How First Union Pulled Its Georgia Franchise Together

Making acquisitions work is often, like genius, 1% inspiration and 99% perspiration. The inspiration is the acquisition itself. The perspiration begins as the acquirer tries to integrate the purchase into existing operations and make it profitable.

First Union Corp.'s 1986 acquisition of $3.7 billion-asset First Railroad and Banking Co., for $797 million in First Union stock, was viewed by Georgia's banking industry as an inspired move initially, according to John Poelker, a bank consultant with Edgar Dunn & Co. But then everyone began to realize just how unsophisticated First Railroad's operations were.

Charlotte, N.C.-based First Union, which had $19.4 billion in assets at the time and was expanding aggressively in South Carolina and Florida, made its first significant entrance into Georgia with the First Railroad purchase.

First Railroad operated a "classic multibank holding company with little or no central management and control in place," Mr. Poelker said. In addition to First Railroad, First Union picked up three smaller banks in the Atlanta area in 1986 and 1987 in an effort to increase its presence in that booming market.

Branches and Staff Pared

That left First Union with 18 dissimilar banks in Georgia, 3,600 employees, 154 branches across the state, and a lot of work to do. Four years later, First Union operates a unified statewide operation with 1,999 employees and 119 branches.

The banks took the First Union name in February 1987, but the process of transforming them into a manageable system had began in the fall of 1986 with the creation of a centralized approval process for loans.

"We had a $4 billion institution and wanted to keep it moving," said Harold R. Hansen, CEO of First Union National Bank of Georgia. "Keeping it moving," required reforming the lending culture of the First Railroad banks.

"There were clearly severe credit problems in that portfolio," Mr. Poelker said. Many of the small community banks followed asset-based lending policies that contrasted with First Union's cash-based lending strategy. "We had to show them that the asset is important, but how you're going to pay back the loan is more important," Mr. Hansen said.

Back-Office Bonanza

Initially, First Union faced a potential eight-year wait before it could fully consolidate the back-office operations of its Georgia banks, thanks to a contract that the First Railroad banks had with a third-party data processor, First Financial Management Corp.

"We really didn't want to wait eight years to convert from FFMC to First Union systems," Mr. Hansen said, "so we were able to renegotiate and bring it down to three years." With the contract set to expire in December 1989, First Union established a timetable and chose Atlanta as the site for the consolidation of administrative and back-office functions.

"The sad thing, looking back on it, is that it would have been an easier task if we'd decided on Augusta or Columbus, because those banks were larger," Mr. Hansen said of the decision.

Setting up shop in Atlanta meant additional employees had to be hired and trained to run the new service center, which would house First Union's back-office functions. Mr. Hansen estimated that the training, planning, and preparation for the consolidation consumed about 150,000 man-hours by the time the center was in operation in January 1988.

Uniform Product Line

As early as March 1987, Atlanta was home to First Union's Georgia headquarters, providing centralized control for the confederation of banks.

The new statewide bank also needed a consistent product line, a step that required unifying the 175 different transaction accounts offered by the 18 banks into a manageable list of 30.

Mr. Hansen estimated that restructuring the product line took about 130,000 hours and triggered the issuance of 130,000 new ATM cards, as well as the installation of 100 new teller machines and 560 new teller terminals. First Union also had to expand the operations of a trust division, which serviced five banks, so it could meet the needs of the other 13 banks.

By 1990, the transformation was complete and First Union emerged with a much leaner statewide operation than it had acquired three years earlier. The back-office consolidations, coupled with the reduction of the employee base by about 1,800 people and the elimination of 36 overlapping or no-growth branches, allowed First Union to save $30 million in operating expenses annually.

Slicing away the fat made all the difference for the bank financially: First Union of Georgia reported unimpressive returns on average assets of 0.59% in 1988 and 0.31% in 1989, but posted a healthy 0.99% for 1990. In 1991, First Union of Georgia is on the way to duplicating its 1990 performance, recording a 0.98% as of June 30.

[Tabular Data Omitted]

Mr. Dillon is an associate editor of Bank Mergers and Acquisitions, an SNL Securities newsletter. SNL is a data base and publishing firm based in Charlottesville, Va. outlay of money. Nor, by any means, are they all bad loans.

But because the insurance companies and others who provide permanent finance have fled the risky, overbuilt real estate markets, banks will have to keep most of these loans on their own books for a while longer. And these loans must be capitalized - at 8% of book value under a standard being phased in by the end of 1992 - with money that could have been held against new loans.

In addition, the banks are under regulatory pressure to adjust the value of real estate assets downward to today's values. This results in an additional drain on capital, as banks increase loss reserves.

In New England alone, according to one group of lenders, at least 100,000 jobs will be lost if appraisal standards for real estate aren't eased by the time the demand for new credit returns. This group, the real estate finance division of the Greater Boston Real Estate Board, estimates that every dollar of bank capital translates into $10 to $15 of lending capacity.

Overbuilding a Factor

That an overhang of debt left over from the go-go 1980s might flatten the economy has been part of the conventional wisdom for several years. And that is not only because corporations are pouring money into debt service instead of expansion.

The current recession is different from those past, because of "the extreme speculation in commercial real estate and higher-income" investment by banks, Harvard professor John Kenneth Galbraith said. "That's where the whole credit system is focused.

"The further effect of real estate [overbuilding]," he added, "is unemployment in the construction sector."

What caught many people by surprise, though, was the size of the wave of refinancing demand that reared up just when nobody was willing to lend on real estate.

Timely Payoffs Uncommon

The National Realty Committee, a lobbying group, cited a recent Federal Reserve survey of loan officers that showed only one-third of the miniperm and construction loans that came due in the last 12 months were paid off as originally scheduled. Most of those loans have been temporarily extended by the banks, in a trend that affects big domestic banks more than small banks or the domestic branches of foreign banks, according to the survey.

Large-bank problems are more likely to spill over into the national economy, impeding a recovery, the committee said.

Bankers told the Fed another two-fifths of the construction and miniperm loans on their books was due to mature in the next year, and 80% had no permanent financing arranged.

One banker, speaking on condition of anonymity, said the general policy at his bank is to extend the loans for two to three years - rather than provide a 10-year permanant loan - in hopes that the permanent-financing market will rebound by then.

Improvement Less Likely

But prospects of a rebound seem to be getting worse.

The seizure of Mutual Life Insurance Co. this summer accelerated a flight to liquidity on the part of run-sensitive insurance companies, said David Shulman, managing director and real estate expert at Salomon Brothers. Although their flight caused a sharp drop in the yield on seven-year Treasury securities, making it cheaper to refinance real estate with loans of similar maturity, the bottom line is that the market got "more illiguid," he said.

Illiquidity cuts banks in two ways. Not only does it force them to pick up more of the credit burden, it knocks the legs out from under the current market price of real estate collateral.

Leniency in valuing real estate is the measure most often proposed by bankers and developers, who complain examiners are forcing them to value loans based on today's liquidation value, rather than on a fair market price. The Office of the Comptroller of the Currency has conceded the need to recognize the future value of real estate, but bankers say the leniency is not yet in practice.

In a study commissioned by the Greater Boston Real Estate Board, appraiser Richard E. Bonz said that has to change, or-banks will be caught in a vicious cycle of declining value.

Not for the Losers

"This approach will not obscure the problems of permanently impaired real estate for which there is no reasonable demand," he said, advocating projecting future economic conditions in evaluating the probable demand for real estate.

To contrast his approach to the current practice, Mr. Bonz used the example of a commercial property loan of $12 million, in which the value of the collateral was temporarily impaired by the bankruptcy of a tenant and a temporary oversupply of office space in the market.

In the example, a recent appraisal valued the property at $11 million, and an estimate of fair value from a current sale of came in at $9.5 million.

According to Mr. Bonz, the regulators today would force a writeoff and reserve of $3.45 million, and $41.4 million of credit would be "erased from the system," assuming a 12-1 ratio of lending capacity to bank capital.

A Different Result

Using an appraisal method that allows the bank to recognize a $12.1 million market value - based on a 10% improvement when conditions stabilize - a $2.4 million loss reserve would be required, and only $28.8 million of credit would be lost.

Anthony Downs, real estate expert at the Brookings Institution agreed, saying the current practice amounted to telling banks to foreclose and sell as soon as possible.

"It's bad advice," Mr. Downs said. "It's like telling everyone in a fire you ought to be the first one out of the room.

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