Finding Morgan Stanley's Suitor

The dismal performance on Wednesday of our country's two largest independent investment banks has resulted in rampant speculation that these banks will be forced to merge with a traditional commercial bank in order to get access to the commercial bank’s large deposit base.  Such an action would allow Goldman Sachs (GS) and Morgan Stanley (MS) to dramatically reduce the liquidity issues that are inherently tied to short term financing, which is at the core of their business model.  When looking at possible suitors it is important to understand that the commercial bank must have not only a significant deposit base but a strong capital position as well.  The market has driven down the market caps of the vast majority of publicly traded commercial banks because of the possibility that their capital positions have been impacted by non-performing loans.  The reduced market capitalization of our country’s commercial banks make it much harder for either of these two investment banks to get a deal done.

Given Morgan Stanley’s $25B dollar market cap and Goldman Sachs $42B dollar market cap any deal would dramatically reduce the ownership stake of a commercial banks current shareholders.  Their sheer size dramatically limits the number of commercial banks capable of completing any deal and likely means that in order to survive these two investment banks will have to race against each other in an effort to tie the knot with whoever will take them.  Should one of the investment banks merge it will likely lead to the other’s demise, as it will likely be unable to withstand the relentless market speculation against it.  Below I have summarized the deposits and capital ratios of the ten largest U.S. commercial banks as well as the five largest Canadian commercial banks, they are listed from largest market capitalization to smallest.  

US Banks
Bank	Market Cap	Deposits	Tier 1 Capital Ratio
Bank of America	$124.0B	$786B	8.25%
JPMorgan Chase & Co.	$122.3B	$722B	9.20%
Wells Fargo & Co.	$110.6B	$310B	8.24%
Citigroup	$76.4B	$803B	8.74%
U.S. Bancorp	$58.1B	$135B	8.50%
The Bank of New York Mellon	$37.9B	$127B	9.33%
PNC Financial Services	$24.9B	$84B	8.20%
Wachovia Corp.	$19.5B	$447B	8.00%
BB&T Corp.	$19.4B	$88B	8.90%
SunTrust Banks	$16.8B	$81B	7.47%
Canadian Banks
Bank	Market Cap	Deposits	Tier 1 Capital Ratio
Royal Bank of Canada	$55.0B	$409B	9.50%
Toronto-Dominion Bank	$43.1B	$354B	9.50%
The Bank of Nova Scotia	$40.1B	$332B	9.80%
Bank of Montreal	$21.3B	$248B	9.90%
Canadian Imperial Bank	$19.8B	$228B	9.80%

 

Yesterday, I talked a little bit about the lack of regulation in the financial markets and it is interesting to see how well the Canadian banks have done despite having to operate under what some would call "excessive" regulation.  Continuing though with today's article you can see from the information above that there are maybe five U.S. and five Canadian commercial banks capable of taking on the balance sheet that would come with the merger between any one of the respective commercial banks and Goldman Sachs or Morgan Stanley.  I have removed any possible European suitors due to their incredibly low capital ratios and the possibility of any Asian suitors because of almost certain objection by government regulators. 

In looking at the likely domestic purchasers, we see that Bank of America, JPMorgan, Wells Fargo, Citigroup & Wachovia all have the balance sheets to get the deal done.  However, on closer examination we can throw out nearly all of them.  Bank of America’s recent deal with Merrill Lynch almost certainly removes it from the hunt, while Citigroup’s massive exposure to hard to value securities likely would force regulators to block the deal as it would only add lighter fluid to the bonfire that is already raging in Citigroup’s books. The bad loans at Wachovia that are related to the company’s most recent California acquisition will also likely remove it from the hunt for much the same reason that Citigroup will not be participating.  Wells Fargo, despite holding up fairly well during the recent credit crunch has the lowest Tier 1 capital ratio of any of the large commercial banks and I doubt that the Federal Reserve and the Treasury will want to waste Wells Fargo’s balance sheet on an investment bank when they will likely need it to help clean up the mess in California.  I will not be surprised at all to see Wells Fargo grow its presence significantly in the West as a result of the Federal Reserve’s near incessant requests for it to absorb failed California, Nevada and Arizona based banks.

This leaves JPMorgan as the only U.S. domiciled commercial bank with the ability to purchase either Morgan Stanley or Goldman Sachs.  While I fully realize that JPMorgan has already absorbed Bear Stearns this year, it would not surprise me at all to see the authorities overlook anti-trust concerns in order to ensure market stability.  If given the choice to choose between Goldman Sachs and Morgan Stanley we should not be surprised to see Jamie Dimon reunite the House of Morgan.  In doing so he will have prepared JPMorgan to battle Bank of America for financial supremacy in America over the course of the coming decades. 

Should Morgan Stanley merge with JPMorgan, Goldman Sachs would be left to the whims of the market and I doubt that their alleged ability to master any type of market environment will hold true forever.  With the volatility of the financial markets, it is not a question of whether or not they will make a mistake but when and when they do the bears will be waiting to mull the company’s stock.  Goldman Sach’s management team needs to realize that they must be attached to a depositary institution, as it is the only way to assure their survival in the current market environment.

As seen above there are five Canadian commercial banks with balance sheets and a deposit bases that are capable of absorbing Goldman Sachs.  Unfortunately, only two of the five have truly global aspirations and as a result, these are likely the only two that would even consider a Goldman Sachs deal.  They are the Bank of Nova Scotia and Toronto-Dominion Bank, both of these company’s have shown an aggressive drive to expand overseas and an acquisition of Goldman Sachs would move either of them definitively into the ranks of the global money center banks.  The Bank of Nova Scotia has a strong international business with branches in the Caribbean, Mexico, Central America, Latin America and Asia while Toronto-Dominion Bank has been aggressively expanding into the U.S., most recently with the purchase of Commerce Bancorp. The major trouble with a cross boarder deal is the additional regulatory bodies that will have to approve the merger and it is doubtful that the Canadian government will want to sacrifice its near impeccable banking institutions just to help the United States out of its own self-inflicted wounds.

As a result of capital base, depositary and regulatory limitations it is likely that JPMorgan is the only large commercial bank capable rescuing either of the two large remaining investment banks via a merger.  Therefore, it is without any real doubt in my mind that both Morgan Stanley and Goldman Sachs should be running into Jamie Dimon’s arms as his bank offers the only chance that these two banks have to preserve significant shareholder value.  Goldman Sachs reluctance will ultimately lead to its demise, as there will be no one left to save the firm should the Canadians be unwilling to sacrifice their institutions for ours.  Such a merger would not be seen as a sign of failure as both investment banks have done a fairly good job of navigating the credit crunch but rather the result of a changing world that has made it inconceivable to fund one's operations through constant involvement in the credit market.

Disclosure: None