice job summarizing the facts and identifying the issues. I would, however, like to challenge one of your conclusions, that "Federal regulators seem to be ignoring antitrust rules."

Although these mega bank mergers certainly increase concentration in the banking industry, the banking industry in the United States is spread among many more large banks than you find in most other countries. Even after these mergers, there are many large banks and there is a great deal of competition among them.

Furthermore, from the standpoint of the average individual or small business, the competition is not just the large money center banks but also the regional and local banks.

While I suspect that bank fees will continue to rise, I think that it will be for the same reasons that banks have been able to increase fees in a more competitive environment - most consumers will grumble about the fees but not change banks over them. Until the banks feel that raising the fees is costing them good customers, they will undoubtedly continue to push fees higher.

[Josh Neumann]

I agree with your conclusions, competition is always best, and this seems like it will hurt consumers in the long run, but only time will tell.