Attorney H. Rodgin Cohen proclaims himself an optimist about the future of banking. The 56-year-old chairman of the New York-based law firm of Sullivan & Cromwell, and perhaps the nation's most prominent banking attorney, sees a healthy, profitable future for the industry. But he also voices a host of concerns, from the pressure of meeting unrealistic earnings expectations to the tension between federal regulation and the desire of states and municipalities to have a greater say in how banks do business.

"I perhaps am more optimistic than many, because I continue to believe that the banking industry can be profitable," Cohen says. "I believe that the industry is a viable one, which a lot of people seem to doubt." He even sees a benefit to the economic climate getting tougher: "It will make banks focus on what they need to do to retain profitability."

Just how profitable is another matter. Cohen thinks that investors and bankers alike will become more reasonable in their expectations, which he feels got "ahead of reality" in the past 18 months or so. For the most part, he says, the industry is not one that generates a return on equity of 25% or even 20%, and that "there is nothing wrong with" a 16% to 18% ROE. Reaching much higher inevitably brings extra risk, and "ultimately you have to pay for that."

Cohen doesn't blame Wall Street alone for earnings expectations climbing out of reach. "I think it was a combination of the analysts and the banks," he says. "You can't hold the analysts to blame when the banks were telling them that they could reach these levels. On the other hand, the banks felt they had to reach these levels to get the analysts to pick the stocks."

Adjusting to lower sustainable profits hurts, "as the prices of bank stocks now demonstrates," he says. "Unless there are very substantial credit problems out there--and that's always a risk, because that's always been the problem in the banking industry--it is very difficult to understand the current pricing of bank stocks."

Not that banks need capital right now: "The industry remains highly capitalized. It's throwing off far more capital than can actually be deployed." But cheap stocks limit banks' ability to grow by acquisition. More important, he adds, is that bankers may take rash steps to boost their stock. "Banks may be panicked into quick fixes and do unfortunate things. They need to be careful in the rush to meet the current fad, to avoid selling businesses which make sense or might make sense" in the future.

"We will probably continue to see some increased focusing on specific product lines--shedding some, emphasizing others," he says. Citing Bank of New York Co., Northern Trust Corp. and State Street Corp., banks whose price/earnings ratios are among the highest, he says, "If you look at the most successful banks, they are highly focused. And I think, therefore, you will see other banks starting to shed business lines and to focus on others."

That doesn't mean that every bank ought to try to transform itself into a Northern Trust or a Bank of New York. "There is a tension between higher profitability in the short-term and greater diversification, which from an economic model theory means less risk," Cohen points out. "For example, selling a credit card business may make sense for a lot of institutions; it's not clear it makes sense for every institution."

Not surprisingly, Cohen has a number of legal and regulatory concerns. First is how the Federal Reserve will implement last year's Gramm-Leach-Bliley Act, under which regulations are only now coming out. He considers regulatory interpretation of the technology and merchant banking aspects of the law as the "poster children," since they represent the first major initiatives out there.

Although the regulators have issued proposals about which the banking industry has voiced substantial concerns, the new rules are far from final. "It's going to send a very powerful signal depending on where the Fed comes out on each of these two," Cohen says.

He feels that bankers' belief that the Fed is too conservative a regulator misses the mark. "It's made great strides which are never appreciated." He cites the Citicorp/Travelers merger, saying it was seen primarily as one between a bank and an insurance company. "What to me was even more fascinating twas that here a bank had become affiliated with a bulge-bracket investment firm and the Fed approved it," he says. "So the Fed gets there when they get comfortable with the situation."

One problem is that regulators have a hard time keeping pace with rapid changes in technology. Cohen cites the current debate over what role banks may play as go-between for their customers on the Internet. "Over the years, the Comptroller has said that banks can act as a 'finder' in the sense that you can bring a buyer and seller together, and the Fed has said it, too." But there are limitations to that role. "So, for example, today can you set up a Web site where a buyer of goods and a seller of goods can come together? And under what circumstances?" Cohen asks.

"This is very important for the industry as it tries to deal with the demands of technology and the fact that new technology is the means by which goods, products, services and information are being distributed," he says. "If banks don't have the ability to own these technological sites, and somebody else owns them and can impose a toll for banks' usage, it's a real problem for the industry."

The other hot spot on the legal front is privacy, on which Cohen expects further legislation in 2001.

"Privacy raises an issue that should be of great concern to the banking industry: What I call the question of federalism," he says. "For many years, banks have basically been regulated by federal regulators--the Comptroller, the Fed, the FDIC. But in the current climate there is increasing risk of regulation by the state attorneys general and state consumer fraud bureaus and so forth."

Calling many of the state statutes "very broad, very ambiguous," he says, "I think that the banking industry can ill afford a state-oriented regulatory system, because you're going to be dealing with so many different states. What do you do, for example, with a customer whose account is opened in California with a bank in New York, and the customer then moves twice, once to Illinois and once to Florida? Which privacy rules govern, or how many of them govern? And so this is, I think, a significant issue."

But privacy is just one example of this dichotomy. "This is a broader issue. It's far more than just the banking industry," Cohen says. "It's a basic question of the relative powers of the states and the federal government."

Internet banking holds other dangers, particularly for Web-only banks. Virtual banks have competed primarily on deposit rates, attracting customers by paying through the nose for their accounts. While traditional banks, with their expensive branch networks, resent the competition, Cohen sees a more important reason to worry.

"The real concern is whether we're seeing a repeat of the S&L problems of the 1980s," he says, "because it doesn't take a lot of brain power to figure out how to attract deposits--you just offer higher rates. At some point, however, you've got to return a profit, and that means you've got to invest in assets that yield more than you're paying on the deposits. And that's going to be the trick."

For independent, Web-only banks, the Cohen asks, "How will they be able to generate the assets without going out further on the risk curve?"

Web banking also raises the issue of whether the U.S. Department of Justice and Federal Reserve need to change the way they analyze competition for antitrust purposes. Preferring rhetorical questions to outright prescriptions, Cohen asks, "Does antitrust policy need to change to accommodate the new competitive landscape?"

He implies that the answer is "Yes," and that the industry needs a new analytic model. "To totally ignore the Internet in analyzing competition for banking services to me is a mistake, even if you acknowledge that you cannot capture its impact with specificity," he says.

Using the old formulas and geographic market-share figures doesn't apply, and simply extending those methods to the Web isn't easy, Cohen says--something that Justice and the Fed already realize. "If they wait to say, 'You've got to be able to demonstrate that 25% of the deposits in the community are held by banks outside the community, which have attracted them through the Internet or some other form of technology,' you may never get there. You probably can't figure out the precise numbers, and so have to modify the guidelines, even if informally."

You can't talk with Rodge Cohen without discussing M&A. This fall's unpopular U.S. Bancorp/Firstar Corp. deal notwithstanding, he points out that lately "a very high percentage of the transactions have not been traditional bank-to-bank deals, they have been banks acquiring securities firms. Frankly, I don't know whether Chase and J.P. Morgan would agree with this, but I think that deal was more like a bank acquiring a securities firm than, certainly, a traditional bank deal."

Citing the UBS acquisition of PaineWebber, Credit Suisse First Boston's deal for Donaldson Lufkin & Jenrette and Royal Bank of Canada's purchase of Dain Rauscher, what fascinates him is not just the trend of banks buying securities firms and asset managers, but the predominance of foreign buyers in the U.S. market. "That's an interesting phenomenon, particularly with the Euro weak," he says.

Despite the glamour quotient, M&A isn't Cohen's only interest as a bank attorney. He enjoys delving into the minutia of regulation and balance sheet structure. "Some of these [issues] can be very exciting, but not very interesting to anybody outside of people who have a fascination with subjects such as Regulation Z." That's the provision that covers consumer lending, on which Cohen is working on a project now.

And despite the laundry list of issues on his mind, "the only issue that I must say I worry about a bit is the question of--let's call them high-yield bonds," he says. "There are a lot of these bonds out there. Many of them are trading at whopping discounts to par, and the question is: Who's got them? The investment banks say, 'Not me.' The commercial banks say, 'Not me.' If that's the truth, and I assume it is, then they are sitting in funds somewhere."

Depending on the type of funds, it may not be a serious problem, he says. But if those bonds are in highly leveraged funds, such as those run by Long-Term Capital Management, which melted down more than two years ago, or "if they are sitting in retirement funds run by big institutional investors, it is a problem." He hopes such bonds are "widely dispersed enough that the losses will be at most a ripple," he says, "but it does lead to some concern."

With 525 attorneys and offices in the U.S. and Europe, Sullivan & Cromwell is run by a ten-member executive committee chaired, since last July, by Cohen. But he has no intention of cutting back on his banking practice.

"As I've said to several people, I have found it's actually much easier than I'd realized, because if I spend 80% of my time on client matters and 40% of my time on administrative matters, I have plenty of time to get everything done," he jokes. "No, obviously, it's a juggling act. But so far, in large part because of the cooperation of the partners here, it's been manageable."

Cohen says he has learned a lot about management by watching his clients. "Perhaps the single most important lesson is that the best managers manage by inclusion rather than exclusion," he says. "The more you include people in the decision-making process, the more you empower them, the stronger the organization will be, the better the management will be."

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