Further consolidation of the nation's banking industry is virtually unavoidable because the economic rationale for it remains so strong, according to H. Rodgin Cohen, a lawyer who specializes in banking issues and has handled mergers and acquisitions for nearly 20 years.
Mr. Cohen, a partner in the New York firm of Sullivan & Cromwell, said he expects a resumption of major consolidation activity this year after last year's lull, although he doesn't think it will match the huge volume of 1995.
At some point, the consolidation trend will focus attention on antitrust questions, Mr. Cohen said. He spoke during a Jan. 10 interview with Aaron Elstein and Gordon Matthews.
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Bank mergers and acquisitions slowed down last year after a big year in 1995. Should we anticipate more or less consolidation in the industry this year?
COHEN: Consolidation has been the dominant trend in the banking industry for at least 15 years because of compelling economic reasons. There are tremendous competitive pressures, and consolidation is really the only way to really deal with them.
Those pressures have not dissipated at all. In fact, I would argue that with more competition - both geographically and with banks able to offer more and more products - they have increased.
Ten years ago it was credit card loans. Today it is small-business loans and other products. Technology is a further pressure. Nonbank providers of services, as they get more and more into the banking business, apply more pressure.
I think the inevitable conclusion is that - absent some major extraneous force, some huge (financial) market disruption, or some huge credit quality problem, which does not appear imminent - we're going to see a continuation of the consolidation trend.
Nineteen-ninety-seven will be a stronger year for bank mergers than 1996 but almost certainly not as strong as 1995, which was one of those occasional peak years. But you don't need a 1995 to have a fairly strong year in bank M&A.
Does bank consolidation beget more consolidation?
COHEN: Yes. I think to some extent it does, although I don't know that anybody that we've ever worked with has rushed out to do a deal just because somebody else did a deal.
But it sets forces in motion?
COHEN: It does. If I can deliver my products over a far greater customer base, then my competitor has to worry whether I don't have a competitive advantage. Clearly, I think the Wells Fargo-First Interstate merger has led to further consolidation of California.
What about trends in bank regulation - deregulation, actually. Banks have gotten expanded powers. Does this encourage or discourage consolidation?
COHEN: There is a yin and a yang here. You can only do so much at one time. You can't be out buying a lot of banks and at the same time building up another aspect of your business.
Quite clearly, for a bank like First Union, one of the reasons that they were not as active in 1996 as in 1995 or in previous years, is that they have made a definite commitment to capital markets.
So to some extent, added powers are a short-run negative for consolidation. But in the longer run, they encourage consolidation, because banks with more products will eventually want more customers to deliver those products to.
At some point, will the 10% limit on nationwide deposit market share in federal banking law have an impact on consolidation?
COHEN: That's actually a fascinating question that people tend not to focus on because it seems so far away. I think 10%, which is based on all insured depository institutions, is about $325 billion of domestic deposits, so the largest institutions could still double in size. And the deposit base itself is not growing that fast.
But it's now not unthinkable that someone might approach the ceiling within a decade?
COHEN: Oh, absolutely not.
What sort of consolidation are we likely to see this year?
COHEN: There will most likely be a return to the traditional bank-to- bank deal this year, but there will also be some bank-thrift deals, some thrift-thrift deals. And I think perhaps this year we may see banks acquire regional brokerage firms.
The Federal Reserve has made these transactions feasible now, and some of them sit well. Some of these brokerage firms have the same problems as the medium-size banks, including costs of technology.
What about the insurance area?
COHEN: Now, that could make a gigantic difference. If you had legislation letting the insurance industry and the banking industry consolidate, it could totally change the map.
What about cultural issues? The managements of the insurance and banking industries seem more alike than the securities industry.
COHEN: Yes, in a lot of ways they are more alike. The focus is on the left side of the balance sheet, as opposed to the fee-generating business. And there is increasing homogenization of products.
The cultural thing is also clearly there. At most investment banking houses, the key people are all in their 30's and early 40's, other than the very top level of management. It tends to be 10 years older at commercial banks and insurance companies.
If a profitable independent bank wants to remain independent, what can it do these days?
COHEN: The first thing is, you make sure the board is committed. Give me a board of directors committed to independence with no defensive measures in place and I could probably succeed in defending them. But give me all the defenses in the world and a weak board, and I'll lose. The only thing that can really break through a committed board is a compelling price.
Does "never" always mean never?
COHEN: Independence is an objective. It doesn't mean you always say "no." That can't be. That is not consistent with the board's fiduciary duty. What it does mean is that you will not accept an offer unless it is compelling, and you will not be actively, or even to a limited extent, seeking to sell yourself.
What about antitrust issues? Once they were the major factor, even a controlling factor, in banking deals. They're rarely mentioned much anymore.
COHEN: Ultimately, I think we are going to see antitrust as an issue again unless there is a new paradigm for analysis. And frankly, the industry needs to do more to make it clear that a new paradigm is appropriate.
The deposit market share index used for antitrust analysis in bank mergers was not actually devised for that purpose, right?
COHEN: It was originally devised to measure competition in the steel industry in the 1950s. Mathematically, it may still be better than anything else, but there are some very severe flaws in the present process.
One of the most significant is that you go into a major city and all deposits count the same, but a bank headquartered in that city will concentrate a lot of deposits, which has nothing to do with the market. For instance, it might involve a national CD program.
A second is that, to my way of thinking, measuring bank market share with deposits rather than loans is as if you went to the automobile industry and said, "We're not going to base things on how many cars you sell, but on how much steel you have in inventory." Deposits are banks' inventory, while loans are the real products.
How serious is this flaw?
COHEN: For example, imagine a $100 million-deposit bank with a commercial loan-to-deposit ratio of 25% and a huge multiregional bank with a billion dollars in the same market and also with a 25% ratio.
If you measure by deposits, it looks like the big bank has 10 times the loans the small bank has. But by definition all of the $25 million in loans by the small bank are small-business loans, while it is probably one- fifth for the big bank. The big bank has two times the loans of the small bank, not 10 times.
This is a serious flaw, an enormous flaw. This is just looking at banks alone and leaving aside the huge philosophical question of whether finance companies compete, whether American Express competes, whether AT&T Capital competes.
Is this issue going to have to be resolved at some point?
COHEN: Sooner or later, it is. There is also another huge problem. Using deposits as proxy for loans inherently assumes that no bank can make a loan except in a market where it has a branch. That's ridiculous.
The Department of Justice has shown flexibility in dealing with these issues and has not said, "We're going to go straight by the numbers." To date, it has not been a problem, but sooner or later it will be, unless there's a change.
Do you detect changes in sentiment on the part of bank managements about consolidation? Are they much more realistic about this than they were five years ago or three years ago?
COHEN: I think generally they are. But the level of realism varies from bank to bank. It's natural that people tend to believe their institution is going to improve. I don't think I've ever started on a deal where somebody hasn't said, "If we could only wait six more months when our stock price will be higher. ..." Do you have a final prediction for this year?
COHEN: The only sure prediction is that there will be one large merger which nobody has anticipated. I have no idea which one it will be, but there will be at least one.
