Probably no bank analyst is more intimately associated with merger mania than Thomas H. Hanley of Warburg Dillon Read. He recently agreed to an interview on the virtual standstill in bank mergers, the beating the stocks have suffered, and the recent events at Bankers Trust, BankAmerica, and at his own firm:
Do you see mergers and acquisitions resuming in a big way, or is the year-2000 issue going to prevent much from happening?
HANLEY: My gut feeling is that as we head toward the close of this year M&A activity will accelerate, perhaps over a very compressed period, then it will slow noticeably during the first half of next year. But once the testing behind the Y2K issue is done, banks will be in a position to start buying again.
At the same time, the market's fall has affected matters. When I talk to boards nowadays, I hear questions I haven't heard in years. They're asking more questions about buyers-how they've handled prior deals, their lines of business, and how much dilution they've been willing to take. You didn't used to hear that as much.
That said, the fundamental problem in banking remains excess capacity. And the only way to get rid of this capacity is to merge it out. So you'll see straight acquisitions, mergers of equals, nonbank acquisitions, the whole bit over the next few years.
What happened to the summer rally for banks you forecast in June?
HANLEY: In one sense we did have that rally. In April the stocks reached new heights, we tested them in May and came back in June and July to reach new heights again. They peaked between July 17 and the 20th.
What we didn't see coming was the avalanche of investor concerns. You had the terminal case out there: that Japan would do nothing (to resolve its banking problems), so China would devalue, then Brazil would, which would in turn force Argentina, then Mexico would follow suit, then it would all come home to our shores. It was a neat package. Part of it was clearly real-Russia was real. Worse, the potential existed for further problems because you didn't get the feeling that economic policymakers had fully grasped the situation.
During the worst days of August and early fall, part of me said, yes, this is serious, and part said, this is emotional. But you couldn't quantify it either way. And when you can't quantify something, you tend to overreact.
If you look at the history of bank stocks, we've had two severe downturns-October '73 to October '74, when they fell 50%, and October '89 to October '90, when they fell another 50%. But you have never seen the group fall 44% in two and a half months like they just did. That the stocks came back so fast over the last three weeks shows you how large the overreaction was. I'm not saying there aren't real problems out there, but I am saying we overdid it on the downside. We're also seeing momentum investors returning to the sector.
Are you satisfied that regulators have got a handle on the world's economic problems?
HANLEY: I feel a lot better than I did last summer. What (Federal Reserve Chairman Alan) Greenspan did in cutting interest rates again is reminiscent of what he did in the early '90s, when he brought the fed funds rate down to 3%. That's not to say there won't be more tremors, but you get the feeling that policymakers know what has to be done and they have acted much more proactively this time around.
Our leaders have put tremendous pressure on Japan, and the Japanese have finally moved. Before President Clinton arrives in Japan with (Treasury Secretary Robert) Rubin next month, I suspect another Japanese bank, probably the week before, will be nationalized. In other words, I see the steps being taken now, and you can quantify things, whether you like them or not.
Is it justified for Bankers Trust's stock to suffer more than anyone else's during the turmoil as it has?
HANLEY: I thought their earnings were poorer than expected. The silver lining is that credit quality was better than expected, nonperforming assets came down, and loan-loss expense levels were lower than expected, though trading losses were higher than we thought. But would you rather have reasonably good credit quality and bad trading losses or vice versa?
My biggest concern is that their leverage ratio has slipped below 3% and it can't fall much further. But (CEO) Frank Newman went through this at BankAmerica - to improve the leverage you must shrink your assets, or improve equity, or become part of someone that's bigger.
You were pretty upset with BankAmerica, downgrading its stock to "reduce" from "strong buy" after it reported surprisingly bad earnings. What does the company have to do to regain favor?
HANLEY: When a company loses money across most trading businesses, that's saying something about management. When a company says it's set up a special loan-loss reserve for "global uncertainties," that tells you something about management.
I thought the way the David Coulter issue was handled was nothing short of terrible. There should have been a board meeting to determine his fate. (CEO) Hugh McColl should have asked for his resignation personally. Now there is clearly a management succession issue, if there wasn't one before. There appears to have been too much politics and not enough management.
I've loved NationsBank and BankAmerica for many years, but the burden is now on management to earn its way back with the investment community. Someone took their eye off the ball.
How's the investment banking business at Warburg Dillon Read, especially after many investment bankers left in the spring while the UBS/Swiss Bank merger was being worked out?
HANLEY: The firm's global head of research is coming here from London for two years, and so is the global head of sales. That shows commitment, and we are looking to hire in both sales and research. In the meantime, we've been getting deals, both leading them and co-managing. Our view is that we'll be seeing a lot more capital-raising and less M&A business.