With financial modernization reform on the legislative fast track, wholesale bankers are probably salivating at the prospect of boosting their investment banking businesses through mergers or internal buildups.
Before bankers rush to create the next Citigroup Inc., however, they may want to consider that, though regulatory hurdles may be wiped out, there are still pitfalls in the marketplace -- culture clashes, economics, and a lack of suitably priced acquisition targets.
(A proposed FASB rule change would spur mergers next year but discourage them later. See story, page 3.)
"I think there will be a lot of mistakes made and probably more bad deals than good deals," said Richard Kovacevich, chairman and chief executive officer of Wells Fargo & Co. "I know there will be an initial flurry. Cross-segment consolidation makes a lot of sense ... but you can't let your excitement get the best of you." After all, widening loopholes in the current regulations have let companies such as Citigroup meld investment banking, specialty finance, asset management, commercial banking, and insurance.
But for every successful bank-nonbank merger there is a rocky marriage.
In 1997, the former NationsBank Corp. bought Montgomery Securities, a San Francisco investment bank known for financing Silicon Valley start-ups. A year later Thomas Weisel, Montgomery's CEO, departed, taking 100 of its most senior investment bankers with him.
Citicorp's $70 billion merger last year with Travelers Group Inc. wedded Wall Street powerhouse Salomon Smith Barney with Citibank's Fortune 500-oriented corporate bank. Before the merger closed, the No. 2 executive at Travelers, James Dimon, who had been responsible for overseeing the combination of the two corporate finance units, resigned amid criticism that the integration was going too slowly.
Deutsche Bank AG's 1989 buyout of Morgan Grenfell in London was marked more by infighting than profits. In 1998, the bank's investment banking technology group in Silicon Valley bolted to Credit Suisse First Boston. This year Deutsche's acquisition of Bankers Trust Corp. has also been bled by defections.
Even J.P. Morgan & Co., which set out in the late 1980s to build an investment bank internally and did some high-profile hiring from Wall Street firms, has only recently turned a profit with the venture.
In each case, the banking company paid mightily to retain investment banking talent, largely without success. Bankers said the real problem was not money but autonomy. The freewheeling style of investment bankers simply does not mesh with the bureaucratic tendencies of commercial bankers.
"You pay a price," said Sanjiu Sobti, a managing director of bank mergers and acquisitions at J.P. Morgan, "but the cultural issue goes well above price."
Donald H. Layton, vice chairman and global markets chief at Chase Manhattan Corp., said, "The old saying about investment banking is true: The assets go down the escalator every night." For many commercial banks, "it's hard to integrate those guys in. There's enough failures out there to show it's not as easy as it looks."
Mr. Layton also pointed to the shrinking number of investment banking targets as a deterrent to commercial banks looking for quick entree. The field is dominated by a small number of firms. The barriers to entry are high for a commercial bank, he said.
With regulatory constraints lifted, "there will be more of a push for size, scale, and consolidation," Mr. Layton said, and it will come from three directions.-- commercial banking companies, insurance firms, and investment banks. This will be "a three-handed game of poker rather than a two-handed game," he said.
For many banking companies, especially those in the $30 billion- to $40 billion-asset range, it may be safer and more sensible to focus on a core business rather than to seek out investment banking capability, said J.P. Morgan's Mr. Sobti. The key question for midsize banks, he said, is: "Do you get critical mass" through an acquisition? In other words, will you really be able to compete with other investment banks in the region?
"It doesn't make sense to dabble in this stuff," he said.
One of the financial modernization bill's chief authors, Gary Gensler, the under secretary of the Treasury for domestic finance, cautioned that diversification may not be for every bank.
"Just as with any other industry, some companies will be successful at serving their customers by remaining specialized and focusing on particular markets or areas," he said. "There will not be just one single approach that will be successful."
Ultimately, Wells Fargo's Mr. Kovacevich said, the financial services reform bill making its way through Washington is most likely to bring about banking and insurance deals. At least for Wells, there is no interest in becoming an insurer, he said.
"Manufacturing of insurance has never been a high priority for us. We see ourselves as a financial adviser and as a distributor. So just because we can doesn't mean we will," he said.