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Financial Services' Fire Sale

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As firms frantically sell off assets, it pays to wait.

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With the bankruptcy/ insolvency/ nationalization of Fannie Mae (FNM) and Freddie Mac (FRE) looming in the not-too-distant future, investors in their preferred securities have quickly come to understand the true meaning of "non-cumulative" dividends.

Given that "non-cumulative" dividends are a requirement for Tier 1 bank capital, it's fair to say that the preferred market for financial institutions is all but buried. In fact, many are already receiving the tender loving care of Nurse "Ratchet."

No, not Nurse Ratched. For those unfamiliar with the term, a "ratchet" is a common provision in private equity transactions: It enables the purchaser of equity to benefit from further price improvements should additional equity be raised at a lower price. In the 4 private transactions to date in which this has occurred -- Citigroup (C), Merrill Lynch (MER), Washington Mutual (WM) and National City (NCC) -- any additional common issuance has been extraordinarily dilutive to existing shareholders, not only because of the absolute level of common stock prices, but because of the existing "ratchet" provisions.

Thanks to mandatory repricing of recently issued sovereign wealth fund and private equity convertibles, Nurse Ratchet and her latex glove are just raring to reach in and eviscerate existing shareholders. I think it's fair to say that common stock issuance is on the outs for all but the truly desperate - which leaves us with asset sales as the only game in town.

The question is not whether Merrill Lynch will sell its stakes in Bloomberg and Blackrock (BLK), but when. Similarly, I firmly believe that newly appointed Wachovia (WB) CEO Robert Steel will end up selling both AG Edwards and Evergreen before too long - and using the proceeds to effectively recapitalize Wachovia.

I could go on. And on. And on.

But I do think it's important to recognize that this enormous garage sale is just a symptom of an even starker reality: Integrated financial services (IFS) have been a mirage all along - albeit an enormously attractive one that duped customers and shareholders alike.

Due to blatant conflicts of interest, regulatory encumbrances and bureaucratic internal business silos, the benefits of integration were never truly realized. And with an abundance of better one-off choices across available across the board, IFS firms now feel as outdated as department stores.

But there is a bright side: Some great businesses are about to be liberated from their IFS prisons. Though not all will flourish, we can expect a few enormous success stories.

Few remember that monoline credit card firm MBNA was born from the ruins of Maryland National Bank, or that First USA (FUS) rose from the ashes of MBank. Due to the failures of their parent companies, both were forced -- or allowed -- to go forth and prosper.

As someone who's been not-so-patiently waiting for the disintegration of the financial services industry, I'm very excited by what's ahead. But I'm not going to rush it: If this crisis has taught us anything, it's taught us that it pays to wait.

By the time fall rolls around, the "Back to School" specials on these forthcoming asset sales should look very appealing - and the after-Christmas sales will be even more spectacular.
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No positions in stocks mentioned.
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