More Wall Street Firms to Be Bought Up: Analyst

More Wall Street firms, facing the specter of tougher regulation and slumping capital markets, will follow the path of Bear Stearns and be forced into the arms of deposit-rich commercial banks, veteran banking analyst Charles Peabody told Reuters.

Investment banks that focus on underwriting and securities trading may find themselves severely weakened by write-downs and credit losses, said Peabody, co-founder of independent research firm Portales Partners. Peabody served clients well by warning early on about the pending credit and mortgage market slumps and putting "sell" ratings on many banks.

"There's something about the (Wall Street) model that says they're going to emerge from this cycle as walking wounded and the walking wounded really can't compete on a stand-alone basis," said Peabody, who rarely grants interviews.

Taking their place, he said, is the "universal banking" model that combines banking, investments and insurance, he said. Citigroup , JPMorgan Chase and large European banks sit on huge pools of deposits and could benefit in a cash-poor world.

Last summer, Peabody said there would be forced marriages in the brokerage industry.
While he did not forecast Bear Stearns' collapse in March, or that it would sell to JPMorgan for $10 a share as cash balances dried up, he contends that stand-alone investment banks have been hobbled by the debt crisis.

And with losses mounting and profits tumbling, other Wall Street firms may follow Bear's example.

"I thought their survivability was very much in question as independent entities and I still do. Whether it's Morgan Stanley , Merrill Lynch or Lehman Brothers , I don't know," said Peabody, who rates all three banks "sell."

Walking Wounded

Nearly 20 years ago, the commercial real estate crisis hammered a number of U.S. regional banks and much of the savings & loan industry. And while banks such as Shawmut, BayBanks and First Fidelity survived, all were snapped up by stronger rivals by the mid-1990s.

"That's what I think you're going to see here. Maybe (investment banks) make it through this year. Then they'll realize that, in order to compete in an effective way, they're going to have to be part of a bigger entity."

There has long been recurring speculation that various Wall Street firms were in merger talks with big lenders such as Bank of America , HSBC or BNP Paribas. Until recently such talk was easily dismissed, as Wall Street firms were far more profitable.

Responding to takeover talk involving Lehman, chief executive Richard Fuld told analysts on a conference call last week that he is obliged to consider reasonable offers, but added the firm is committed to remaining independent.

"If the model changes, so that, for example, I guess your question was (commercial) banks are the only way to go, then that is a model that has to be considered," Fuld said during an exchange with one analyst.

That said, the most-likely suitors have bigger priorities right now, including looming credit problems.

JPMorgan is finding its takeover of Bear Stearns is no slam dunk, even at less than $10 a share.

The estimated costs of the shotgun marriage have soared to $9 billion, while a number of Bear employees seek work elsewhere.

One exception may be Goldman Sachs , said Peabody, who said the firm may be seeking a bank deal — as a buyer. The firm, largely unscathed by the credit crisis, is in a position to buy up a small deposit-gathering bank and build it up.

"If your model is to take on proprietary risk, you will want a stable source of deposits," Peabody said.

He also noted that federal regulators are expected to increase their scrutiny of Wall Street firms in exchange for granting access to the discount window funding.

"If you're going to be regulated by the Fed, you might as well become a financial services holding company," Peabody said. "These times create opportunities for transformational deals."

Peabody observed that different kinds of specialized "monoline" lenders were forced into sales when they lost access to capital markets due to their own missteps or industry-wide slumps. Wall Street firms are no different.

"I understand the monoline entities can be a little more proactive, more aggressive in good times," he said. "But they just don't have the capacity to survive in bad times."

Copyright 2008 Reuters. Click for restrictions.