Carlos M. Gutierrez, chairman and CEO of Kellogg Co., is a brave man. He defied the stock market late last year, telling investors that double-digit earnings growth was "overly ambitious." Instead, he said he was "targeting mid-single-digit growth over the next several years."
Many a CEO would have been guillotined for that, and in fact, Kellogg's stock immediately plunged 5%. But sofar at least, Gutierrez still has his job.
Bankers have been under similar pressure, and several have lost their jobs as they failed in attempts to meet the unrelenting and fantastic demands of the stock market. But unlike Gutierrez, none has had the courage to speak out, trying instead to do the undoable.
Speaking out may have become unnecessary, thanks to the recent performance of the stock market, particularly the steep plunge in once-high-flying technology stocks. They set the market's tone by creating expectations that could not be met.
Even some of the nation's most sophisticated bankers were hooked by the hype that propelled price-to-earnings ratios of many technology stocks to infinity.
"I got converted--I became a believer" in the power of the New Economy, William B. Harrison Jr., said at the end of 1999, when his then-Chase Manhattan Corp. toted up $1.3 billion in private equity gains in the fourth quarter. A year later, that same portfolio produced a $300 million loss.
And Chase's stock--now J. P. Morgan Chase & Co.--rode the roller coaster up and down in tandem with the performance of the Nasdaq, where most high-tech and dot.com stocks are listed. Harrison's euphoria when high-tech stocks were riding at sonic levels reflected the general atmosphere that had characterized the markets.
The euphoria has subsided, but important remnants of it remain, sustaining the unreality that had permeated the markets. This lack of reality continues to exert unhealthy pressures on companies and executives.
The heart of the problem is the pressure to maximize profits on a constant, short-term basis. That pressure is driven by the importance placed on each company's day-to-day performance in the stock market, which in turn is based on expectations of growth in earnings and revenue. As a result, it is difficult for CEOs to implement long-term strategies, or to be willing to accept a few quarters of so-so performance to create a stronger organization for the long term.
Many companies thus are constantly making dramatic shifts in strategy to please investors. Banks, in particular, have been flocking into fields that, for the moment at least, seem to offer the pot of gold.
Private equity was one. In addition to Chase, others betting heavily on investments in fledgling companies include: J. P. Morgan & Co., which has merged with Chase; Imperial Bancorp of Los Angeles, which is being acquired by Detroit's Comerica, also an aggressive lender to Silicon Valley firms; and, naturally, Silicon Valley Bancshares of Santa Clara, CA.
In the long term, these investments may or may not work out, but they have destabilized the earnings and outlooks for some of these banks.
Many banks also have flocked into various aspects of investment banking, a field notorious for its volatility. Although historically investment banking has gone through seven-year periods of boom and bust, the current flourish has lasted far longer, causing people to forget the past.
But there are indications now that the business is slowing. In recent weeks, several investment banking firms and brokerages have announced layoffs, including J. P. Morgan and two online brokers, Ameritrade and E*Trade.
And the outlook isn't great. In the three weeks ended Jan. 4, according to Keefe, Bruyette & Woods, there were only 11 equity non-shelf filings, "one of the lowest levels in recent memory."
Still another field into which banks are flocking is wealth management. True, the business has been growing rapidly and those who have succeeded in it have shown handsome profit growth and high stock prices.
But how many competitors can the business take before competition becomes too great, driving down profit margins? That already could be happening in the wealth management field, especially if the market continues to be less robust than it had been, or if the rate of growth continues the slowdown begun in the fourth quarter.
Already banks that had started up mutual fund companies of their own are struggling to retain the assets they have accumulated. The latest figures show that assets are flowing out of bank-run mutual funds, creating a drag on profitability. (See cover story, U.S. Banker, January 2001.)
Other banking companies are thrashing about in the wake of failed efforts to increase earnings. California's UnionBanCal, which had aggressively tried to boost earnings and its stock price in the late 1990s, suddenly finds itself with a slew of nonperforming loans and is changing strategy. Now, like many others, it plans to focus on private banking, basically wealth management. And it will place even more focus on processing, a highly capital-intensive business. It plans to compete with firmly entrenched industry front-runners, primarily the Bank of New York and State Street Corp.
A good number of banks have stretched too far in efforts to maximize profits. Hibernia is an example. CEO Steve Hansel was recently fired because a buildup of problem loans practically eliminated fourth-quarter earnings.
He joined Hibernia in 1992 and rescued it from near collapse by cleaning up a huge load of non-performing loans. He brilliantly achieved that but then attempted to make it one of the more profitable banks in the country.
It had been earning about 13% on equity, which was okay by historical standards but not the kind of earnings that would make investors want to buy the stock.
To increase earnings and the share price, Hansel aggressively invested in nationally syndicated loans, with which the bank is now struggling. Hansel's successor is expected to refocus Hibernia's business closer to home.
Other banks that reached too far included First Union and Bank One. Again, their earnings were good by historical standards but their CEOs were caught up in the market mentality of constant rapid growth. It couldn't be done.
Some bank CEOs have had the guts to ignore some of the pressure, and their stocks have performed well anyway. They include Richard Kovacevich, of San Francisco's Wells Fargo & Co., and Ralph Horn of Memphis-based First Tennessee National Corp.
Wells Fargo, huge with $241 billion of assets, ignored analyst suggestions that it buy a large investment banking firm, and also dove even deeper into mortgage banking when that field was highly unpopular in investor circles, as it still is.
Similarly, First Tennessee, a well-balanced bank with $19 billion in assets, has not jettisoned its mortgage business, despite analysts' chagrin. Horn, like Kovacevich, has stood up to market pressure and has kept his company well diversified.
First Tennessee's price-to-earnings ratio based on expected 2001 earnings stood at 15.7 on Jan.12, well above the industry average of 13.6. And Well Fargo's was 19.5.
Bank CEOs, however, find it difficult not to heed the urgings of analysts because a bank with a relatively low p/e ratio is likely to become a takeover target, or shareholders might demand the CEO's removal, even if the bank is performing well by historical standards, which most are.
Not all banking companies need be the best; obviously, they can't all be the best because there would be no best. There is room for mediocrity as long as being mediocre is satisfactory. Considering that the average return on equity for the nation's large banks was about 19.6% in the third quarter, mediocre is extremely good by historical standards.
But if a bank is earning a return on equity of, say, 15%, and if analysts don't think its earnings and revenues will grow as rapidly as those of other banks, it could become a takeover target. The result is that managements often are forced to overreach.
This scenario has been encouraged by regulators, partly in the belief that a more concentrated banking system would be stronger. And that has happened. Bank profits have skyrocketed over the past decade, as the number of competitors has shrunk and as banks drastically raised prices, at least to individual and small-to-medium-sized business customers. The higher profits have also led to stronger balance sheets.
But new problems are beginning to crop up. The determination to be an acquirer rather than the acquired has prompted the taking of greater risk. And as banking resources become more concentrated among a handful of banks, the entire financial structure becomes more dependent on each of those institutions.
If the process continues to its logical conclusion, eventually there'd be one or two giant financial companies. And if one or both of them were to get into serious trouble, they'd have to be bailed out.
But now that the market appears to be returning to a more sober perspective, the pressures are subsiding, at least somewhat. No longer are investors looking for double-digit earnings and revenue growth.
"Today the market expects 8%, which is reasonable," says Ruchi Madan, who heads Salomon Smith Barney's bank research team.
So, the recent stock market declines, while painful in many ways, may prove to be a blessing in disguise.