The financial institutions group of Alex. Brown & Sons Inc. this month opened its first California office, signaling its belief that the state is about to become a hotbed of bank merger business.

The group, which has never ventured farther west than North Dakota as an adviser in a bank merger, named Jean-Luc Servat, a former Merrill Lynch & Co. managing director, to run the office. (See article below.)

The San Francisco office, yet to be publicly announced, is a key element in the Baltimore investment bank's strategy to expand the group's business beyond middle-tier banks on the East Coast.

"Now is the time to make the investment in the [California] market," said Donald W. Delson, managing director and head of Alex. Brown's financial institutions group. He emphasized that the bank group's primary focus remained east of the Mississippi.

Mr. Delson conceded that recession still nagged California, but argued the economic downturn had passed its nadir.

"You don't make the investment in the market when it is clearly on the way up, and you are in the middle of activity, because these relationships and transactions take some time to develop," he said.

"So the time to make an investment is when you are in a recession ."

The four-person San Francisco office, which will include Mr. Servat, an associate corporate finance director, a corporate finance analyst and one research analyst, will by its very presence redefine the company's financial institutions unit.

Since 1989, the Baltimorebased Alex. Brown financial institutions unit has been a major force, advising on 30 bank deals worth $4.2 billion.

Among banks of $1 billion to $5 billion in assets, Alex. Brown always seems to be the adviser on acquisitions, complained one competitor based in Virginia.

But Mr. Delson and his group are hardly alone in their zest for California these days.

The New York investment banking houses Salomon Brothers Inc. and Keefe, Bruyette & Woods Inc. each recently issued research reports identifying M&A prospects in the the state, particularly among thrifts.

"In our view, the California banking and thrift markets are on the threshold of substantial restructuring and consolidation," Keefe Bruyette wrote.

"Powerful forces are at work that should, over the next 18 months, bring about the merger of many midsize California thrifts ."

Some of these forces include stabilizing real estate prices and a modestly improving economy, the report said.

However, because the recovery is only modest, and credit costs have reached normal levels with little room for improvement, acquisitions offer the only avenue to further earnings growth, KBW said.

Mr. Servat, who left Merrill Lynch in August, has already taken the helm in San Francisco, where Alex. Brown has a large office for industrial clients.

Another area the unit is setting its sights on is the Deep South, which includes Alabama, Florida, Louisiana, Mississippi and Texas.

J. Adam Hitt, a principal, has been assigned that region. And despite the conventional wisdom that Florida is all played out, he is convinced there are still many M&A candidates to be found there.

"Just when you think there is nothing left, you find another large bank making its first big entry," he said, citing PNC Bank Corp.'s recent purchase of a small bank in Vero Beach.

Aside from expanding geographically, the Alex Brown unit is positioning itself to broaden its speciality beyond bank acquisitions of banks.

Roger G. Powell, a principal in the firm, has been charged with the task of beginning to push clients toward the acquisition of products and services that can be mass marketed, and away from merely bulking up branch networks.

These product lines range from credit cards, to mortgages, asset management, indirect automobile lending, and home equity loans, Mr. Powell said.

"If you look at the highestvalued banks, the market values certain business lines more than bread-and-butter banking," said Mr. Delson.

"That is why we think that the banks that are not just going to be bought, but are going to he valued separately and independently by the market at sufficient levels to justify independence, really have to have something above average about their profitability.

"And that is going to come about either by really unusual management of the expenses or more generally by having product areas that have above-average growth and profitability."

Since 1993, there have been roughly 120 announced, completed, or rumored acquisitions of nontraditional assets by commercial banks, Alex. Brown estimated.

Examples include the highprofile purchase of Dreyfus Corp. by Mellon Bank Corp. last year and PNC Bank Corp.'s purchase of Blackrock Management.

Commercial finance companies could be the next big niche, Mr. Powell said, unless the federal government interferes in this market, which the Clinton administration has indicated it may do.

Either way, he added, banks have two choices to improve earnings: acquisitions or expanding beyond traditional banking, he said.

A good example is First American. Corp., Nashville, which formed First American Enterprise in January to invest in high-growth areas.

Recognizing that bank expansion was limited in Tennessee, First American created the subsidiary to pursue entrepreneurial sources of revenue by buying some of the niche businesses Alex. brown is now pushing.

Another example of a company that may need to look toward niche businesses is the new Southern National Corp., which merged with BB&T Financial Corp. earlier this year to form the largest bank in North Carolina.

Alex. Brown, which is known to be close with BB&T and its chairman John Allison, did not advise on the merger, partly because it was advising Commerce Bank in its pending acquisition by BB&T.

In a few years, Mr. Delson said, Southern National could be very attractive to outside acquirers, he added, unless it can add a partner.

Essentially the new company will eat up its expense savings in a few years and then will have to either acquire or find a niche business to remain competitive, Mr. Powell said.

For these other businesses to be viable as acquisition targets for banks, Mr. Powell said, annual return on equity must be 25% to 30%, or roughly double the ROE for a traditional bank.

Buying nonbanks and hoping to run them as profitably as the previous owner is a chancy proposition for bankers, Mr. Powell pointed out.

"They either realize they don't understand the business and will be reliant on the management team that they bring in, or they're convinced they know all about the business, and they mismanage it," he said.

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