After making their bread for years advising banker clients which banks to acquire or be acquired by, investment bankers have begun selling a different strategy.
A growing body of opinion within the investment banking community holds that survivors in banking will be the ones that acquire innovative financial services companies, rather than those that merely bulk up their commercial banking franchises.
"Banks traditionally have intermediated Cash, and they have got a fantastic infrastructure and overhead associated with that intermediation," said Gerard L. Smith, a managing director at Salomon Brothers and co-head of its financial institutions group in investment banking.
But that's "not a business anymore," Mr. Smith said. "The intermediation of information is a business, and the story of banking going forward, and the story of M&A in banking going forward, is going to be who understands that the best."
The banks that acquire data processors, investment managers, and the like stand to earn fee income that will make loan revenue pale by comparison, he said.
Buying dozens of branches in Florida or Texas will not cut it anymore, another leading advisor said. Not only are bank branches terribly expensive, they may not even exist in two decades, he said.
One of the reasons for this sea change in investment banker thinking began to be evident in the first half of this year.
Of the transactions that have occurred recently, many have been between midsize banks. Most of the large transactions have been completed, advisers agree.
Few Big-Bank Mergers Seen
Mr. Smith said that of the top 100 banks, only 10 or 15 would likely merge. And in fact, said Sanjiv Sobti of Lehman Brothers, if not for the Bank of America purchase of Continental in the first quarter, 1994 M&A activity would have been dramatically down from the past year.
Some experts said it may be a While before banks begin to focus on nonbank financial service companies.
"The consolidation will go on at a rapid pace for quite a while, and the trend will continue," said Richard Kneipper, a partner with Jones, Day, Reavis & Pogue in Dallas, a prominent law firm in the M&A field. There is still a lot to acquire out there, and only when that is exhausted will banks turn to the nontraditional firms, he said.
But a dwindling number of potential acquirees is not the only reason banks are increasingly being advised to look outside their industry for growth.
Banks have a vast untapped reservoir of information that is left unused, Mr. Smith said. It is this information that is the commodity of the future. Knowledge of transactions is more valuable than the transaction themselves, he said.
"Asset management is information technology, banking is information technology, investment banking is information technology," Mr. Smith said. "The market knows this.
"The firm you would want to own is Bloomberg [Financial Market and Business News]," he said. Founder Michael R. Bloomberg "sits on the fringes of the banking world reporting on what we do. If he were to sell his business he would get 40 or 50 times earnings. If we were to sell our business, we would get 14 to 16 times earnings. Is that fair? No."
Mr. Smith's view is hardly universal, but more investment banks now are directing acquirers' attentions away from traditional targets.
Management Companies Next?
Michael E. Martin, managing director in the depository institutions group of CS First Boston, predicted there will be a wave of purchases of investment management companies.
While bank acquisitions of mutual fund companies have received a lot of attention recently, he said, the price for these companies may be too high. Banks will still seek mutual fund alliances, he said but investment managers are cheaper.
One investment banker said he had contacted a number of investment managers who were eager to negotiate mergers with banks.
One potential hookup to look for in the future, the banker said, is Pasadena-based investment manager Provident Investment Counsel, which has $11 billion of assets under management. Keycorp and Boatmen's Bancshares both are rumored to be interested in the company.
Question of Attitude
"On the institutional money management side, the issues are more cultural than anything else," Mr. Martin said of the obstacles to purchasing an investment management' company.
"The issue here is: Does a conservative bank want to give an investment firm millions that will be divided up by just a few people who walk away?"
Buying an investment management company for $50 million means multimillion-dollar payouts for the founders, he said.
"The thing is, banks have their own culture, money managers have their own culture, and to get those two cultures to be compatible is certainly a challenge." added Mr. Sobti, of Lehman Brothers.
Mr. Sobti agreed that investment management companies would be popular in the future, but he pointed to mortgage banks as the attractive play right now.
"Mortgage banking, especially the origination business, is basically at this point a very fragmented industry," he said.. "In some ways the origination business is a cottage industry. Therefore an ability to expand nationwide is generally easier than for a bank, because for a bank to expand nationwide they would have to make a series of acquisitions of different banks."
Mr. Sobti disagreed however, that bank branching is on its way out.
"Quite honestly the biggest competitive advantage the banking industry has going for it right now, including on the investment side, is so many stores out there that reach out and touch the customer."
Branches Seen as Passe
Mr. Smith of Salomon Brothers countered that roughly 80% of the people that use branches are over the age of 40. The age of branches is coming to a close, so that by 2010 there will only be 10 superregional banks left, he predicted.
By that time, he added, banking will be only one function of a financial services company.
Some competitors already are offering customers financial statements that combine credit card, mutual fund and credit card information, and the statements figure to become even more comprehensive.
If banks could offer such a statement, Mr. Smith said, customers might be willing to pay more for some' of the services.
"The real value added for the user of financial information is the statement," he said. "And the guy who wins is the guy with the best statement."
Customer Loyalty Lauded While agreeing all banks must find sources of fee income, M.A. Schapiro & Co.'s Richard J. Kelly, said today's deals, in Which banks gobble up banks, are headed in the right direction.
Schapiro, whose founder Morris Schapiro is best known for advising the merger that resulted in Chase Manhattan in 1955, services midsize banks, and owns over $300 million of bank stocks.
What the large institutions miss-both investment bankers and banks-is the loyalty engendered by small banks, Mr. Kelly said. Smaller banks will always have a place, he concluded.
Murray M. Beach of Advest Inc., which advises banks ranging in asset value from $200 million to $2 billion, said that when a large bank moves into a new state, opportunities are unleashed for small banks.
The new bank will not want to expand into every nook and cranny of a state, he said, so that leaves these areas ripe for community and midsize banks.
Because the deals are smaller, and because banks have so much spare capital, another key change in the M&A market was in evidence this year.
Many of the transactions are now being financed with cash, noted Mr. Martin of CS First Boston. And even of those financed with stock, the buyer is often buying that stock back with cash, he added.
Only when stock prices reach higher levels, he said, will banks return to stock transactions.
On a topic much in the news there is wide disagreement: interstate banking Mr. Smith and Mr. Martin concur that there is already de facto interstate banking, while others say there are too many restrictions intact to describe American banking as interstate.
"Why bother talking about interstate banking? It is a non-event; it happened years ago," Mr. Smith argued. "It's over. Anybody who wanted to do it did it."
Not so, countered Mr. Sobti of Lehman Brothers. Bank holding companies have to establish separate banks in each state, and the Southeast is off limits to all outside banks, he said. Passage of the interstate banking bill will definitely be a boon to M&A, he said.
But whether or not interstate branching is a factor, whether banks continue to consolidate with other banks or look outside the industry for partners, whether they use cash or stock, there is one thing on which the experts agree: In a matter of decades, mergers will render the face of the banking industry unrecognizable.