The Hard Part For Chemical: Realizing Gains

Now comes the hard part.

The merger of Manufacturers Hanover Corp. and Chemical Banking Corp. offers great potential for eliminating redundant costs and creating a dominant force in the wholesale and retail markets of the New York region.

But while the possibilities are great, they are far from a sure thing.

The deal's success hinges largely on smooth consolidation of the institutions' business lines and sprawling portfolios. Senior management will have to achieve this without finding new credit woes and creating internecine conflicts. It won't be easy.

"We have our work cut out for us," admitted William Harrison Jr., vice chairman of Chemical Bank, who will assume the same post at the new Chemical.

Insiders and outside agree that the business lines mesh. Both companies are very strong in institutional finance, small and middle-market business lending, and retail banking. By combining these businesses, they will clearly become a more powerful competitor.

"We have a common sense of vision," Walter V. Shipley, Chemical's chief executive, told Monday's press conference.

"Overall, it's an exceptional fit," agreed Judah Kraushaar, banking analyst at Merrill Lynch & Co.

The merger announcement boasted that the new company would have the greatest number of primary corporate relationships among major banks. While that's an elusive figure to confirm, there clearly will be strong market penetration among blue-chip clients.

Each Has Expertise

Each player brings a certain expertise to the corporate and institutional businesses.

Hanover has one of the most "rigorous" credit cultures among money-center banks, in the words of a rival banker, and that allowed it to steer clear of the New York real estate market. It has a well-respected acquisition finance department that has strong relations with many deal sponsors, including Kohlberg Kravis Roberts & Co.

Chemical, on the other hand, has one of the most dominant loan distribution networks among banks. It recently raised more than $12 billion for American Telephone and Telegraph Co.'s new credit line at rather thin fees and interest rates.

"They're much better at syndication and distribution," admitted a senior money-center banker. "They're the market leader."

A Survivors' Game

Picking the survivors who will run these businesses will be like pro football's college draft: Competition will be fierce and only the best performers will remain, predicted a Chemical insider.

Areas where there is clear overlapping include the lending and syndication groups and brokerage units. Both banks are primary dealers in government securities.

Whoever comes out on top in the combination, bankers on both sides of Park Avenue are girding for serious retrenchment, and sooner rather than later. A full $200 million of the $650 million in projected cost-cutting will be squeezed out of institutional businesses.

"People are going to get creamed," said one official.

A Likely Casualty

One official with knowledge of the merger said one casualty would be the traditional relationship corporate banker. Hanover has at least 80 "relationship managers"; Chemical, a bit fewer.

"There are aggressive plans to pare the relationship managers," a source said. Spokesmen for the merging banks could not be reached for comment.

One of the biggest boons for the new Chemical will be the merger of businesses that cater to small and mid-size companies in the greater New York region. While banks do not specifically break out these smaller business loans, both banks have been market leaders in loans to businesses with annual sales of $1 million to $250 million.

"We'll be the equivalent of one, two, and three for middle-market business loans," said John F. McGillicuddy, Hanover's chairman and CEO-designate of the new Chemical. "This is an unparalleled strength in any marketplace."

|Owning' the Middle Market

"They will own the middle market," said Melville Blake, a partner at the Mac Group unit of Gemini Consulting.

But Chemical has one department that caters to these types of loans, while Hanover reportedly has three units. The officials involved in the merger, led by Joseph G. Sponholz, chief financial officer at Chemical, must "make the tough decisions," said a knowledgeable source.

The good news in looking at the combination of the two portfolios is that there is little in the way of overlapping credits. The bad news is that it might reflect the institutions' differing credit cultures. And there is still the risk of unknown problems as bank managements pore over the portfolios credit by credit.

The C&S/Sovran Corp. merger for example, was greatly impaired by Sovran's real estate exposure in the Middle Atlantic region.

Unplumbed Risks?

"There's always the question about if either party understands the risk profile they're getting involved with," said Mr. Kraushaar of Merrill.

Chemical has one of the highest exposures to commercial real estate as a share of loans, while Hanover is still grappling with its large exposure to lesser-developed-country loans. Executives believe those are offsetting risks.

"We really feel that as you bring the portfolios together we're not multiplying risk but, rather, spreading risk against a broader and stronger base," said Mr. McGillicuddy. "One of the things that struck Walt and I was the minimal overlap in HLTs and commercial real estate," he said, referring to Chemical chairman Shipley.

Chemical is still smarting from its mistakes in commercial real estate lending. It has 15% of all its loans, or $6.68 billion, in commercial real estate, according to Keefe, Bruyette & Woods Inc., and 17% is nonperforming.

"Hanover looked at the real estate credits Chemical put on its books and laughed," said a source close to Hanover.

Hanover, by contrast, has the second-highest LDC exposure among money-center banks, at $4.4 billion. Reserves cover 32% of its exposure, at the low end of such coverage by money-center banks.

Among highly leveraged borrowers, both have large pools of loans. The new institution's total exposure, including unused commitments, would total $9.54 billion, a hair's breadth away from Citicorp's huge $9.6 billion portfolio, according to data from Keefe Bruyette.

Commercial real estate loans would total 7.42% of total assets in the new bank, according to pro forma analysis of the balance sheet by Chicago Corp. That compares with a 10.55% average for the top 35 banks.

Says Mr. Shipley, "The combined company is a stronger company."

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