The Risky Business of Bank Mergers

THE BALTIMORE SUN

New York. -- A kindly preliminary round in the cruel business of merging banks was much in evidence during the past few weeks. First, two major New York institutions, Chemical and Manufacturers Hanover Trust, agreed to consolidate. Then two regional banks, C&S;/Sovran and NCNB, followed.

The accolades and handshakes come first, next the inevitable cutting of costs. If the second phase goes as well as the first, the troubled U.S. banking system could be salvaged by the much-predicted consolidation of the nation's banks. That may be a dream.

Wall Street analysts predict merging overlapping bank operations can trim 20 percent to 40 percent of the expenses of the combined entities without simultaneously destroying the franchise. It sounds great. But.

Cost reductions can come from three areas: people, systems and real estate. History suggests only people can be quickly pared, but doing so often provokes low morale and chaos. Turf wars erupt. Employees begin printing resumes rather than business proposals. Credit officers familiar with accounts leave. Loyalty dies. Files get bungled. Irate customers are left waiting on hold, disconnected because of telecommunication problems stemming from office shifts and the firing of the familiar old operators.

And personnel problems can pale besides the other two. Banks build computer systems in a hodgepodge fashion over many years. Typically, merely keeping the myriad generations of machines in a single bank working together is a difficult task. Merging the systems with others that are almost inevitably incompatible can be a nightmare.

Moreover it is a nightmare that can become particularly acute because merged banks attempting to cut costs typically lean toward the area where customers, and bank executives, don't look, the back office. Unfortunately, the cuts are equally blind, eliminating technicians in precisely the area where technical assistance becomes paramount. Maddening errors result.

Lastly, a major area of savings for the consolidation of banks in one market is real estate. But few leases are short term. Even Chemical, whose long-term lease on its Park Avenue headquarters was concluding, still has a commitment until 1994. And headquarters is only the tip of a vast, sprawling network of offices and operations owned by the two banks in New York City. Chemical's lower Manhattan operations center occupies more than one million square feet; Manufacturers Hanover owns a huge data processing center nearby. Dumping leases or unnecessary space -- the equivalent of the entire inventory of smaller cities -- will be difficult in the current depressed real estate market, to say the least.

Successful bank mergers typically have a strong chief executive in charge who can make brutal decisions quickly. Customers stay put because the problems are brief, rather than because they are absent. Hugh L. McColl Jr., chief executive of the C&S;/Sovran-NCNB conglomeration, to be known as NationsBank, has the reputation for being tough and decisive.

More gentle mergers have often gone awry, such as Sovran's merger with Citizens & Southern a year ago. Sovran's bad Washington-area loans may have been the killer, but an inability to trim expenses sufficiently or to refine bureaucracy set the stage. Importantly, it, like the Chemical-Manufacturers deal, was merger of equals, leaving two sets of top executives.

Underlying the tenuous prospects for bank combinations is the reality that banks are only service companies. Unlike, say, Oreos, which taste as good under the management of Nabisco Brands, Reynolds Tobacco, or Kohlberg Kravis & Roberts, who have all held the reins in recent years, banks do not have an enduring brand. They are as good as their current management, and the consequence is that many institutions that dominate in one era fall by the wayside in another. Indeed the major beneficiary of some bank mergers is the competition, which may find that sought clients become eager customers.

Motivating bank deals, on the other hand, is that in many ways these companies have become less like traditional banks, meaning lenders of money, and more like commodity manufacturers, depending for their survival on production efficiencies. Credit card and check processing, for instance, all are subject to economies of scale. Merged back office operations, if done well -- a big if -- can produce substantial savings. Already, that has taken a substantial toll on bank employment, which has been declining since 1985.

In this sense, banks are no different than the postal system or magazine subscription departments, constantly seeking to reduce the cost of processing paper. They have become factories.

A point often lost in the shuffle, though, is that these operations needn't be done by banks at all, and soon may not be. Huge subcontractors adept at doing high volume transactions cheaply are already processing payrolls and insurance claims. They are moving into banking and may soon provide even the smallest banks with access to operations as efficient as those operated by their larger competitors.

There are two distinctly different kinds of bank mergers: those linking banks in a similar market (Chemical and Manufacturers ,, Hanover), and those linking banks in disparate regions (C&S;/Sovran and NCNB -- now known as NationsBank).

In-market mergers, as those in the same area are called, are the ones that must rely most heavily on cost savings. Regional linkages often use another justification, contending that a more diverse client base will provide a less risky loan portfolio.

It makes sense in theory and there are examples where it has even been true in reality, most notably in the case of North Carolina-based NCNB, which earned most of its money last year in Texas.

Historic limitations on interstate banking mean there are few similar examples of domestic diversification. Alternatively, though, banks have sought geographic diversification by going abroad. Typically, they have been clobbered. Recently, Security Pacific Corp. concluded an expensive fling in global strategy by refocusing on Orange County, California, its home base. Bank of America and Chase among U.S. banks, as well as Barclays and Midland among English banks, have similarly contracted overseas operations after suffering reverses.

Indeed size, and what can be done with it, seems to be a dubious advantage for a bank. Industry statistics compiled by IBCA, a bank ratings agency, suggest large banks are no more profitable than small ones -- often less so. Of the four major difficulties that have rocked the industry during the past two decades -- Third World loans, leveraged buyout loans, real estate loans, and desertion of core customers to alternative financial markets, the small banks have only been hit by one: real estate.

"Small banks haven't had the appetite, or the opportunity, for those other kinds of risks," said Patricia Krall, a vice president at IBCA. Instead, many small banks have focused on individuals, a far more profitable segment.

Being the nation's largest bank has been a particularly dubious honor, held at times by Chase, Bank of America, and Citicorp. All have suffered when wearing the crown. John Reed, Citicorp's chief executive, says the distinction will soon pass to Banc One of Ohio or NationsBank.

This, he contends, is not a bad thing. Banc One, the most profitable heir, has succeeded by being a big bank operating as if it was a small bank, catering through independent subsidiaries to small and mid-sized companies.

Bank analysts argue mergers are required because the U.S. banking system has too much capacity. An ironic footnote is that new capacity continues to come on line. According to Federal Deposit Insurance Corp. statistics, 159 banks failed last year, but 165 banks received new charters. Since the 1929-1934 period when the number banks fell from 25,000 to about 14,000, the number of banks operating in the United States has been fairly stable, vacillating between 13,000 and 14,000. The post-Depression peak of 14,496 achieved was reached as recently as 1984.

Since then, a wave of failures and mergers has reduced the total to 12,343. Because some of the failures and the mergers have occurred among big institutions, the actual contraction is understated. Interestingly, though, the most consistent trend in the industry since the early 1930s has been the steady expansion in the number of branches. It may come as a shock, but despite all the upheaval, banking continues to be a growing business.

Thomas Easton writes about business from The Sun's New York bureau.

Bank mergers

The five largest U.S. bank mergers of the past four years. The acquisitions are rated according to the amount of the assets the absorbed bank now holds.

BUYER: Chemical Banking Corp., (N.Y.)

SELLER: Manufacturers Hanover Trust Corp., (N.Y.)

DATE: 7/15/91

.. .. .. .. .. .. .. .. .. .. .. .. ..$61.3 billion in assets

BUYER: NCNB Corp., Charlotte (N.C.)

SELLER: C&S-Sovran; Corp., Norfolk (Va.)

DATE: 7/22/91

.. .. .. .. .. .. .. .. .. .. .. .. ..$49.2 billion

BUYER: Bank of New York Co. (N.Y.)

SELLER: Irving Bank Corp., (N.Y.)

DATE: 1988

.. .. .. .. .. .. .. .. .. .. .. .. ..$24.2 billion

BUYER: Sovran Financial Corp., Norfold (Va.)

SELLER: Citizens & Southern Corp, Atlanta (Ga.)

DATE: 1990

.. .. .. .. .. .. .. .. .. .. .. .. ..$23.0 billion

BUYER: Chemical New York Corp., New York (N.Y.)

SELLER: Texas Commerce Bancshares, Houston, (Texas)

DATE: 1987

.. .. .. .. .. .. .. .. .. .. .. .. ..$19.2 billion

SOURCE: Alex Sheshunoff & Co. Inc/ASSOCIATED PRESS

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