By Michael Rudnick for The Deal Magazine
William Isaac, 66, who sat squarely in the eye of the savings and loan storm as chairman of the Federal Deposit Insurance Corp. from 1981 to 1985, observed the most recent meltdown from a more comfortable perch as chairman of financial services consulting firm LECG Global Financial Services. He also assumed the role of chairman of Fifth Third Bancorp earlier this year.Isaac is not shy about espousing his views on how little regulatory reform would have done to prevent the recent crisis and “has not done anything material to prevent the next one.” He argues that reform will hurt an already fragile network of community banks by robbing them of their ability to use trust preferred stock to bolster capital levels and burden them with additional compliance costs.
“An important force behind consolidation in the past has been that the largest banks have had lower capital requirements than the medium-size and smaller banks,” he says. “Regulators allowed the large banks to go out and issue all sorts of quasi capital, but they let them reduce their tangible equity to around the 3% range.”
Larger banks could then take aim at smaller brethren because they could “go in and buy that bank and cut in half the amount of capital they have to maintain on those assets,” he says. This consolidation driver may disappear under the Basel III regulatory regime, which is going to be “much more heavily focused on tangible equity [across the banking spectrum].
“If they do equalize the capital requirements between large and small banks … that will argue for a slower pace of consolidation, because you’ve removed a huge incentive that was facilitating consolidation — get bigger and you need less capital,” Isaac says, adding, “I think that to the extent the regulators reduce the disparity between the large and the small banks makes it less appetizing for them to take on acquisitions.”
While a balancing-out of capital requirements may decelerate top-tier banks’ acquisitive strategies, the cost and compliance burden on smaller banks “that do not have vast teams of lawyers and compliance systems and do not have millions of customer transactions to spread those costs over” may incentivize them to sell, he says. Smaller banks may find it more difficult to survive with the removal of trust preferred shares as a source of new capital, which he says “was a principal method” of fundraising.
A dearth of top-tier buyers and a wealth of lower-tier sellers suggests the likelihood of “more mergers of equals [among regional and community banks] than straight-out acquisitions,” he says.
“When you add all this up, I believe that the very largest banks are not going to be allowed to get larger, relatively speaking,” he says. “We have five banks that have more than 50% of the banking system [assets]. I believe that the powers that be in Washington are not going to want to see that number get any bigger.”
Meanwhile, he says, “we are going to see fewer and fewer banks at the smaller end of the range [under $1 billion assets], so if we have about 6,000 banks today, maybe in six or seven years it’s 4,000.”
This shrinkage at the top and bottom “suggests that those in the middle are going to be increasing their share of the banking pie,” he says, specifically referring to large regional and super-regional banks.
Community and regional bank numbers have been reduced over the past two years due to roughly 270 failures.
“If we don’t turn down into a double-dip recession, the FDIC [failed-bank sales] should begin to dwindle over the next six months,” he says.
Bank failures generally lag behind a recession by about 18 months. “The experts are saying the recession ended around June or July a year ago. If that’s the case and if we don’t dip back into another one, failures should level off and start to head down in the late part of this year or early next year.”
Original Article Located Here.