Academic journal article ABA Banking Journal

Merge or Die?

Academic journal article ABA Banking Journal

Merge or Die?

Article excerpt

By Bill Streeter and Steve Cocheo, editor and executive editor, respectively.

Not many years ago, people would have said in response to this query, "What kind of question is that?" Or, they would have assumed it referred to troubled institutions.

Now, well into the era of bank consolidation, the connotation is that a bank must grow larger in order to remain competitive. And while nobody contacted-banker or banking observer--answered the question with an unqualified "yes," all took it seriously.

A typical response came from Frank DeSantis, Jr., of Donaldson Lufkin & Jenrette, New York, who said, "It depends what size you're talking about." For banks between $500 million and $5 billion, he said, "merge or die" can be true.

"There's a real issue of how you grow, otherwise," said DeSantis. There isn't enough new loan demand in the current economy to make up for the shrinkage of net interest margins, he explained. "For the $5 billion or larger bank, however, there are plenty of ways to grow that don't require merging."

In general, the consensus was that banks under $500 million in assets, particularly those under $100 million, while not immune to consolidation forces, have more latitude to be spectators without adverse consequences.

The race goes to the quick

"Consolidation is a once-in-a-lifetime opportunity," observes Ken Puglisi, an analyst with Sandler O'Neill & Partners, New York. "It's been going on in earnest for ten years, and it will keep going for maybe another ten."

If the industry is halfway through a once-in-a-lifetime adjustment, it's not surprising that pressure is mounting among bankers to "move before all the good deals are gone." This is particularly true now that "rescue" deals of ailing banks and thrifts have pretty much run their course.

The same situation applies to bank/nonbank deals. How many Mellon/Dreyfus or Chemical/Margaretten deals are there? Opinions vary on that score, but James McCormick, CEO of First Manhattan Consulting Group believes that such a bold move is one way a bank holding company can maintain earnings growth through nontraditional products and services. When it comes to mutual funds et al, McCormick says, "unless you're a major participant, proportionate to your size, they will not make a material difference to the overall corporation's profitability or growth."

Looking for loans

There was no disagreement with the notion, expressed by DeSantis earlier, that there is overcapacity in banking's main line of business--lending. "Few banks will tell you that they have all the good loans they'd like," says D. Paul Jones, Jr., chairman and CEO, Compass Bancshares, Birmingham, Ala.

U.S. banks are flush with capital, reports Richard Kelly, director of investment banking for M.A. Schapiro & Co., New York. "While loan demand has picked up, it's not robust." Acquirers, he says, are trying to leverage capital and build market share--and to boost returns through expense reduction.

In the June issue of ABA Banking Journal, Kelly Matthews, chief economist for First Security Corp., Salt Lake City, said that commercial banks have essentially five ways to increase earnings: 1. expand margins, 2. cut costs and enhance efficiency, 3. reduce loan-loss provisions, 4. enhance noninterest income, and 5. increase loan volume.

Of those, margins and reduced loan-loss provisions are pretty much topped out, he said, while growing noninterest income is a gradual process. That leaves improving efficiency and building volume--both of which are powerful forces for consolidation.

Efficiency can be elusive

There's an ongoing debate as to how applicable the concept of "economies of scale" is to banking as compared to most manufacturing processes. Are banks over $100 million, $500 million, $1 billion, or $50 billion more efficient because of their size?

Not under debate is the basic economic concept that a more efficient producer can offer the same product at a lower price, or be more profitable at the same price. …

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