First Interstate Bancorp's purchase of San Diego Financial Corp. is a breakthrough deal at a breakthrough price.

In acquiring the biggest independent financial institution in San Diego, First Interstate will triple its local share of deposits, making itself the No.3 bank in California's second-largest market.

But it's paying an eye-popping price to get there. The nation's 13th-largest bank company has agreed to a stock swap valued at $340 million - or 2.55 times book value - for San Diego's Financial's $2 billion of assets.

"That's a very high price," said Dakin Securities analyst Campbell K. Chaney. "I'm surprised."

Indeed, not since the heady years of the late 1980s have California banks traded hands at such multiples. First Interstate was far more frugal in two transactions earlier this year, paying no more than 1.7 times book value for California community banks.

But first Interstate officials contend that San Diego Financial is a special case that justifies a premium price.

Strong Franchise

The company's San Diego Trust and Savings Bank unit has 52 of its 53 branches in San Diego County, a one-of-a kind franchise in a market of nearly three million people.

First Interstate has just 15 offices in the area and a paltry 3% share of commercial bank deposits. That puts it far behind market leaders BankAmerica Corp. and Wells Fargo & Co.

"For some time, First Interstate has sought to increase its presence in San Diego County," said First Interstate Bank of California chairman Bruce G. Willison in a statement. "The acquisition of San Diego Trust allows us to quadruple our local branch network."

End of an Era

The deal, expected to close early in 1994, is by far First Interstate's biggest acquisition since returning to financial health last year. And for the San Diego banking community, it represents the end of an era.

San Diego Trust and Savings, founded in 1889, remains an old-line institution with conservative management and ties to the local business community that go back generations. Descendants of Joseph W. Sefton, the bank's founder, still own a majority of the holding company's thinly traded stock.

The company is well capitalized and steadily, if unspectacularly, profitable. It has posted returns on assets ranging between 0.6% and 0.8% in recent years.

It is also known as a tightfisted lender, with loans equaling only 45% of deposits.

Despite the slumping Southern California economy, San Diego Financial's problem assets represented just 1.7% of loans and foreclosed property at the end of June. That may have been one of the biggest attractions for First Interstate. Since returning to the acquisition market last year, the company has scrupulously avoided buying banks with credit problems.

|You Pay for Quality'

"This is a premier bank," said executive vice president Theodore F. Craver, who oversees acquisitions for First Interstate. "You pay for quality."

Still, First Interstate faces a challenge in earning back the huge premium it is paying. It can earn an adequate return on its investment only if it cuts costs sharply and takes advantage of cross-selling opportunities to boost revenues.

Analysts who were briefed by First Interstate said it is aiming to trim $50 million in San Diego Financial's annual operating costs, with more than half the amount coming from staff cutbacks.

First Interstate is reluctant to provide details of cuts because of community concerns in San Diego.

Fund Sales May Be Boosted

On the revenue side, First Interstate expects to sell its diversified product line through its new branches and is also considering expanding sales of the San Diego bank's successful proprietary mutual funds.

Based on these assumptions, First Interstate has been telling investors to expect less than 1% earnings dilution in 1994. By 1994, they added, the acquisition should begin adding to earnings.

"You look at all these things and the price begins to make a little more sense," said Brent B. Erensel, an analyst at UBS Securities.

First Interstate executives also told analysts they expect an acquisition-related charge of about $50 million in the first quarter of 1994.

Family Considerations

In San Diego, the disappearance of the biggest locally owned bank was a surprise. Through the years, Sefton family members repeatedly proclaimed their determination to keep San Diego Financial independent.

The family changed its mind to avoid hefty estates taxes that could force the sale of the bank under disadvantageous conditions, said Harley K. Sefton, a family member and vice chairman of the company.

At the request of the Sefton family, the company's board hired J.P. Morgan Securities earlier this year to contact potential buyers, a bank spokeswoman said. Several potential buyers explored the deal, the spokewoman added, but she declined to identify them.

For San Diego Financial stockholders, the deal is a tremendous windfall. They are expected to get about $756 a share when the deal closes. The stock has traded hands most recently at about $255 a share.

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