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Title: Organizational Stripping and Reassembly is Also Financial Engineering: Stockholder Value Can be Crea


1
Organizational Stripping and Reassembly is Also
Financial Engineering Stockholder Value Can be
Created by Overcoming Regulatory Burdens and
Charter LimitationsSIVs exemplify the
Re-Engineering of a Firms Corporate Structure
and/or Its Contracting Technology
Week 07-0910
2
TYPICAL STRUCTURE OF AN SIV
ASSETS
AAA tranche
Junior tranche
Z tranche
Hedges
3
Exercise
  • According to Wikipedia, Structured Investment
    Vehicles (SIVs) are usually sponsored by either
    an investment company or a bank. SIVs describe
    themselves as credit arbitrage funds that make
    profits from the difference between short-term
    borrowing rates on commercial paper and long-term
    returns on corporate and mortgage-backed debt.
  • SIVs show at least three tiers of liabilities a
    AAA-rated senior collateralized commercial-paper
    tranche a low-rated or unrated junior tranche
    and an equity or Z tranche. Typically, SIV
    assets are medium-term asset-backed securities
    whose maturity runs between 4 and 5 years.
    Assume that in February 2007 the ratio between
    the market value of The Eagle SIVs assets (A)
    and the value of its Z tranche (N) is 10 and the
    cost of equity is 15 percent. Suppose that the
    SIVs assets are 3.5-year bullet notes whose
    value is 100 million and whose yield is 5.5
    percent and that its liabilities consist of
    junior and senior tranches of single-payment,
    asset-backed commercial paper that mature in 6
    months.

4
Exercise
  • Find the value of L/N, and the duration and pvbp
    of the SIVs equity tranche.
  • L/N 9
  • DN 10(3.5) 9(1/2)
  • 35 4.5 30.5 years
  • pvbp(N) -(30.5/1.15) (10m) (.0001)
    -26,521.73

5
Exercise
  • (b) Is it reasonable to describe this firms
    strategy as arbitraging the yield curve? Please
    explain why or why not.
  • No, it is not. Eagle is highly exposed to
    interest-rate risk and possibly to default risk
    as well. Leverage produces high returns on this
    strategy when interest rates are stable or
    falling. But when asset values decline, leverage
    works adversely and equity can be quickly
    exhausted.

6
Exercise
  • Suppose, to hedge its exposure to interest-rate
    risk, Eagles managers use a single interest-rate
    swap whose pvbp in February 2007 is equal in
    value but opposite in sign to the pvbp of its
    equity position. Suppose further that 7 percent
    of Eagles assets deserve to be written off as
    uncollectable and that the interest rate on
    Eagles assets had increased by 50 basis points
    by the time Eagle had to roll over its
    liabilities in August 2007. Explain whether and
    how the SIVs losses on its assets might have
    blown through the hedge, ruined the ratings of
    its senior debt, and put pressure on its sponsor
    not to walk away.
  • The assets are now 3-year bullet notes promising
    (.93)x120.61 million in 3 years. At the new
    yields, Eagles assets are worth only
  • 112.17 mil./(1.06)-cubed 94.18 mil.
  • If it were not for the hedge, the equity hedge
    would have lost more than half of its value. But
    the hedge is far from perfect. It did not cover
    default risk and such a large movement in asset
    yields makes probable differences in convexity
    between the swap and equity positions very
    important. Whenever insolvency exists or
    threatens, its sponsor would feel pressure to
    support the fund both for reputational reasons in
    a repeat business and because implicit or
    explicit recourse arrangements might force the
    assets and the losses imbedded in the Z position
    back onto the sponsors balance sheet.

7
MEGACEPTS AND MEGATHEMES
  • 1. Differences in Ownership Structures alter
    owners responsibility for losses corporations,
    partnerships, sole proprietorships, holding
    companies.
  • 2. Importance of Choosing the Right Charter
    Charter is a legal document authorizing specific
    rights and functions.
  • a. Stock vs. Mutual vs. Partnership Form
  • b. Alternative Charter Issuers State (which
    state?) vs. Federal vs. Foreign (which
    country?)
  • c. Charter type Com. Bank vs. thrift vs.
    industrial loan co. vs. credit union vs.
    securities firm vs. Insurance Co., etc.
  • 3. Regulators Compete for Jurisdiction This
    explains why U.S. fin. system is so messy. Leads
    to Loopholes and Regulatory Migration in response
    to differences in net regulatory benefits.
  • 4. Managerial searches for Value-Creating Teamups
    and Consolidations Are Always in the Background.

8
Why Do FSFs Let Themselves Be Regulated?
  • 1. Regulatory services can produce benefits for
    society and private benefits for regulatees.
  • 2. But who watches the watchdogs? Layers of
    conflict of interest exist for regulators These
    result in either partial or total regulatory
    capture.
  • 3. Etymology REGULA (latin for rules)
    Distinction between rulemaking and enforcement.
    Example of Montana enforcement of 55 mph limit.
  • a. Different rewards accrue to rule-breakers
    and to those who conform.
  • b. Enforcement uses both carrots and sticks.
  • 4. Metaphor FSF safety regulations share
    entailments with traffic safety.
  • a. stop signs (e.g., CD orders)
  • b. speed limits (caps on activities)
  • c. one-way street restrictions (exclusionary
    rules)
  • d. radar guns vs. radar detectors (resistance
    to transparency)
  • e. traffic courts (due-process guarantees)
  • f. Risk-rated insurance premiums
  • 5. Different Incentives for Private vs.
    Government Regulators Self-Regulatory
    Organizations.
  • 6. Role of Regulatory Culture.

9
Definition of Financial Regulation
  • Purposeful efforts to monitor, discipline, and
    coordinate the behavior of individual firms in
    the financial-services industry to generate
    social and private value by promoting specific
    macroeconomic and microeconomic goals.
  • Microeconomically, the socially approved purposes
    are to increase FSF-customer confidence and
    convenience. A socially unpopular purpose is to
    insulate banks from competition to some degree.
  • Overtly, regulators seek financial-stability
    missions, but covertly also seek jurisdiction and
    prestige.
  • Internationally, regulators help their regulatees
    compete more effectively against differently
    regulated foreign and domestic firms.

10
Regulatory Competition
  • Regulators compete whenever their jurisdictions
    overlap or when they proffer chartering
    relationships that differently chartered FSFs
    may choose among. In negotiating a contract
    with a government regulation supplier, exchanges
    of value take place as repeat business in markets
    for political and bureaucratic services that are
    imperfectly competitive and dysfunctional in the
    discipline they generate.
  • Why and how dysfunctional? -- Regulatory agencies
    resist their exit even when exit might be
    efficient. Top regulators are made to pay a
    price if they weaken their clientele often they
    become cheerleaders and seek post-government
    careers in the regulated industry.
  • Promontory is a shining example of
    loophole-exploiting postgovernment career
    opportunities. Top managers are an ex-Comptroller
    of the Currency and an ex-Fed Governor.

11
Six Elements Define a Regulatory Culture and Vary
Across Jurisdictions
  • -- Legal Authority and Reporting Obligations
  • - Formulation and Promulgation of Specific Rules
  • -- Technology Used to Monitor for Violations and
    Compliance
  • -- Penalties for Proven and Material Violations
  • -- Duties of Client Consultation and
    Administrative Due Process, with Assigned Burdens
    of Proof (to Guarantee Fairness)
  • - Right to Invoke Outside Judicial Review
    Appeals Procedures (to bond the fairness
    guarantee)

12
Avoiding vs. Evading Rules
  • Legalistic elements imbedded in a countrys
    regulatory culture both empower and limit
    avoidance.
  • We may illustrate this by drawing an analogy to
    filling out ones tax return optimally. Avoidance
    activities and their control are restrained by
    TAX LAW (which specifies rules and penalties) TAX
    AUDITS (monitoring), INTEREST AND OTHER PENALTIES
    (imposed by auditors), ADMINISTRATIVE APPEAL
    RIGHTS (within the IRS), TAX COURT (which exists
    to handle first stages of outside appeals).
  • Evasion is illegal avoidance of burdens of rules.
    Distinction between avoidance and evasion is
    jesuitical. It turns on whether the letter of the
    law is obeyed while its spirit is broken and on
    the size and likelihood of penalties imposed on
    violators.

13
THE HOLDING COMPANY (HC) AS AN AVOIDANCE
PLATFORM
  • Definition of an HC A corporation that owns
    enough of at least one other corporation to
    control it. May even be a shell corporation
    that does no other business. A shell is a hard
    outer case or covering. A shell corporation
    serves only to layer or mask a corporations
    ownership.
  • 1. Every HC must have at least one subsidiary
    corporation (sub), but it may have many.
  • 2. Queries What is a holding-company
    subsidiary? an affiliate? a consolidated income
    statement or balance sheet? (Be sure that you can
    show the difference on an Organization Chart.)
  • 3. Metaphoric use is made of language of the
    human family parents, progeny, siblings. CARTOON
    scolding of a subs board members by CEO.
  • 4. What is meant by upstreaming and
    downstreaming funds within a HC? What would
    sidestreaming describe?

14
What is a bank holding company (BHC)?
  • - A corporation that owns a bank as the
    quoted terms are defined in the BHC Act of 1956,
    as subsequently amended. BHCs are usually named
    after their leading bank sub. e.g., Banc One
    differed from Bank One.
  • - Subject to Evolving Affiliation and Ownership
    Restrictions. BHC and SL HC (SLHC) regulations
    differently restrict the affiliations that are
    allowed within the HC. Statutes also constrain
    what type of corporations may own or sponsor
    various types of chartered FSFs.
  • - Provided a circumventive platform through
    which banking industry could test the limits of
    geographic, capital, product-line, and ownership
    restrictions piecemeal on many fronts.

15
Financial-Engineering Origin of BHC Form
  • Initially used mainly to disguise ownership or to
    save taxes.
  • Became even more important as a way for bank
    owners to transform an FSFs offices and
    divisions into separate corporations with
    separate charters.
  • This kind of transformation can favorably affect
    FSF profit generators and profit killers.

16
It is Instructive to Compare a BHC With Each of
the Following
  • 1. A bank with nonbank subsidiaries. BHC is
    usually not itself a bank. (A national bank may
    not itself even be a BHC, but some states do
    permit the banks that they charter to become a
    BHC.
  • 2. A financial-services mall in which a
    commercial bank, brokerage firm, insurance
    company, SL, leasing-company, and sales-finance
    company have offices located around a central
    parking lot. Sources of difference
  • - common vs. diverse ownership? Idea of
    minority interests.
  • - presumption of back-office links?
  • - extent of common marketing and employee
    interchange?
  • - Do components have to be located in a single
    geographic neighborhood?
  • 3. A Japanese or European financial
    conglomerate in which individual firms own each
    other (cross-shareholding with no parent
    corporation).
  • 4. A European universal bank.

17
What is a One-Bank BHC (OBHC)?
  • 1. How might an OBHC not be a single-subsidiary
    BHC?
  • 2. How many different kinds of affiliates can an
    OBHC have? Many kinds. BHC Act largely allows the
    Federal Reserve Board to determine this. A
    secular expansion of laundry list driven by
    Regulatory Competition led to Gramm-Leach-Blilely
    Act of 1999.
  • 3. Why were OBHCs more common before 1970 than
    afterwards?

18
What is a Nonbank BHC Subsidiary?
  • Any sub that is not a bank by the definitions of
    the BHC Act e.g., a monoline credit-card bank.
  • 1. How does it differ from a subsidiary of a
    bank?
  • 2. Illustration of where subs metaphorically
    hang on the following chart

BHC Parent Corp.
Domestic Foreign NonBank Nonsecurities Subs
Bank Sub 1
Bank Sub 2
Subs operating subs - service corporation -
mortgage banking sub
Foreign Banks or Foreign Securities Subs
19
Multibank Holding Company (MHBHC) With a Lead
Bank vs. Multi-Office Banking
  • A branch office is a direct and integral
    extension of the corporation of which it is a
    part organization would have one charter and a
    consolidated balance sheet.
  • A multibank holding company differs in several
    dimensions from a bank that puts branch offices
    in exactly the same locations and premises as the
    MBHC puts its subs.
  • Which of the following items in the sub might be
    separated from or consolidated into the HC?
  • a. in management structure separate officers
    boards
  • b. in balance sheet sub net worth passes
    through via stock
  • c. in income statements key role played by
    dividends from bank(s)
  • d. in deposit-insurance coverage (per account
    name branches foreign subs)
  • e. in regulatory relationships
  • 1) parent regulated by Fed
  • 2) bank sub regulated by chartering authority
  • 3) special treatment of state-chartered member
    banks
  • 4) source-of-strength doctrine (slide 19).
  • f. in transferability of ownership branches
    cannot offer stock, but can be sold as
    units.
  • g. in managerial authority or independence FRB
    rules limit when an official may work for
    two different banks
  • h. in taxation (especially for foreign subs)

20
Legislative Chronology of Changes in Federal
Reserve Responsibilities in BHC Regulation and
Reregulation
  • 1. BHC Act of 1956 OBHC exemption (Douglas
    Amendment)
  • 2. BHC Amendments of 1970 Closed OBHC loophole
    and established BHC bank definition
  • 3. CEBA of 1987 Amended 1970 amendments.
    Importantly Revised BHC bank definition
  • 4. FIRREA of 1989 Instituted cross-guarantees
    among affiliated banks.
  • 5. FDICIA of 1991 Strengthened regulators
    rights to demand that capital be injected from
    parent BHC.
  • 6. GLBA of 1999 Authorized reciprocal entry of
    banks, securities firms, and inscos into one
    anothers signature businesses.
  • 7. Law-Making Role of the Courts Key rules are
    always challenged and litigated. Courts sometimes
    resist and sometimes legitimize
    cross-jurisdictional forays by regulatees.
  • .

21
In the Past, BHC Subsidiaries Served to
Circumvent Limitations On
  • 1. Where a bank might locate a branch office
    (say, across Massachusetts counties or across
    state lines)? Leapfrog Loophole 30-mile moves of
    headquarters after a merger represented a
    loophole for national banks and later for state
    banks in a few states.
  • 2. What activities a bank may undertake? ANS.
    Parent can deliver bank-restricted financial
    services from a nonbank sub that it operates as
    an affiliate of the bank.
  • 3. Restrictions on bank mergers? (How does an HC
    acquisition differ legally from a merger? ANS.
    Purchase of controlling position in stock vs.
    complete consolidation of both firms accounts).

22
DOUBLE-LEVERAGING
  • 1. Capital requirements initially focused only on
    how much capital a bank had to hold to support
    its risk-taking.
  • 2. The following balance sheets illustrate the
    concept of consolidated leverage
  • Bank
  • Assets 100 Deposits 80
  • Owners Equity 20
  • OBHC (parent)
  • Assets (Bank Stock) 20 BHC Debt 19
  • BHC Stock 1
  • - The banks leverage A/E is only 5 to 1, but
    the consolidated leverage of the bank and
    its parent is 100 to 1. Try to construct the
    consolidated balance sheet. What terms cancel
    out?
  • 3. What market and regulatory reactions serve to
    limit such double-leveraging?
  • 1) Market requirement for sizeable
    interest-rate premiums on BHC debt when BHC
    leverage is high. Most BHCs have lower credit
    ratings than their lead banks.
  • 2) FR regulation of consolidated entity Since
    1987, Fed has sought to enforce its twofold
    source-of-strength doctrine (1) that a BHC
    parent should infuse additional capital into
    any failing bank sub and (2) that a BHC could not
    selectively liquidate its weakest bank subs
    FRBs assertion insisted that affiliated banks
    cross-guarantee one another was eventually
    passed into law.

23
Instructive History Lesson How BHC Loopholes
Destroyed Longstanding Restrictions on Bank
Activities and Geographic Locations
  • IBBEA of 1994 and GLBA of 1999 reduced need for
    circumvention
  • Passage of this legislation resembled a pair of
    storms taking down a forest of hollowed-out
    trees Expansion of de jure powers followed prior
    de facto hollowing out of limits
  • 1. Charter shifting state vs national
    charters thrift vs. bank charters mutual
    vs. stockholder form.
  • 2. Insurance powers small-town exemption
    credit life annuities South Dakota
    loophole
  • 3. Securities Powers Starting in 1987, not
    principally engaged loophole for Section
    20 securities affiliates, was widened by an
    expanding definition of principally
  • 4. Leapfrog loophole for national-bank branches
  • 5. OBHC and Unitary SL loopholes
  • 6. Non-bank bank debanking
  • 7. Nonbranch-office geographic extension e.g.,
    Loan- Production Offices
  • 8. Shuffling bad loans across subs ahead of
    scheduled examiner visits (Butcher
    Banks)

24
MMEMONIC METAPHORS USEFUL IN UNDERSTANDING CASES
  • Medieval City Walls Fences with Gates and
    Leapfrog Opportunities
  • Laundry List
  • Fig-Leaf Outsourcing
  • Upstreaming and Downstreaming funds
  • Spinning activities out of the bank
  • Salami-slicing
  • Speed limits De Jure vs. De Facto
  • Grandfathering of privileges Underlying
    metaphor recalls exemption from literacy tests
    for voters that were introduced to exempt
    illiterate white people in the South. These rules
    allowed people to vote if their Grandfather
    could.

25
Why Change Control of a Bank or BHC?
  • Benefits that might be pursued Substitute
    Forms of Dealmaking
  • Correct Inefficiencies Joint Ventures
    Outsourcing
  • Enhance Market Power Cartel Agreements
  • Pursue Loophole Benefits Lobbying Building
    Clout Offering Bribes

26
ALTERNATIVE CONTRACTING STRUCTURES FOR
CONSOLIDATION
  • Mergers (e.g., fold target into an existing bank
    sub) vs. Direct Acquisitions of Stock
  • -- voluntary vs. supervisory
  • -- hostile vs. friendly
  • ? Terms
  • -- pay by cash vs. swap of stock vs.
    mixed

27
Stanford Weills Assembly of Citigroup
28
Why is Consolidation Happening Now and Why at
Such a Rapid Pace?
  • 1. Twofold push from (1) Too-big-to-fail and
    too-big-to-discipline adequately policy
    frameworks and (2) release of pressure against
    consolidations that past regulatory policies had
    damned up
  • 2. Twofold pull from industrys prospects for a
    different and richer (1) national and global
    competitive environment and (2) technological
    future.

29
Industry Conditions of 1940s through 1970s are
Helping to Shape Current Events
  • Regulation protected commercial banks from
    competition
  • Geographic entry barriers (McFadden Act, state
    laws).
  • Product-line entry barriers (Glass-Steagall Act,
    limited thrift powers).
  • De novo entry slowed by FRBs application of
    convenience and needs tests.
  • Deposit-rate ceilings (Regulation Q, but
    money-market mutual funds).
  • Relatively stable population of between 13,000
    and 14,000 banks
  • Most banks operating well below efficient scale.
  • Bank mergers and new entry tightly regulated.

(with thanks to Robert DeYoung of FDIC)
30
Industry Conditions 1940s through 1970s
  • Very stable demand for banking services,
    primarily due to the lack of substitute products
    and services.
  • Physical bank offices were the main portal to a
    paper-based payments system.
  • Banks were the primary source of investment
    products for households (savings accounts, time
    deposits, CDs).
  • Banks were the primary source of business
    finance. Only the largest firms could access
    capital markets.
  • Banks and thrifts were the main sources of
    consumer finance (auto loans, mortgages).

(with thanks to Robert DeYoung of FDIC)
31
Industry Conditions 1940s through 1970s
  • Through the 1960s, little technological change or
    innovation
  • Pre-computer, pre-internet, pre-cell phone.
  • Pre-mutual fund, pre-money-market fund, pre-NOW
    account.
  • Pre-junk bond, pre-NASDAQ.
  • Banks held information advantages about most
    firms.
  • Relatively stable market interest rates
  • Bank financial performance was profitable and
    predictable
  • 3-6-3 banking
  • Failure unlikely Most large losses traced to
    fraud rather than to exposures to credit or
    interest-rate risk.

(with thanks to Robert DeYoung of FDIC)
32
Deregulation
  • Deregulation was an endogenous response to
    economic conditions (volatile rates) and
    technological progress.
  • Riegle-Neal Act (IBBEA of 1994) and prior state
    laws allowed geographic entry.
  • Over 9,000 commercial bank mergers between 1980
    and 2001.
  • 1980 14,078 community banks, with 33.4 of
    industry assets.
  • 2001 7,631 community banks, with 16.0 of
    industry assets.
  • 1986 28 of industry assets in ten largest
    BHCs.
  • 2001 76 of industry assets in ten largest
    BHCs.
  • Gramm-Leach-Bliley Act of 1994 and prior
    regulatory rulings directly exposed banking
    markets to nonbank competitors.
  • Thrifts, credit unions, brokerages, insurance
    companies, investment banks.
  • Repeal of Reg. Q authorized explicit price
    competition for deposits.

(with thanks to Robert DeYoung of FDIC)
33
Information and Financial Technology
  • Payments
  • Credit cards reduced consumer bank deposit
    balances.
  • ATMs, Internet, debit cards reduced consumer
    reliance on paper-based payments and physical
    bank location.
  • Hard information (credit scoring) transforms
    consumer credit into a commodity product.
  • Mortgages in bank share of household debt in
    1983 11.6
  • Mortgages in bank share of household debt in
    2001 38.0
  • Mutual funds, online brokerage, and 401K plans
    reduce banks share of household investments.
  • Household assets held in depositories in 1983
    22.7
  • Household assets held in depositories in 2001
    10.3
  • Businesses forgo bank loans for direct finance
    (high-yield bonds, commercial paper, IPOs).

(with thanks to Robert DeYoung of FDIC)
34
Increased FSF Competition
  • Nonbank competition for investment products.
  • Nonbank competition for business finance.
  • Nonbank competition for consumer finance.
  • Intensified competition required banks to become
    more efficient
  • 27 FTEs per office in 1970............... 23 FTEs
    per office in 2001.
  • 586,000 payments per office in 1987.............
    1,001,000 in 2001.

(with thanks to Robert DeYoung of FDIC)
35
A Strategic Map of the Banking Industry
hard INFORMATION
soft
high COSTS low
small SCALE large
Relationship banking Low-volume, high
value-added Personal service Interest income
Transactions banking High-volume, low
value-added Commodity products Fee income
standardized PRODUCTS
personalized
(with thanks to Robert DeYoung of FDIC)
36
Growing less alike Loans as of assets.
1991 100
(with thanks to Robert DeYoung of FDIC)
37
Different production technologies for large and
small banks
  • Patterns of survival are consistent with cost
    studies of traditional banks, performed during
    the 1970s and 1980s.
  • Substantial scale efficiencies up to about 500
    million.
  • Studies using more recent data that sample larger
    sizes than existed before suggest that the
    largest banks have not yet reached efficient
    scale!
  • Hughes, Lang, Mester, and Moon (2001).
  • Rossi (1998) for mortgage banks (transactions
    banks).
  • DeYoung (2005) for Internet banks (transactions
    banks).

(with thanks to Robert DeYoung of FDIC)
38
Market extension mergers
  • Quickest way to exploit the scale economies
    available to transactions banks.
  • Concentration in local markets is unaffected,
    but
  • the business plan of acquired bank changes.
  • competitive rivalry in the local market changes.
  • External entry improves local bank efficiency
    (DeYoung, Hasan, and Kirchhoff 1998 Evanoff and
    Ors 2005).
  • Outside entrants with brand images gain local
    market share more quickly (Berger and Dick 2004).
  • De novo re-entry response of small banks when
    managerial jobs are extinguished by outside entry
    via acquisitions by large banks (Berger, et al
    1999, Keeton 2001)

(with thanks to Robert DeYoung of FDIC)
39
Sources of increased non-interest income
  • Production or delivery of non-traditional banking
    services (insurance, brokerage, mutual funds,
    etc.).
  • Production of traditional banking services
  • New methods (e.g., electronic payments and
    banking).
  • Expand existing products (e.g., back-up credit
    lines).
  • New pricing schemes for traditional banking
    services
  • Vertical unbundling of loan production (e.g.,
    origination, securitization, servicing) generates
    fees.
  • Unbundled deposit pricing (concept?) generates
    fees.

(with thanks to Robert DeYoung of FDIC)
40
Advertising and Image Creation
  • Large banks spend twice as much per dollar of
    output on advertising, relative to small banks.
  • Little research on advertising at banks, but what
    exists suggests that depositories use advertising
    strategically.
  • DeYoung and Ors (2005) examined advertising by
    thrifts
  • For differentiable deposit products (e.g.,
    checking accounts), data suggests that thrifts
    use advertising of elements of implicit interest
    to reduce elasticity of demand.
  • For commodity deposit products (e.g., CDs), data
    suggests that thrifts use advertising to
    communicate information.

(with thanks to Robert DeYoung of FDIC)
41
Creating Customer Switching Costs
  • Transactions banks encourage customers to use
    direct deposit and direct payment services.
  • (Have you tried to change banks recently?)
  • Transactions banks differentiate themselves by
    packing the map with multiple, convenient
    delivery channels.
  • Bank branches doubled, and ATMs tripled, since
    1990.
  • Internet banking obviates geographic location.
  • Convenience masquerades as personal service.
  • Depositors appear willing to pay higher fees at
    convenient banks.
  • FRB annual surveys support this.

(with thanks to Robert DeYoung of FDIC)
42
Precluding Entry
  • The explosion in bank branches has been largely a
    strategic phenomenon
  • Packing the map (product differentiation)
  • Waving the flag (image differentiation)
  • Toeholds and packing the map (preclude entry)
  • Chicago provides an excellent example.

(with thanks to Robert DeYoung of FDIC)
43
Transactions banking and risk mitigation
  • Pure size creates diversification opportunities
  • Geographic
  • Product lines
  • Loan securitization separates and redistributes
    risks
  • So does hedging in financial markets
  • Interest rate derivatives
  • Credit derivatives

(with thanks to Robert DeYoung of FDIC)
44
U.S. banking system is flush with capital
(with thanks to Robert DeYoung of FDIC)
45
Multiple drivers of increased capital
  • Record earnings
  • Fortunate macroeconomic conditions
  • Freeing up of longtime regulatory constraints
  • Innovation and Strategic Focus
  • Globalization of large institutions
  • Pressures to operate efficiently
  • More banks publicly traded
  • Market for corporate control
  • Strong competition from nonbanks
  • Improved regulation and supervision
  • Basel I standards
  • FDICIA and the specter of Prompt Corrective Action

(with thanks to Robert DeYoung of FDIC)
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Minicases for Classroom Discussion
  • 1. Wachovia-Golden West Deal
  • a. how big?
  • b. what kind of fit?
  • -- geographically?
  • -- product-line revenues and costs?
  • -- charter issues?
  • -- corporate culture?
  • 2. Bank divestures of proprietary mutual funds
    and their purchase by large asset-management
    firms e.g., Amsouth Bancorp sold to Pioneer
    Investment Mgt. (July 2005)
  • - comparative advantages in gathering assets
    vs. managing them
  • - small size of most bank fund families.

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More Minicases
  • 3. Citigroups Decision (July 2006) to fold
    164B in assets at its San Francisco and Virginia
    Federal Saving Banks into its main National Bank
    charter.
  • 4. Demutualizations Two-Step Conversions
  • (a) of credit unions to mutual thrifts and
    thence to stockholder form
  • (b) of mutual thrifts into federal mutual
    holding companies wholly owning a
    subsidiary stockholder bank followed by
    partial or full conversion of the mutual
    HC to stockholder ownership.

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  • Example People's of Conn. Takes Second Step
    From American BankerThursday, September 21,
    2006 By Laurie Kulikowski
  • Ending months of market speculation, People's
    Bank of Bridgeport, Conn., said it plans to
    become a fully public company -- a move analysts
    said could raise as much as 3.4 billion.
    People's said Wednesday that it plans to convert
    to a public-stock savings and loan company. It
    took its first step toward doing so 18 years ago
    when it created People's Mutual Holdings, the
    mutual holding company that now owns 58 of the
    11 billion-asset banks shares Peoples stock
    rose by 6.9 Wednesday.

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  • Cont.
  • Under the second step of its conversion,
    People's said, it would retire the majority of
    its shares held by the mutual holding company
    and sell them as common stock under the company's
    new name, People's Holdings. The bank also said
    it would exchange the 42 of its shares that are
    already publicly traded with shares of the new
    company The bank, which converted to a mutual
    holding structure in 1988, said it plans to
    conduct an appraisal of the new holding company
    and determine the exchange ratio at a later date.
    It did not provide an estimate on the value of
    the offering, though analysts said the proceeds
    could range from 2 billion to 3.4 billion. In
    June 2005, Hudson City Bancorp Inc. of Paramus,
    N.J., completed the largest second-step offering
    by a banking company. It sold 53 of its
    ownership stake to raise 3.93 billion.
  • For months analysts had questioned People's
    executives on whether a second-step offering was
    in the worksIn March it said it was interested
    in acquiring companies outside Connecticut that
    would make it look more like a commercial bank.
    In May it announced that it was switching from a
    state charter to a federal one, and that over the
    next three years it would open 15 Westchester
    County, N.Y., branches -- its first outside the
    state. The charter conversion was completed in
    August.
  • On Sept. 6, People's disclosed that it had
    recently sold the remaining 835 million of
    securities on its balance sheet as part of a
    restructuring plan. It said it would use the
    proceeds to pay down short-term borrowings and
    reinvest the rest in federal funds and other
    short-term securities.
  • Jared Shaw, an analyst at Keefe, Bruyette
    Woods Inc., who estimated that the offering could
    raise up to 3.4 billion, said People's "needed
    to get their ducks in a row internally" before
    going public.
  • "For the last three years they've been keeping
    busy with improving fundamentals at the bank," he
    said. "The first priority was improving earnings.
    The second was improving its balance sheet. ...
    Now that they've hit all those they feel they
    have cleaned up enough in-house" to do the
    offering. He rates People's stock "outperform.
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