FDIC: Controversial Deals Create Difficult Environment

by: Troy Racki

Oh great, here we go. When you do it for one, err two, then you have to do it for all. But can you really blame investors when the rules of the game have changed? All they are seeking is equal opportunity to profit.

This week potential buyers looking to acquire BankUnited (BKUNA) have asked the FDIC to put the bank into receivership prior to selling its assets. This comes after BankUnited failed to raise sufficient capital to meet a $1 billion injection requirement by its May 4th deadline, prompting a warning by the Office of Thrift Supervision. Now the vulture capitalists are circling in the hopes that the FDIC will put a bullet to the bank and hawk off the assets at a rock bottom price.

Such a move would wipe out shareholders and place creditors on uncertain ground. This would not be the first time.

BankUnited shares ended Friday at $.79, similar in price to the $.75 low Wachovia (NASDAQ:WB) set on September 29th, 2008 when the FDIC announced that it would facilitate an "open bank" transfer of company ownership to Citibank (NYSE:C). The deal was valued at $2.2 billion, or $1 a share. Just a year earlier Wachovia Bank shares had rested in the mid to low $50s, a testament to how rosy the market had become. The announcement drew criticism that the deal's price was too low. Institutional investors had little choice however. If they did not agree the FDIC would have placed Wachovia into receivership and their $1 a share price would have gone to $0.

However on October 3rd, Wells Fargo (NYSE:WFC) stepped in and announced that it would acquire Wachovia for $15.1 billion in an all stock swap. This was a significant improvement over the price the FDIC had brokered, which saved taxpayers and institutional investors a lot of money. Had the original deal gone through the FDIC was prepared to absorb 87% of Citibank's losses on Wachovia's $312 billion loan portfolio, assuming the worst case scenario.

Regardless of either deal, Wachovia's bondholders faired well, receiving par on their $54 billion of bonds. This prompted outrage from some.

Bondholders in the case of Washington Mutual were not so fortunate. On September 25th 2008, the FDIC seized the bank and sold its $307 billion balance sheet to JP Morgan Chase (NYSE:JPM) for $1.9 billion. During this process $38.9 billion of senior and subordinated note holders were wiped out. Additionally $3.5 billion in preferreds and 1.7 billion common shares that had closed at $2.62 the day prior were also zeroed. All those losses added up to $46.8 billion for anyone aligned with WaMu.

The FDIC's actions at eliminating this many creditors would seem to have benefited JP Morgan which reported that its total mortgage losses would be only $39 billion in a deep recession, according to the recent stress tests. So given the worst case scenario it appears that JP Morgan has profited by $5.9 billion by letting the FDIC do its thing.

Consequently bidders for BankUnited want a similar deal. Rather than getting into a price war and acquiring the bank prior to receivership, by waiting until the end bidders can eliminate creditors from the equation. Then if the FDIC sells the bank for less than market value the acquirer pockets the difference. Given that this has happened already for JP Morgan, and almost happened for Citibank, will it again?

Currently the FDIC has extended BankUnited extra time, allowing for bids until May 19th, making it more likely the bank will find a buyer prior to receivership.

But will it? The banking environment is looking more like a high stakes poker game. What if all the bidders call the FDIC's bluff? Has the FDIC's previously poor judgment created a new environment where none will bid until the risk is eliminated by axing the creditors? Is this fair to creditors or is it simply the new rules of doing business?

As investors in a new environment the safest course of action would be to withdraw from the financials until the rules of the game have been well established. Of course if you do that you might miss out on some wonderful gains, as seen in the spike in prices of such financials as Bank of America (NYSE:BAC). But is the risk of being seized and the creditors negated worth the reward? Another move may be to just purchase the winners from these deals, both past (JP Morgan and Wells Fargo) and future and avoid the rest.

Just hope that what goes around does not come around.

Disclosure: Long WFC.