Bank M&A May Hinge on Deposit Cap Rule

Federal lawmakers are going to need to do something soon regarding the limits on how much deposit market share banks can take, whether the caps are increased or repealed altogether.

The financial crisis has essentially crippled most major U.S. financial institutions, moving regulators at times to encourage, with the help of federal assistance in some cases, healthier banks to acquire weaker ones.

But laws setting a 10% cap on overall U.S. deposits could stymie further acquisitions for the three largest banks: Bank of America ( BAC), JPMorgan Chase ( JPM) and Wells Fargo ( WFC). Until something is done about the deposit cap, these banks, all of which have recently made significant acquisitions, may not be able to do further opportunistic deals for some time, analysts say.

The moves could leave open potential targets for Goldman Sachs ( GS) and Morgan Stanley ( MS), both of which recently became bank holding companies and have publicly said that they are looking to garner deposits either organically or via acquisitions.

"Now that you have several banks approaching that 10% limit, my guess is they will lobby to make that change," says Mark Fitzgibbon, the director of research at Sandler O'Neill & Partners. Lawmakers will likely bump up the maximum national deposit share to 12% or 15% of total deposits, giving "plenty of breathing room for all the major players," he says.

Until recently, BofA was really the only U.S. bank in danger of hitting the maximum deposit caps, especially after it acquired LaSalle Bank last year.

But in the past two months alone, three large banks acquired weaker banks at the behest of regulators. In September, JPMorgan Chase acquired Washington Mutual, after regulators seized what was the nation's largest thrift. Wells Fargo stepped in last month to seal a deal for Wachovia ( WB), besting a Citigroup ( C) offer that included federal assistance.

And while not technically a bank, Merrill Lynch ( MER) in September agreed to sell itself to BofA. The brokerage firm has several bank subsidiaries underneath it.

Observers expect more M&A in the sector since several dozen large and regional banks have received investments through the $700 billion Troubled Asset Relief Program, or TARP, approved by Congress last month. The $250 billion in preferred equity stakes the government intends to make are aimed at fostering lending, but will no doubt lead to more acquisitions. Indeed, PNC Financial Services ( PNC) last month agreed to purchase National City ( NCC) after announcing it had accepted a $7.7 billion investment.

"The government doesn't want to ultimately be in a position where it can't encourage two large banks to get together because of this cap," Fitzgibbon says.

In 1994, Congress enacted the Riegle-Neal Interstate Banking and Branching Efficiency Act, which amended the Bank Holding Company Act of 1956, to allow for banks to do business in multiple states under one national charter. As part of the law, banks were restricted to owning a maximum of 10% of deposits nationwide and 30% within states via an acquisition.

Regulators, at the time, were fearful that some banks could impose "undue financial power nationwide" or grow so large "that their failure could threaten the financial system and in turn, the economy as a whole," if there were no restrictions on deposits, according to a 2006 research paper by Robert Litan, who was at the time at the predecessor to what is now called the AEI Center for Regulatory and Market Studies.

Litan, now a vice president for research and policy at the Kauffman Foundation and a senior fellow in economic studies at the Brookings Institution, argued in the paper that the cap should be lifted. In a brief email response to TheStreet.com last week, he said he "still thinks" doing away with the caps makes sense, since federal antitrust laws allow regulators to move against a bank that is growing too large.

To be sure, there are loopholes in the law, allowing for banks to circumvent the rules.

Banks are allowed to be above the 10% cap if the deposits are grown "organically" instead of through acquisitions. Banks can also technically be above the deposit cap if they acquire deposits from a financial company that is not a bank holding company, such as a savings and loan association or thrift, credit unions, or other more obscure institutions, such as an industrial loan company. The law does not count deposits from these institutions as part of the caps on banks.

Additionally, banks can exceed the threshold if the acquisition was of a bank in default, or in danger of default, or where the government assistance was provided.

BofA's deposit market share would have been 11.89% of the more than $7 trillion in U.S. deposits at the end of the second quarter, if deposits from both Countrywide Financial and Merrill Lynch are included, according to Highline Financial data analyzed by TheStreet.com.

But Countrywide's deposits are housed in the firm's thrift subsidiary, while Merrill Lynch's roughly $100 billion in deposits as of June 30 were in both thrift and industrial loan company units, so they didn't bring the bank's total deposits above the 10% limit. Even without the acquisitions, however, BofA was hovering at 9% of total U.S. deposits.

Wells Fargo is also close the limit. According to a Federal Reserve statement late last month approving Wells Fargo's merger with Wachovia, the San Francisco-based bank "would not control an amount of deposits that would exceed that nationwide deposit cap on consummation of the proposal."

As of the end of September, the San Francisco-based bank said it would own a combined $731 billion of deposits from the deal, or 9.9% of total domestic deposits, according to initial Fed deposit estimates for the third quarter.

Wells agreed that it "would not exceed the nationwide deposit cap" at the time the deal is completed, the statement said. "This commitment includes a commitment that Wells Fargo will reduce its deposits by any amount that exceeds the national deposit cap" by no later than Dec. 31, it added.

A Wells Fargo spokeswoman declined to comment further for the story.

Scott Siefers, an analyst at Sandler O'Neill & Partners, says banks typically sell branches and the deposits that go with them or initiate pricing changes, such as lowering the interest rates on certificate of deposits, to gradually "run off" deposits.

"At Wachovia and Wells they've got overlap in Texas and California, so you could just sell some deposits with branches," he says.

JPMorgan Chase may take advantage of the law's loopholes if it does another bank acquisition. With the addition of WaMu, the New York bank's deposit share is 9%, according to Fox Pitt Kelton Caronia Cochran Waller analyst David Trone.

After speaking with the company's CFO Michael Cavanaugh, Trone believes the bank wants to do another deal by the end of the year. JPMorgan Chase is interested in targets primarily in the Southeast, but also New England and the Midwest, he writes in a note last week.

But at 9% deposit market share, JPMorgan Chase could only take on another roughly $75 billion in deposits, meaning smaller outfits like Synovus ( SNV), First Horizon ( FHN) or Colonial Bancorp ( CNB), Trone writes.

But WaMu's status as a thrift will likely allow for JPMorgan Chase to scoot around the limit. The New York bank, which is still digesting its takeover of Bear Stearns from this spring, paid the Federal Deposit Insurance Corp. just $1.9 billion for WaMu's deposits, branches and select assets.

Excluding WaMu's deposits, JPMorgan Chase's deposit market share is 6.4%, allowing the company to acquire another $263 billion of deposits before hitting the cap, Trone writes. That includes target companies like Regions Financial ( RF), SunTrust Banks ( STI) or BB&T ( BBT) -- each of which would provide "substantial presence" in the South, Trone writes.

In the Midwest, JPMorgan has a bit more flexibility to do acquisitions without exceeding the deposit cap through targets such as KeyCorp ( KEY), Fifth Third ( FITB), Marshall & Ilsley ( MI), Comerica ( CMA) or Huntington Bancshares ( HBAN), he writes.

A bank spokesman declined to comment regarding deposit cap information or further acquisitions.

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