Bank Mergers & Acquisitions, May 1999
PLAYERS Susan Webber
An Interview with Susan Webber
of the most difficult things to manage - what nobody really wants to
manage - is a business in decline. Banking is in structural decline."
- Susan Webber, Aurora Advisors Inc.
Webber has been skeptical of the logic behind huge bank mergers for
some time. She cites research that suggests greater efficiency can be
achieved in the industry without the mergers that disrupt operations
and sometimes even work against the greater efficiency that they supposedly
skepticism seems to be validated by the recent announcement by First
Union Corp. that it would not meet its earnings estimate for 1999, and
by other bumps on the consolidation road. But could it be that Wall
Street looks only a few months ahead, not far enough for consolidation
to prove its merits? Webber considers that, too.
is president of Aurora Advisors Inc., a New York management consulting
firm specializing in finance and financial institutions. Her consulting
practice focuses on corporate and business-unit strategy, mergers and
acquisitions, new business entry, asset management, wholesale and investment
banking and securities businesses.
Mergers & Acquisitions Editor Mary Beausoleil discussed industry
trends with her recently; this is an edited transcript of that conversation.
In 1997, you said in article in U.S. Banker that there was not much
evidence to support the rationale for the merger boom that was going
on then, and the boom certainly has continued. Has anything happened
since then to change your mind?
No. In fact, the recent earnings disappointments announced by some of
the leading banks, if anything, confirm that the financial logic of
large bank acquisitions is questionable. For example, First Union Revised
its earnings lower twice. Ed Crutchfield, a former M&A maven, now
is going on the record saying he doesn't think that any combination
of traditional banks makes a lot of sense. That's a radical change.
NationsBank-Bank of America - you've got them discovering the D.E. Shaw
problem, then that the branches needed to be rewired, then the Russian
loan problem, which admittedly is more of a market event. You can point
to some specific events that are fairly dramatic with those institutions.
I don't say there is no logic to these deals, but the logic is not an
economically justified logic if you look at the industry data. FDIC
data shows that the banks with the best efficiency ratios are in the
$1 billion to $10 billion range. Every academic study ever done shows
that beyond a certain size threshold, banks exhibit a slightly increasing
cost curve. The studies vary as to where that kicks in; some say as
low as $100 million, but more commonly I've seen it in the $5 billion
to $10 billion range.
Again, that doesn't mean that certain businesses don't exhibit strong
scale economies - things like mutual funds do, securities processing
does. Some studies indicate that the whole fund-raising side - the combination
of market fund raising plus branches - may even be subject to scale
economies. But, the offsetting fact is that banks haven't really sorted
out where scale makes sense and where it doesn't.
So the simplistic argument that is made for these deals - that consolidation
makes the industry more efficient - just doesn't hold water.
hear all the time about the overcapacity that's a legacy of the old
patterns of regulation, that there's a lot of excess that needs to be
wrung out of the system. Aren't mergers a good way to do it?
But nobody's presenting them that way. The fact that banks exhibit an
increasing cost curve says that these banks could have gotten these
costs out without merging - and done a better job. They could have gotten
to a lower cost point.
Yes, if you look at the industry as a whole, it has become more efficient.
We all remember the times when for a bank to have an efficiency ratio
in the low 60s was a good job. Now the benchmark has moved to the mid-to-low-50s.
So there's no question the industry has become more efficient.
I think a lot of this merger activity is driven by behavioral issues.
One of the most difficult things to manage - what nobody really wants
to manage - is a business in decline. Banking is in structural decline.
If you look at the banks' share of total financial services, those trends
are straight-line down from the '80s. Banks have been losing share to
other financial intermediaries for a very long time. And that, from
an organizational perspective, is something nobody really wants to manage.
It's easier to manage growth. Even when growth is produced by mergers,
Wall Street tends to give people credit for it - even though it shouldn't.
On top of that, you've got a whole worldview that doesn't want to question
this logic. You've got investment bankers pushing deals - that's their
job. You've got a recognition that the industry is inefficient. There
is a bunch of people who profit from this line of argument - lawyers,
various consultants, and frankly, the bank CEOs. CEO pay is correlated
with asset size of banks. So there's every reason in the world to want
to do deals.
In fairness to bankers, they are faced with a very difficult set of
problems. Their industry is in decline. They've got more regulatory
freedom than they've had in the past, but they still don't have full
And probably the biggest factor is the whole banking culture. Banks,
historically, have not been very entrepreneurial. That's the whole reason
they're not very effective against investment banks, and when they acquire
investment banks, they tend to screw it up. They've got time-and-grade
promotion; they can't really pay for performance. The measure for success
in commercial banking is how many people you manage.
That's not to say there might not be a way to change some of these basic
behaviors, but most bank executives grew up in the industry and for
them to manage an institution into a shape that they're not used to
managing - it's quite a visionary leap.
some of them - including First Union, actually - getting better at that?
At imposing a sales culture and changing the system of rewards?
Yes, but its a matter of degree vis-a-vis their competitors. If you
look at First Union as a specific case, when they acquired CoreStates,
one of the places they lost business big time was in the Philadelphia
market when specialty lenders began calling aggressively on their accounts.
Where were the First Union people when Heller and G.E. Capital were
picking off their business? Something was dropped there.
They may be much more aggressive than they were, but the whole world
has gotten more sales-oriented. The bar has been raised. It's just hard
for them to move fast enough as the world gets more and more competitive.
ironically enough, it's harder to make changes in a big organization,
even with the recognition that it needs to be done. Implementation is
more difficult with 15,000 employees than with 1,500.
Exactly. You've got procedures and processes and computer systems and
a whole myriad of issues. So it's not that these guys aren't up against
something very difficult.
Again, I'm talking about mergers as if it's mainly a cost issue, because
that's where the data is clearest. But some of the proposed benefits
like, "We'll offer a broader scope of products," sounds very good, but
the experience in cross-selling has been mixed at best.
A lot of institutions have been down that one-stop shopping road, and
maybe somebody's got the magic bullet somewhere, but nobody seems to
have found it. For a lot of institutions to be following a vision that
doesn't really work in practice, or that they haven't found out how
to make work in practice - it's an open question how that's going to
be pulled off.
Of all the recent deals, the one that seems to be going about it most
sensibly - and again, we'll see if they make it work - is Wells Fargo-Norwest.
Part of it is, they've got the biggest institutional stretch; they're
trying to marry high-tech with high-touch. They're systematically going
out and trying to find and preserve best practices in both organizations.
But they've had to move back their expense-reduction targets. They were
targeting to achieve 50% of their total reductions this year, and they've
got an institution genuinely struggling with how to do this better,
and they're not meeting their numbers.
banks, even ones like Norwest or First Union that have done a lot of
deals, continually underestimate the difficulties of integration?
A lot of analysts think First Union, to justify the price they paid,
was way too optimistic. Some of these problems were self-created. They
were simultaneously predicting revenue increases and big cost cuts.
To hit both at once is very difficult. And we are in an environment
where people have to justify their numbers. That's just the way it is
with Wall Street.
There's a technology writer, Michael Schrage, an expert in prototyping
and simulation, who talks about how the culture of how deals are done
really changed with the computerized spreadsheet. I've observed this,
too, with the deals that I'm in. The spreadsheets and the numbers, when
you're putting a deal together, somehow assume a life of their own.
It's so easy to talk yourself into pushing the assumptions a little
bit too far.
There were complaints about the Wells Fargo-Norwest deal that they were
only projecting cost takeouts of 18% of the smaller institution. There's
a perception that around 30% has become more the norm. But it's not
just cost takeouts. The question really should be, how does the bottom
line of the combined institution look? So much of the emphasis is making
sure that we tell the cost-cutting story.
If anything, academic work suggests that the real opportunities for
banks to improve their profitability lie more on the revenue side. There's
that old Journal of Finance study that says banks ought to be able to
get to ROAs of 2.7%, 3.7%. There are - admittedly very isolated - cases
where they have. Bank of Granite Corp. in North Carolina, they've got
an ROA of 2.7%. They're a very lean bank, the tellers know everybody's
name, and they charge customer more. They charge more because they're
nice, and they're responsive, and people will pay more. What a novel
Remember, banking has been a commodity industry for ages, going back
to when they were regulated. You had a small number of banks offering
basically the same products and services, and they had regulated prices
and guaranteed profits if they were reasonably prudent. Then the world
dramatically changed, with volatile interest rates, competition and
a whole bunch of things banks historically never had to deal with.
There are some trends afflicting the entire industry that the merger
process seems to make worse. There was A First Manhattan study that
showed that 60% to 80% of the business that banks originate is on unprofitable
terms. The study suggests that the merger process makes this worse by
putting the emphasis on costs. Behaviorally, if you're in a cost-cutting
environment, how are people going to try to protect themselves? They're
going to want to be associated with more revenues. So you've got people
trying to make it up with volume instead of sitting down and saying,
"Gee, what's wrong with our origination model?"
The second trend that was pointed out in the study is that the whole
industry is losing profitable customers. Profitable customers are the
ones that are going to be sought and picked off. That's worse in an
acquisition environment because people get nervous about what's going
to happen to their branch, what's going to happen to their loan officer,
and they're more susceptible to invitations to leave. There are things
banks could be doing now in terms of understanding their product profitability
and customer profitability. It's basic blocking and tackling, and that's
getting lost in this merger shuffle.
fee income is part of what you're talking about, and many banks have
increased that dramatically. Some people even say, at least on the retail
side, they've about reached the saturation point.
That's a fair point. The question becomes more on the loan product side,
what the model is there. Some academic studies suggest the lending process
becomes less efficient with scale. It appears that the old model of
the banker who knew his customers may work better than the multi-layered
Nobody's really answered the question for me: whether know-your-customer
works better than by-the-numbers, or whether the multilayered review
adds enough costs that it becomes less cost efficient. That gets back
to a cost-side question.
On the income side, you've got a channel conflict that I see banks flip-flopping
on. Here you've got the branch, which is their most expensive selling
channel, and banks have been trying to drive more volume to ATMs. On
the one hand that improves their cost numbers, but on the other hand
that degrades the customer relationship. How do you play at that? And
then you've got banks sending mixed signals in terms of how they charge
for ATM usage. If this is a channel you prefer, that's not a place you
should charge fees.
with the Internet.
Yes. Why are you charging people? You should want to encourage usage;
this is a cheap channel. The question is, 'What are we trying to accomplish
here on a macro customer level?'
Maybe there is a certain subset of customers we want to get very close
to, and everybody else we want to drive to the cheapest channel.
it just that they haven't thought this through enough? Or they're playing
follow the leader?
Some of it's follow the leader. Some of it's that you've got different
imperatives happening at different points in time. Managing channel
conflict is not an easy issue, so I don't want to say that bankers haven't
thought about the trade-offs. But what's the name of the game we're
trying to play here? I see enough things happening on an atomistic level
that suggest that some of the institutions don't have a clear vision
of how they're going to maximize profits from the customers. They seem
to be wanting to pick off low-lying fruit. That works short term, but
there are all these second-order effects, making the customer less loyal.
There's a real generational shift. People in their 50s and 60s still
want to have a relationship with their banks. Banks have basically created
the situation, with baby boomers and younger, where we don't feel that
way. It's much more prevalent in the younger age cohort; they don't
really care who their bank is, as long as the rates are fair and they
don't screw up. And that puts you at a very disadvantaged position,
in terms of trying to extract anything extra.
We're moving to an environment where banks have got to look at the service
question if they want to differentiate themselves. And they may choose
not to. Banks' record with customer service has not been very good.
Again, back to the historical model, banks are used to having power
in the relationship vis- -vis the client. As much as they talk about
promoting customer service, I don't see that happening. There's an expression,
'They've changed their minds but not their hearts.' I think there's
a lot of that going on. There's intellectual recognition, but the degree
of follow-through isn't adequate.
The implication of all of this is that these bankers aren't doing a
very good job. But they're in a very difficult situation. It's extremely
hard, particularly in an environment where you have to be so responsive
to Wall Street, to do something radically different from what everybody
is doing. You have to be extremely confident in your judgment to do
bigger banks, which ones are better at service?
Go back to what Norwest is trying to do. Norwest really prided itself
on buying community banks and trying to preserve the community banking
culture. And Wells is trying to preserve that while layering the Wells
systems in. If they can make it work, they may have a winning model.
But it's not proven yet.
Citibank has done it internationally with their retail strategy. That's
a very explicit cherry-picking strategy, where they're going after the
internationally oriented, high-net-worth individuals, and offering superior
service in terms of extending hours, flexible products. You can's point
in the U.S. to a foreign bank that's had a successful retail entry.
The fact that they've done it, they get kudos for that.
I'm surprised that you haven't seen more retail banks looking at models
from the retail industry. Finally, now you see banks looking at data
mining. That was done in retail many years ago. Another retail model
is having people have the same branch experience. That's something that
Citibank has thought a lot about. Citibank has done that internationally;
in the U.S. they're stuck with more legacy real estate so its harder
to implement. But you walk in a branch and physically things are roughly
in the same place. That gives people a sense of consistency of brand
image, and they feel more taken care of.
You noted in 199 that the market loved all these mergers, and that may
be one thing that has changed. We need only look at the Zions deal of
a couple days ago, to name only one, where the stock of a well-regarded
acquirer took a pretty bad beating after announcing an acquisition.
Do you think that's a temporary thing?
I think it may be driven more by the prices to which bank stocks have
climbed, particularly after the first quarter. With bank stocks trading
where they are, you throw the acquisition premium on top of that and
it just becomes very difficult to justify. If you see bank values relative
to the market as a whole change, I could see this changing back.
Wall Street, with its notoriously short horizon, give these banks enough
time to see whether these mergers are going to work or not?
That's a fair question. The banks are pressured to deliver fast, and
they may do things that are expedient in terms of meeting the numbers
but aren't in their long-term best interest.
Wall Street only looks 18 months ahead. And if you're talking about
something on the scale of Citigroup, Citibank doesn't even expect to
have its international systems from the old Citibank merged for years,
let alone the Travelers-Citibank systems integrated. You've got pieces
of this that are just so far beyond the analysts' time horizons. that's
an extreme case, because it's such a large, complex integration but
it may be true in other cases, too.
You also don't have the same degree of analysts' objectivity that you
had in the past. I hate to say it, but it's true. A major part of analysts'
compensation now is based on their involvement in investment banking,
in terms of proposing deal ideas. I don't see how you can pretend that
there are really firewalls. There's also the mundane fear that analysts
will be frozen out of meetings, cut off from information by the companies
if they take a critical stance. The industry didn't used to be that
way, with the analysts so involved in the transactions, although in
fairness I think that's less true of bank analysts than of, say, analysts
in technology, where there's just such rampant deal activity.
do you see these trends headed?
I don't see bankers' mindsets changing, although given the current price
environment, the current Wall Street environment - if your stock trades
down after you announce something, that will have a chilling effect.
You've had a few years where the activity has been at a lot higher level
than you've had in the past. Earlier in the decade the transaction level
was a notch lower, and that level was considered to be a pretty heated
pace. I happened to sit next to a money manager on the plane yesterday
and he was saying, "Who's going t buy First Union?" because Crutchfield
has clearly signaled that he is open to a merger of equals. The only
logical party is BankAmerica Corp., who would love to do it, but they
can't right now.
There are doubtless other institutions that are ripe to be acquired,
but the timing is off. You've got tax and value considerations arguing
against deals, at least until values correct. The institutions have
gotten bigger, and there are fewer big guys to sell to but the biggest
You can see people doing fill-in acquisitions, and you're going to have
the usual branch sales and branch acquisitions. So that doesn't mean
there aren't going to be deals. But those are not the sort of things
that are going to capture Wall Street's attention.
But, in my mind, there's been no change in the fundamental industry
assumption that consolidation is good for the industry. Given the number
of other factors going on, you're going to see a slowdown. How long
is the slowdown going to last? I don't know. Certainly until relative