In the 1980s, banks thought commercial real estate lending was the ticket to high profits. History proved them wrong. Today, some banks think devotion to technology- driven, product-focused delivery channels is the future, and the human touch be damned. But the problems besetting Wells Fargo & Co. following its merger with First Interstate Bank should give them reason to consider whether the right approach isn't walking a line between the two. After Wells emerged from the commercial real estate disasters of the early 1990s, it chose technology as its savior, becoming a true-believing missionary for what it saw as the future of banking and building a set of electronic, product-focused delivery channels of which it was justifiably proud and to which it was totally devoted. Theoretically correct tech strategy Wells wasn't alone in this belief, and banking numbers support the logic of cutting operations and delivery costs with technology; after all, average bank profits are 10 percent, and banking inefficiencies are 20 percent, so it's not hard to see that choosing the road taken by Wells looked like the right decision at the time. But Wells's well-publicized problems after the $11.3 billion hostile takeover of its former rival last year can be traced to the bank's blind faith in technology, and to its equally strong belief that customers who didn't come around to the bank's product-driven point of view weren't customers it wanted anyway. In the process, it's lost not only hundreds of millions of dollars in income and millions of accounts, but also some of its luster on Wall Street. Interviews with former First Interstate employeesoall of whom insisted on anonymity before agreeing to be interviewedoand former customers paint a picture of a bank so filled with hubris because of its technological superiority that the problems that followed the merger were almost inevitable. They speak of a company that foreclosed discussion of any sort contrary to its beliefs; deaf to warnings, blind to problems, slow to correct obvious mistakes, and then apt to find fall guys. The result has been a massive loss of accounts, from those as large as $1.3 billion in custodial assets (with $500 million a year in cash flow), to business accounts, to personal checking accounts; of the imminent loss of Fortune 50 accounts; and of horrendous public relations from Houston to Seattle. Many stock analysts, as well as bond rating agencies, had generally felt that Wells's merger problems had bottomed in the fourth quarter of 1996, when earnings were only $1.12 per share, compared to $12.21 for the year. They anticipated a continuation of what they regarded as an upward trend begun in the first quarter of this year, when earnings were $3.62 per share. But after a Wells press release issued a week before its second quarter earnings were due out warning that its earnings would be about 30 percent below estimates, the stock fell 6.59 percent in one day. The announcement was apparently intended to preempt a bad market reaction to the real earnings report, which stated that earnings were down 37 percent. The stock see-sawed in the week prior to the report, and then, after a brief plunge on July 15th following release of the earnings, the stock steadied, closing at 267. No Wells Fargo executives or spokespersons would agree to be interviewed for this story, and a direct call to chairman Paul Hazen's private telephone number was bounced back to public relations, which didn't respond to interview requests. Reports are circulating, however, that Hazen and company have recognized their mistakes and are moving to correct them. Of course, Wells Fargo is not about to sink into the sea. And not every informed observer thinks Wells is in trouble. "There's nothing in their announcement this week that would suggest anything about their on-going earnings or their operations," said Thomas Brown, Donaldson, Lufkin & Jenrette's banking analyst, after the warning appeared on the earnings report. "This week's announcement is all about what happened before." Others disagree. Thomas Stone, a banking analyst with Duff & Phelps, says: "(Before the announcement), my guess was that they had fixed most of the problems, and you wouldn't see anything (negative) until maybe the fourth quarter. But obviously, they haven't fixed things, and it's my understanding that it's related to the inability to process a lot of clearing items. So it's an operational issue that still hasn't been worked out that's causing a lot of charges." Whichever perspective chosen, the Wells experience provides a useful lesson to bankers about blind faith in the power of technology at the expense of the human element, as well as an indication that the industry may be reaching an inflection point, in which it considers whether its love affair with technology needs to take a breather while roles and lines are better defined. The rationale behind the merger It helps to remember that in 1996 Wall Street considered banks either predators or meals; and that in 1995, First Interstate had invested just over $1 billion in a big computer platform that could support much larger operations than it had at the time. "We were looking, there's no doubt about it," says a former First Interstater. "If Wells hadn't bought us, there's no doubt we'd have been buying (other banks) ourselves." But it's also important to recall that in 1994, Wells and First Interstate had explored a friendly merger, so that when Wells launched its hostile bid, and then persisted in it after First Bank Systems of Minneapolis stepped in as a white knight acquirer, it had plenty of useful information about its quarry. The result was that Wells felt it knew what it was getting, and how much they could pay to get it. Wells's rationale was that, while First Interstate had a corporate business and a large branch system Wells really wasn't much interested in, it did have about 12 million accounts Wells wanted and a 13-state presence it needed if it was going to remain a big bank in the future, say sources. The basic equation: Even if 20 percent of the accounts left the merged bank, and Wells lost $200 million in fees atop that, the accounts and the market presence were worth the price. And at $100,000 per account, it was still cheaper to hold onto an account than to recruit one. Though rumored to be worth more than $300 million, the number of lost accounts was not immediately available; according to the 1996 annual report, costs directly attributable to the merger include $415 million in severance packages to senior management and $302 million in adjustments to goodwill related to the disposition of premises. Losses from dispositions of operations, premises and equipment totaled another $141 million in non-interest income. Losses in fee income are not available. Heading for the exits The problem was that Wells almost immediately started alienating accounts because its people paid no attention to anything First Interstate employees said about their accounts. "You could see it in the meetings before the merger," says a former First Interstater. "As soon as we'd say 'What about the customers? How will they react?', the shutters would just come down." Says another source: "The presumption was that, at the end of the day, they'd lose customers, but that enough would stay on to make it worthwhile, and that meanwhile they could create all these cost savings with their systems." But the problems began almost immediately. No "best of breed" contest was conducted by Wells; except for the First Interstate cash management and call center systems, Wells's system was imposed wholesale, and the $1 billion First Interstate client/server system was basically left on the sidewalk. Then Wells began moving all of the First Interstate information onto its systems, spending $1.459 billion on new equipment. As a result, senior First Interstaters felt they weren't wanted and began leaving, taking with them their knowledge of the customer base. Without that, important mistakes were made at the account level that so alienated First Interstate customers that accounts large and small began heading for the exits. In Arizona, as in much of the west, so-called check guarantee cards are used by merchants to allow customers to pay by check. Wells officials decided to pull the check guarantee cards, leaving onlyoand fewerodebit cards in place, a move that alienated a significant number of merchant and consumer accounts, says Bank of Tucson president Michael F. Hannley. But mistakes were also made internally. According to another First Interstate source, Wells decided to replace the client/server architecture supporting First Interstate's branch system with a Unix- based "dumb" terminal system; on the day the deal closed, it laid off five technical support personnelothe primary support team for the 13- state systemoat First Interstate's operations center. But Wells wouldn't be ready to replace the existing system for four to six months, says a source.The result: Within two days, the outcry in the field was so loud that three of the fired technicians were re-hired through a temporary agency for nearly double (or more) their previous salaries. Also, this source says, the internal technical support line, which had been a menu-driven system reached through a single number, was replaced by a Wells system in which one of 16 numbers had to be called, depending on the problem. This, he says, caused more chaos and poor morale. This sort of confusion affected the most fundamental systems. The state of Nevada's Industrial Insurance Fund, which handles workmen's compensation claims, found checks were taking weeks to clear. With First Interstate, says J.R. Clark, the Fund administrator, check clearing had been routine. Although he says service was improving, its contract was expiring, and the state issued a request for proposals. Although Wells bid for the business, it was not competitive, and the Bank of New York got the Fund's $1.3 billion trust custodial account, while United States Bank of Nevada got the commercial accounts, which amount to $500 million a year. Basic communications errors with customers were also made. Dorothy Finley, for instance, whose Finley Distributing Co. does about $29 million a year distributing beer in Tucson, AZ, discovered that credit cards weren't good in some of the bars and all of the pool halls her salesmen visitedoafter they'd been produced to pay for rounds of drinks for clients. Wells had just forgotten to notify her that its policy is to not honor charges made in pool halls and some bars, and no one from First Interstate in the know was left to tell her. After a number of other, easily avoidable mistakes, she pulled her account, giving it to the Arizona Bank. Even then, it took five months to get her employees' 401(k) accounts out of Wells's hands, she reports. Sans the wisdom of First Interstate peers The lack of First Interstate people who knew their clients and their client's problems has had a bigger fallout, too. Texaco is widely rumored to be "shopping" its account, and a spokesperson for Texaco confirms that her company's account is under review. "We had an excellent relationship with First Interstate," she says. "That relationship has changed under Wells; the account representatives we had with First Interstate left, and a lot of the knowledge of our business has left, too. We are still a Wells customer, but that could change." Counters DLJ's Brown: "Texaco is an unprofitable relationship; (Wells) tried to improve the profitability of the relationship. If Texaco can find another, dumber bank, then that's great for Texaco. .But that's not a negative for Wells Fargo." But a former First Interstater says the bank was making profits "well into six figures" from the account. In June, the city of Tucson took its account from Wells and gave it to the Bank of Arizona, partly because it had replaced 70 tellers with part-time employees, and partly because of dissatisfaction with service, says Mayor George Miller. The monthly account balance was $1.2 million, and earned Wells about $171,000 in fees, he says. "Our detectives would be out at night and would need money for (police business) and they couldn't get it out of (Wells's) ATMsothey weren't authorized. Can you imagine that?" Apparently, Wells Fargo is just beginning to. -reinbach tfn.com

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