At 64, Hugh L. McColl Jr., chief executive of Bank of America Corp., is reaching retirement age. He has been one of the foremost pioneers of interstate banking. He engineered the expansion of what had been a $12 billion Charlotte bank, North Carolina National Bank, into what has become the nation's second-largest banking company, with assets of $680 billion. With this history behind him, McColl has a rich perspective of the past and a strong platform for seeing the future.
Following are excerpts from an interview with McColl by U.S. Banker editor-in-chief Robert A. Bennett.
USB: Where is banking going, and where does Bank of America fit into the picture?
McCOLL: Banks have been around for a long time, hundreds of years, and they'll be around for hundreds more, whether in the same form or not. Probably not, because over my 40 years in the business, we've changed dramatically. The difference between banking and other businesses is that banks have retained the capital they have generated. That gives them a huge advantage in any ongoing battle of financial services companies. So banks will survive and prosper, but they'll do so in a continuously changing fashion.USB: Do you think banks will continue as institutions, or do you think banking will continue as a function?
McCOLL: You could ask why are any of us banks? Why do we submit to the regulation we do? Theoretically, it's two things. One is to be able to attract funds from individuals because of the FDIC insurance. Second is the ability to go to the window at the Federal Reserve during periods of trauma and borrow against our assets to create liquidity, which then can keep the economy going. You could argue those things are not as important as they used to seem. Having said that, no one seems to want to get out of the banking business. On the other side, nobody seems to want to get into the banking business either. That is, insurance companies don't want to become banks.
USB: But we see Merrill Lynch now operating two banks, and Schwab is offering bank-type services. It seems that companies are getting into banking without the obligations of a bank.
McCOLL: There's a lot of truth to that. There's always been the ability to create a single-purpose bank and remain outside general banking regulation--taking deposits only or making loans only. If you go back two decades, we used to worry about Sears Roebuck becoming the dominant financial player, and since then they have essentially discarded all of their financial companies. So I don't worry about that very much. At the end of the day, it's going to be the people who have the customers and the capital and the will to do what those customers want who will win.
USB: It's interesting that you talk about the importance of capital. I thought that had become passé.
McCOLL: Most of us believe that cash flow is what really matters. How much money do you make on the money that you invest? How much cash does it throw off? This company, for instance, will throw off more than $10 billion in free cash this year. That's a huge amount of money that then can be reinvested, can be used for any purpose you want, and it's very real.
We all know that financial assets are subject to fluctuation. And the industry, either through pressure (deregulation or otherwise) will move to a total mark-to-market environment. Then capital will matter even more because you will have to be able to sustain movements in your asset base--that is, the valuation of it. You need capital to do that. Arguably you could be an institution in which you create assets, repackage them and sell them through the market. But that presumes there's always a market there, and experience tells us that's not the case. So my own judgment is that capital will remain important.
USB: So you don't see banks, in effect, becoming the equivalent of investment banks where they hold very little themselves?
McCOLL: Well, yes, I do. We already are doing that. We already package a number of our consumer assets and sell them through securitizations. We do a great deal of syndication of loans, which I call "going away" sales. The issue is, though, the periods I call "Sell to whom?"--the times when the assets cannot be distributed. We've been through that sort of period in the high-yield market, which of course is a euphemism for the junk bond market. So, while I believe companies like mine will create a huge number of assets and sell away a great number of them, we will continue to carry some on our balance sheet. We'll do that for a number of reasons: one might be that the customer wants you to; the other is you'll want to leverage the capital that you have.
Now, do we have too much capital and too many loan loss reserves? I think the answer to that is probably yes. That's always been a problem for the industry and has created an equity problem for us vis-à-vis investment banks.
But let me ask you this: How many investment banks have bought banks? Big banks? The answer is none--unless you consider that Salomon bought Citi, which is a distinct possibility. But the issue is really that the people with the capital, ultimately, if we decided we wanted somebody, we could acquire them--the reverse is not true.
USB: But the Wall Street firms have the market capitalization. Morgan Stanley's price-to-earnings ratio is much greater than yours, and I suspect that, if they really wanted to, they might be able to take you over.
McCOLL: Morgan Stanley? That's interesting.
USB: Could you elaborate on that?
McCOLL: I can't elaborate on that because I don't contemplate that. But one would have thought the reverse of that would be possible, as well. I would have thought the reason an investment bank doesn't want to do it is because commercial banking requires a different type of management and a different type of income distribution and a different type of regulation--none of which they want.
USB: Do you see banking moving toward huge conglomerates? Citigroup seems to be coming close to that.
McCOLL: Citigroup is unique in its particular shape, and Citicorp has always been a very powerful international bank headquartered in the United States. Citi continues to have very good returns from its foreign operations recognizing, of course, that it's been out there for many, many, many years. It's a very mature organization in its offshore operations.
Wall Street's capital market earnings have been getting higher multiples than investors currently are willing to pay for what you might call annuity earnings. One wonders whether it's a phenomenon that will last forever; one doubts it. So it's hard for me to say whether what we see today in market capitalization will be a consistent picture. I haven't seen anything stay the same over my career. And I haven't seen P/Es stay the same; I've seen them go all over the place. Ultimately, what matters is: Do you make money and do you make it consistently? Is it predictable?
USB: How does a CEO deal with a sharp decline in the P/E ratio even when the bank is doing fairly well?
McCOLL: It's extremely difficult. My judgment is that if you produce earnings long enough, the market will pay you for them. In other words, the market over time is rational about earnings. Now, whether or not you survive to get to the end of that is another subject. At times, markets give companies very high P/Es because they like the sizzle in the steak. At other times there's no sizzle--P/Es come down. I call it the old Oklahoma offense: three yards and a cloud of dust. Sometimes what you do is just three yards and a cloud of dust--but you still score. And I expect that our businesses will be around for a long time. It will be dramatically changed; you know, technology is changing our business as we go.
One would have thought that the people who really ought to be worried would be investment banking firms. When I came into the banking business, banks furnished all short-term credit to the corporate world. Very quickly commercial paper started emerging from the triple-A issuers, then the double-A's and the A's, and many began to issue their own paper.
Today large issuers--that is, very, very strong companies--can issue their debt and perhaps even their secondary equity options through the Internet. Will this change the reward system in the sale and distribution of securities? If it does, what effect will that have on the firms that have been making huge amounts of money out of the distribution and sale of equities and debt--including my own? It's an issue for all of us.
USB: My sense is that securities firms are brilliant marketers who make fortunes because people are willing to pay them. That seems to have been true throughout history. Is there any evidence that will change?
McCOLL: There's no evidence at the moment it will, except this rising tide of Internet distribution of both debt and equity that is starting to take place. If you let Joe Public find that he can buy shares without paying inordinate acquisition fees; or, that a triple-A company or a double-A company can issue its securities without paying anybody for it, hey, they'll do it. It's the Wal-Mart theory. In other words, everybody likes dealing with the local hardware store but they go to Home Depot. There are changes going on right in front of our face, and there's no reason to think they won't be real.
USB: For your acquisitions, I suspect you used investment banks.
McCOLL: Yes, we did.
USB: Might you consider not using them?
McCOLL: I've always considered not using them because we had our own financial people and, candidly, we did our own evaluations. Having said that, convention seemed to require that the boards of directors get fairness letters, which then lead to hiring investment banking firms, if for no other reason than providing fairness letters.
Because investment bankers like to make money--and there's nothing wrong with that--they have, in fact, from time to time facilitated the transaction by encouraging the other side. But, as you point out, they're really very good at sales and marketing, and so part of their role is sales and marketing of an idea, so that the Street accepts the new shares that are being issued.
So the investment bankers' real value-added, as I see it, is in support of the stock of the merged company. They did that and were very helpful to us. Merrill Lynch was particularly helpful during much of our expansion period. Bear Stearns was very good at marketing our shares, and lately we've gotten help from others, like Goldman Sachs. Salomon was originally our investment banker, going back into the Sixties. So we've used them all over time--always for the same reason, distribution.
USB: Back to the issue of capital. It seems the importance of capital has declined because most people seem to think the good times will continue indefinitely. What do you think?
McCOLL: I think they're wrong. They're going to have to repeal the laws of economics that have been around for thousands of years.
USB: Is that why you think ultimately capital will be important?
McCOLL: Yes, it is. Businesses will have to be able to withstand difficult times.
USB: My impression is that most people don't care or even think about that. Yahoo has little capital but some people think it someday might supplant Bank of America. Why is Bank of America any different from Yahoo?
McCOLL: That's a valid observation. It takes difficult times or the inability to get money before they'll understand why you want to do business with somebody who has staying power. The Internet has great promise. It's alive and well and breathing, and it'll be here for the rest of our lives, just like the telephone system has been.
Having said that, at the end of the day, the consumer wants fulfillment. When you go shopping on the Net, you want it to work. To Amazon's credit, when you buy a book from Amazon, they send it to you--so you get fulfillment. Now, whether Amazon makes money at that or not is another subject, but the fact is you get fulfillment. Well, the same is true in banking on the Net. If you cannot fulfill the customer's demands over the Net, they'll go somewhere else--and they'll do it very rapidly because they are fickle.
So the advantage I see in capital and the advantage I see in our size is that we already have the back-end of the business. Our real challenge is simply delivering what we already have through the Net. We already have the capability of fulfillment. The guy who starts a new Internet bank and can take deposits or maybe find a mortgage loan can do single-product jobs, but can he deliver a broad array of products in-depth to large numbers of people?
I underline the phrase, "large numbers of people," because to serve many people you need a great deal of behind-the-scenes computing power, storage power, whatever, to handle large numbers of transactions. It requires scalability--and a lot of people just don't have that. It's expensive.
USB: It seems there are vendors who can supply that. BMW is a good example. It decided to create a bank, so it went to an outsourcer which has a lot of capability in terms of scale. It seems that's all it takes to start a bank.
McCOLL: There is some truth to what you say, but it's not clear to me that that's true where scale is an issue. Now also, if you're on the Net, people expect a lower price. Can you get paid? Can you pay for the back-end of the business? In other words, it's not clear to me that this competition is any different from any competition I've faced over my career. It's always been a business in which new vendors were coming into the market all the time--single-purpose companies like the credit card companies. Only one of any significance has really survived, and that's MBNA.
I'm not very much afraid of start-ups or single-product companies. They just don't scare me. I mean, if you asked if I think Citigroup is a formidable competitor? Absolutely. Do I think Merrill Lynch is a formidable competitor? Absolutely. And there are others, but...
USB: You don't worry about the start-ups.
McCOLL: No, I do not. We are growing faster than all the start-ups. We are adding 100,000 to 125,000 Internet customers a month. About 20% or 30% of them are brand new customers--20,000 to 30,000 new accounts from outside our company every month.
USB: To what do you attribute that?
McCOLL: Brand, scale, outreach, got a product.
USB: How do people who are Bank of America customers today find you?
McCOLL: Find us? Through bankof-america.com. And we haven't really been promoting the brand. This is without any advertising. We're getting ready to launch a long-term brand-building advertising scheme in September, which will run on and on. It'll be in there forever.
USB: What does this mean for your branches?
McCOLL: If you look at our branch system today--which we call banking centers--we have about 4,500. We probably have closed, just in the last three years, 500 banking centers--Florida and the Boatman's franchise, and a little bit in the Bank of America franchise. Certainly in Texas--145 in Texas alone when we merged Bank of America and NationsBank in Texas. We've been closing branches at a very high rate. We don't make much ado about it. We average about 10% per annum.
We opened new centers in fast-growing markets like Los Angeles, Raleigh-Durham-Chapel Hill and Atlanta. So we're opening centers at the same time we're closing, but we're opening fewer.
Our goal will be to convert a number of these centers into what I call "full financial" centers that will offer a multitude of products--not just banking products but insurance products and particular investment management products--and we'll have salespeople doing it. So there will be a gradual conversion of a lot of our centers into multi-purpose stores.
It will always be a work-in-process; that is, some will be closing, and over time we will have fewer. But at the same moment, we're trying to open in Chicago, New York, Boston and Philadelphia.
USB: So do you think that the acquisition of this huge branch system will ultimately make sense because it will help you with the Internet?
McCOLL: We find that even our most sophisticated Internet customer visits our branches at least once a quarter. In fact, our most sophisticated customers use all of our avenues of approach. They use ATMs, they use the telephone centers, they use the Net, and they occasionally use a banking center. Nevertheless, the percentage of transactions has continued to drop in the banking centers. It has stabilized, it seems, at around 26%, 27%, 28% of transactions.
Over time that will change. But we believe the migration is an evolution not a revolution. We wouldn't attempt to go with a different delivery system without the banking centers because they're very important in our overall game plan. We have to make them better-selling stores. We have very definite sales goals for our people in our centers. That's very important in trying to build a business in terms of revenues.
We do business with 30 million households. That came with the branch network. We didn't set out to buy a branch network; we wanted to enter markets and capture the customers and the revenue streams, and that's what we're doing. Thirty million households, 2 million businesses, gigantic revenue stream--so, hey, yeah, it's been successful.
USB: Are the banking centers important to maintaining that?
McCOLL: Absolutely. Even Schwab would tell you it opens a majority of its accounts at its centers; Fidelity, the same thing. So even though they're very sophisticated companies using the Net, they still use their physical facilities to introduce the customer to their company. Otherwise they'd get rid of the centers, right?
We need stores to keep people's attention. We think ubiquity has value; that is, lots of ATMs. We like having them in branches, we like having them in stores, in filling stations. We like our ATMs everywhere because we want to make it easy for people to do business with us.
USB: You mentioned earlier that there are some holes in the system, that you'd like to go to New York and Chicago.
McCOLL: We have a very large private banking business in New York, plus, of course, every other arm of our company except our consumer bank.
USB: So would you like to expand your consumer bank in those areas, too?
McCOLL: We'd like to expand our private banking, our premier banking. And the way we would do that is not by buying anybody. If we bought anybody it would be just to get the license. Then we would use the Internet, telephone banking and ATMs and some de novo centers. I'd call them "above the ground" centers; that is, second-floor banks or third-floor banks. We are going to do that in New York and Chicago, probably within the next 12 months.
USB: We've seen two other companies that have grown very, very quickly like yours--Bank One and First Union. You seemed to have avoided some of their problems. Do you think it was skill or do you think it was luck?
McCOLL: I can't comment about other people's problems. My own judgment would be that we've been successful in mergers because we have one person in charge...
USB: That's you?
McCOLL: Yes. We start off with clarity of who's in charge. And I don't mean just me, I mean about everything. We have a way we do things and that's the way we do it.
Do we make mistakes? Absolutely. In Florida, we changed a teller system in the middle of the merger in which neither the old NationsBank people nor the Barnett people knew the teller system. This created a problem for us. We haven't done that in California. In California we've integrated one banking center at a time, or five or 10 or 15. We will complete the installation of the new teller system in California without a glitch, and the reason is we learned something in Florida. You know, don't get in a hurry, don't slam it together in one fell swoop.
USB: You were saying before that Sears tried to get into the banking business, and that it fell apart because it wasn't a financial company. Might that theory apply to Bank of America's attempt to offer a wide array of financial products?
McCOLL: I went to Sears to buy some rubber hose the other day; I like their rubber hoses. But I wouldn't have thought about buying stocks while I was there, or insurance. That wasn't on my mind. I was working in the yard, and I wanted hoses. It was a concept that failed to take into account customer preferences.
That theory could apply to Bank of America. One of the reasons we've never bought an insurance company is we know very little about it. So we want to sell somebody's product--someone else manufactures it, we want to distribute it--and we want to learn about distribution and get paid for it. Will it be successful? I don't know that. We'll see.
We do know that in the investment management area--particularly in the mutual fund area--the banks were very late to the party, and they ceded trillions of dollars. We have about $100 billion in mutual fund assets under management, but we certainly don't have our share of the market. We want to increase the penetration of our own customer base.
We know we can't do that selling only our mutual funds, we have to sell other people's. So we're looking for alliances in which we partner with other mutual fund companies, in which we sell some of their product, they sell ours--so we gain in the distribution. You'll see us have a number of alliances going forward.
USB: There are other organizations that are great distributors--let's take Charles Schwab & Co. Isn't it doing the same thing? I don't think Schwab wants to be a manufacturer of bank products.
McCOLL: No, I don't think Schwab does, either.
USB: But might they be successful in distributing perhaps under their own name someone else's banking product?
McCOLL: I think that's quite possible, and I believe that to be true. The best companies, whoever they are--Schwab being one, I don't know--will be able to successfully distribute their own brand, branded product manufactured by someone else.
The issue, then, is whose? Where will they get the product? We don't rule out our having an arrangement with Schwab. We haven't talked about it, but we don't rule it out. We don't rule out having relationships, alliances, partnerships, whatever you want to call them, in which we distribute one person's product and they, in turn, distribute ours. But it is not likely that we will give anyone access to our distribution system that doesn't offer some kind distribution system that helps us.
USB: Do you think those kinds of arrangements can go on forever in that form?
McCOLL: I don't know if things ever go on forever. Having said that, if people are satisfied on the earnings side--that is, if you get real benefit--then they can go on for a long period of time. You have a very subtle issue which is very important--the customer wants to know with whom they're doing business.
If you sell your mortgage servicing, the bank then has lost control of the type of service that that customer is going to get. The first time the customer has a problem, they don't call the XYZ servicing company, they call the bank and say, "I have my mortgage loan with you, I want you to know this, that and the other, this isn't happening," and they get mad as hell if you tell them, "Well, we've sold that loan."
So customer service--if you believe at the end of the day that that's what really matters--means that it is very difficult to cede away the customer contact and the servicing to someone else simply for a profit. In the short-term you can make money doing that, but in the long term it would be hard to hold onto the customer. So that's one of the key issues.
USB: Former Citigroup co-chairman John Reed said recently that Citicorp had been thinking of linking up with AT&T. Can you see something like that with Bank of America?
McCOLL: I don't know if I can see something like that, but over the years I've actually talked with my associates about, for instance, if we thought Quicken was a better product, why didn't we buy their company? Yes, I can see linkages between software companies or communications companies and the Bank of America.
It's a little-known fact, but we have the second-largest communications network in the United States, second only to AT&T. That includes cables and things that move data and voice transmissions. I don't rule out anything as a possibility. It may be that we find that we need a partner in network distribution--somebody like Yahoo, just to illustrate--but I don't know that. I don't rule out any of that.
USB: If you have such a big physical communications network, have you ever thought of leveraging it?McCOLL: Yes, we have, but I want to make a point: I mentioned scalability to you. You have to be able to move data in massive amounts if you are going to have 30 million households doing business with you. And the payments system requires the moving of huge amounts of data. We found it was better to have our own network than to be dependent on satellites that go down.
Now, we also use other people's networks as backups because you must have backup.
But it's very hard to think about ourselves going into what I'll call the "common carrier" business. You need gigantic capacity to do that. And we can't let it get in the way of our own business. So we haven't contemplated it seriously, but we know it's a leveragable asset, and someday we might do that, let people piggyback on our system, particularly as technology improves so that we can compress data and have much more information run through our existing network. It's a very interesting issue.
USB: Where is most of your capital spending going?
McCOLL: A lot of our capital spending, or software spending, is directed towards providing customers with information about all their relationships with us in a format they want and like. And also providing them the portals to get their other information through us--in other words, to be an aggregator of information as well as a furnisher of our own.
USB: How can you get people to use you as their aggregator? Everyone's trying to do that.
McCOLL: Because we already have the customer. Just to make a differential point, there's no question Citigroup has a much higher P/E than we; no doubt that they have a lot of customers. But they're not nearly as big as we are in the United States. And that gives us an advantage.
Bear in mind that we operate in the fastest-growing part of the United States--the Sun Belt. It's still Raleigh-Durham-Chapel Hill, Charlotte, Atlanta, Miami, Orlando, Austin, Texas, Houston, Dallas, Dallas/Fort Worth, etc.--San Diego and Los Angeles, Phoenix. Need I say more? San Francisco, the Bay Area, Palo Alto. We're growing faster in California than we are anywhere else in the United States. We're the largest bank in California by some staggering margin.
USB: Everyone talks about wireless. It seems like merely a step beyond the Internet. What am I missing?
McCOLL: I don't think you're missing anything. There are two things that all Americans know how to work, and that's their telephone and the TV set. My own judgment about which will be the preferred devices over time; It will be this so-called wireless device, which is nothing but a telephone; and the second one will be the TV--the TV will become the home computer.
The issue with wireless is mainly security of information. There's going to have to be a great deal of scrambling of data, scrambling of information. Again, the technology is there. The question is affording it and getting the necessary speed. Banks have a huge advantage in terms of security because we've done a lot of work and have demonstrated that we are very capable of protecting ourselves against invasion.