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Banks to use bailout for lending, acquisitions

A number of financial institutions, including Capital One Financial Corp. and SunTrust Banks Inc., have announced they will receive funds under the Treasury Department's capital purchase program.
/ Source: staff and news service reports

The Treasury's $700 billion program to rescue the financial services industry, which began with a three-page memo six weeks ago, is evolving yet again.

When the fleshed-out proposal was passed by Congress and signed into law Oct. 3, Treasury Secretary Hank Paulson's plan was to use the money to buy "toxic" mortgage-related securities weighing down banks and clogging the flow of credit to business and consumers.

Then two weeks ago the Bush administration changed course and decided to invest $125 billion directly into some of the nation's biggest banks to restore confidence into the financial system and get capital flowing more quickly.

Now the Treasury is pouring another $125 billion into small and medium-sized banks, but some analysts contend the program has been transformed to a much more grandiose undertaking that will essentially weed out the weak banks from the strong.

Several of the banks that have received preliminary approval from the Treasury for investments have said they plan to use some of the money for acquisitions, including SunTrust and Regions Financial Corp., both of which expect to receive about $3.5 billion apiece. Even smaller institutions, like Seattle-based Washington Federal Inc., which announced a $200 million commitment from the government, plan to deploy some of the money to expand its retail franchise through acquisitions.

Many analysts believe the investments are being doled out to the strongest financial institutions, with the aim of spurring consolidation among banks and protecting the government from having to salvage some of the industry's weakest players.

"It appears to us that these 'gifted' banks will receive the capital whether they need it or not, as they will likely do the cleanup on behalf of the Fed and the Treasury by acquiring weaker institutions," wrote Morgan Keegan & Co. analyst Robert Patten in a research note late Friday.

In what was the first instance of a bank using its investment from the government to make an acquisition, Pittsburgh-based PNC Financial Services Group Inc. said Friday it plans to acquire National City Corp. for $5.58 billion. PNC said it had received $7.7 billion in cash through selling stock to the government under the program.

Fox-Pitt Kelton analyst Andrew Marquardt believes a distressed sale was National City's only option after it became apparent that the Cleveland-based bank would not receive approval to participate in the government's program.

"Our understanding is that a key reason for National City to sell in the same week that it reported third-quarter results was that National City management became aware that it was highly unlikely to be able to participate in the TARP capital purchase program," Marquardt wrote in a note to clients.

Critics of the program contend that the government will in effect wind up handpicking which banks win and which lose.

Assistant Treasury Secretary David Nason said Monday that the administration's major aim is to stabilize the financial system and that stronger institutions will be in a better position to make loans and support the overall economy.

The emphasis on acquisitions makes sense, said Jason O'Donnell, senior research analyst at Boenning & Scattergood, but there are also significant ramifications.

"While on the whole it's positive in terms of its implications for improving capital, improving lending," O'Donnell said, "it is likely to have the unintended consequence of separating the winners and losers, which is normally a process that the free market is engaged in."

And while further consolidation could very well lead to improved lending, it may take longer to achieve, said John Jay, senior analyst at Aite Group, a Boston-based financial services research firm.

Meanwhile, the smaller institutions that don't get any government support will wind up walking around with a big target on their back, he said. "If they're not given any type of government help, that is a pretty explicit statement on where they stand," Jay said.