Strong getting stronger as weak players fall

ANALYSIS:Amid the turmoil, larger banks are consolidating their market share, writes Arthur Beesleyon Wall Street

CAST-IRON grating covers the windows of the Federal Reserve Bank of New York, a fortress-like structure just around the corner from Wall Street. The New York Fed is regulator of numerous institutions here and its imposing headquarters typically stands amid the noisy grind of commerce as a beacon of stability and security. But there hasn't been much of that lately.

As the landscape of the financial world changes by the day, the turmoil on Wall Street has seeped into the wider American economy and spread like a plague across the Atlantic.

Almost a month since the rescue of Fannie Mae and Freddie Mac led to the eruption of full-blown crisis in the financial system, a return to calmer conditions still seems far off.

Although the political system in Washington has been in a funk over an on-again, off-again $700 billion bailout package, the programme itself is not seen as a panacea to the disruption. Many banks remain in jeopardy. The bailout is important for confidence, say market participants, but it will take years before toxic illiquid assets are fully cleared from bank balance sheets.

"I don't think we're out of the woods by any means even if this rescue package passes," says John Carey, an executive vice-president and portfolio manager in the Boston office of asset management firm Pioneer.

"It's probably a positive for the most part, but you still have to have confidence come back to the market, you have to have economic activity perk up and you have to have employment rise again."

These have been days of catastrophic loss for many, but there have been winners on a grand scale too. This is most particularly so in the case of those big banks to the fore in rescue efforts as weak institutions fall by the way.

For now at least, JPMorgan Chase, Bank of America and Citigroup stand as the prime beneficiaries. The "big three" in US banking held 21.4 per cent of all deposits at the start of this year. Now, after a rush of rescue deals, they collectively hold more than 31 per cent.

JPMorgan acquired savings and loan giant Washington Mutual (WaMu) last week in a government-assisted deal, a transaction that followed swiftly on the heels of its rescue of Bear Stearns last March.

Bank of America ran to the rescue of Merrill Lynch, adding a big investment banking arm to a colossal retail banking franchise.

Citigroup prevailed on Monday in the race for Wachovia, taking over the sixth-largest US lender by assets.

"One of the major aspects of valuing a company is the competitive landscape in which it operates. So, at least in the financial area in this country, when weak players are eliminated, stronger players are in a significantly stronger position," says Mark Chemtob, a senior adviser with Ameriprise, a financial services group which targets the affluent and the "mass affluent".

The gathering strength of the big three and the disappearance of so many rival institutions is such that their power to set prices for loans and services has increased greatly. That, in turn, might force yet more mid-sized and smaller players into the arms of larger banks. Even if those smaller players stand free of contamination from subprime-linked assets, the combination of housing slump, bearish equity markets and frozen money markets makes matters worse for them.

Bargain-basement price tags on rescue deals reflect the risk inherent in the toxic debt at the epicentre of the shake-out. In addition, the likelihood of further bank failures in a hugely fragmented industry suggests there will be more pickings for institutions with strong balance sheets and a stomach for additional risk. "It does seem to be the case that the larger, better-heeled companies are able to take advantage of the situation and acquire weaker competitors and consolidate market share," says Carey of Pioneer.

"We've seen the Federal Reserve - and the treasury for that matter - both help out with some of the large acquisitions that have been made so far. There may be room for a few more companies. I'm not sure that JPMorgan and Citicorp and the others tapped so far can do everything. So it may be that some other companies also get opportunities to acquire weaker competitors and consolidate market share."

Possible candidates in that scenario, Carey says, include Minneapolis institution US Bancorp, Pittsburgh bank PNC Financial Services and Wells Fargo of San Francisco.

Indeed, Wells Fargo took a serious look at Wachovia last weekend after investors took fright over its real estate exposure. That investment bank Morgan Stanley was in advanced merger discussions with Wachovia only days previously illustrates the speed at which the market moves from bank to bank in the search for the next weakest link.

Investors are highly strung as a result, says an Irish banker who works in wealth management for a big international institution.

"We were getting to a point - we call it capitulation - where Mrs Smith might decide to sell everything. We're not there yet."

If the implication here is that such a moment might yet be reached, he says those with skin still in the game see plenty of opportunity in the mayhem.

Cue Warren Buffett. After extracting onerous terms last week when injecting $5 billion into Goldman Sachs, his $3 billion infusion to General Electric two days ago came with similarly tough trappings. In difficult times, Buffett's seal of approval doesn't come cheaply - hence the generous dividends on his preference shares.

If all that underscores the legendary prowess of the Sage of Omaha, consider the plight of billionaire investor David Bonderman. Best known in Ireland as chairman of Ryanair, his private equity firm Texas Pacific put no less than $7 billion into Washington Mutual (WaMu) last April. This investment was completely wiped out last week when the Federal authorities seized WaMu last week before selling it on to JPMorgan. It is a given, of course, that Mr Bonderman is not the only loser of scale in these markets.

In the background - at least for the moment - stand Goldman and Morgan Stanley. The latter this week completed the sale of a 21 per cent stake in its business to Japanese group Mitsubishi UFJ Financial.

Having changed stripes to become bank holding companies, the last remaining independent investment banks on Wall Street are now empowered to take customer deposits or acquire deposit-takers. Action might be expected soon from these quarters, given that new regulatory constraints will curtail their ability to generate profits by borrowing heavily on the money markets.

Although Mitsubishi's intervention indicates an appetite abroad for an illustrious chunk of American banking, the lustre of the sector at large has been badly tarnished by recent events. Amid fear, distrust and despair on Wall Street, nervousness pervades.