The local president of Milwaukee-based M&I Bank, Reagan Rick, got the shocking news while waiting for a plane at Boston Logan International Airport.
It came in a text message from Robert Warrington, the former CEO of First Indiana Bank, the Indianapolis bank M&I acquired last year for $529 million. Warrington told him 85-year-old New York-based investment bank Bear Stearns Cos. had been sold to JP Morgan Chase Co.-with backing from the Federal Reserve-for a mere $2 per share.
“The degree of the fall was very surprising,” Rick said.
Just weeks earlier, Bear had traded for more than $150 per share and had been valued at $20 billion. But the firm’s heavy exposure to subprime mortgages and its risky 30-to-1 debt leverage gradually eroded investor confidence, result- ing in an unprecedented run on the bank.
Local bankers say a similar meltdown at commercial banks is unlikely, but they do expect some prominent names in the business might not survive another year. Ironically, JP Morgan also is rumored to be a potential buyer of two Cleveland-based banks, National City and KeyBank. Observers hope a bottom is near for the financial industry, but most believe the carnage could get worse.
For Bear Stearns, it was a lack of liquidity and the prospect of bankruptcy that forced a bargain-basement fire sale, evaporating billions of dollars in value for shareholders and thousands of employees.
To put the deal in perspective, it cost JP Morgan about half as much to acquire Bear Stearns as M&I paid for First Indiana.
“JP Morgan got a great deal,” said Gary Hentschel, Key Bank’s central Indiana president. “That’s a fine firm, with a lot of intellectual capital and a strong reputation. I’m surprised at the ability of JP Morgan to get that deal done at such an attractive price.”
How did they do it? Lenders lost confidence in Bear, and the ensuing panic eroded its liquidity.
But don’t expect a similar, “It’s a Wonderful Life”-style run on commercial banks, Hentschel said. Depositors are insured up to $100,000 by the FDIC. And the Federal Reserve wouldn’t let that happen at a large commercial bank.
Most commercial banks have assets with less risk, but that doesn’t mean all of them are avoiding trouble.
National City, a bank with heavy exposure to subprime mortgages, reportedly has put itself up for sale. The timing couldn’t be much worse: The bank’s shares lost about 40 percent of their value immediately after the Bear Stearns deal amid fears that National City also is worth much less in today’s market.
National City is the second-largest bank in the Indianapolis area in terms of employment, according to IBJ’s most recent ranking (see page 20A).
Hentschel expects merger-and-acquisition activity to pick up later this year as banks look for opportunities to take advantage of the turmoil. KeyBank, for instance, has been heavily promoting its certificates of deposit to capitalize on market turmoil and build funds to fuel growth.
At the end of the day, the strong will survive, he said.
“I don’t think anyone can say this is a low point, with any huge confidence,” Hentschel said. “This is borderline unprecedented, to have this kind of liquidity crisis hitting so many debt markets at the same time. It is without question uncharted territory.”
The downfall of Bear Stearns has added to an already heightened sense of risk aversion, said Morris Maurer, CEO of the National Bank of Indianapolis, the city’s largest locally based bank.
“The market has a very clear way of separating what they believe to be higherrisk from lower-risk institutions,” Maurer said. “This was the marketplace acting on Bear Stearns. It was judged practically overnight by the markets to be high-risk. Now I think the market is searching for other weak players with high leverage and a high degree of risk.”
The implosion of Bear is a stern reminder for financial companies to stick to a business plan and avoid reaching for earnings. National Bank of Indianapolis, for one, avoided subprime loans and riskier derivative investments, Maurer said. That caution helped the bank report record earnings of $8.9 million in 2007, while plenty of other banks struggled.
Bear Stearns is a sad story, particularly for such a storied name in the investment banking world, said Bob Jones, CEO of Evansville-based Old National Bancorp. But the bottom line is the firm’s downfall is part of an economic cycle that eventually will take a turn for the better.
“Clearly, there’s more pain ahead,” Jones said. “I don’t think it’s as catastrophic as some are making it out in the media. The mortgage issue is not completely resolved. Hopefully, we’re close to the bottom.”
John Reed, a banking analyst and executive vice president of Chicago-based investment firm David A. Noyes & Co., isn’t so sure the bottom is near.
The shocking news keeps coming, and there are more problems to unravel.
“We have a scary economy,” Reed said. “We still have a whole lot of people who are 100-plus-percent mortgaged, and we still have another year or two of falling housing prices. That’s before we talk about home-equity loans, credit cards and commercial lending. That’s a huge problem.”
History could view the Bear Stearns collapse as the bottom, or just the beginning.
“I hope this is the worst we see, as compared to all the dismal things yet to occur,” Reed said. “We’re somewhere on the down slope.”
Rick, the local president for M&I, said he believes M&I got a better deal than JP Morgan. The market’s unrest offers an opportunity for M&I, since the bank has a large capital position to shield it from risks other banks are facing, he said.
“M&I is not going to fail, period,” Rick said. “There’s no lack of confidence here.”