John G. Medlin Jr.'s contrarian views have earned him a reputation as the Cassandra of the banking industry.
During the late 1980s, at a time of record earnings for banks, the chairman and CEO of Wachovia Corp. warned of trouble ahead. Two years later, most of his peers were struggling under the weight of bad real estate loans, while Wachovia was steering an even course to profitability.
Today, with the market bullish on most bank stocks, Mr. Medlin is again sounding a cautionary,
In this interview he questioned the high prices being paid in mergers at a time when branch networks are becoming less valuable.
Q.: What is Wachovia's general approach to acquisitions?
MEDLIN: People get the impression sometimes that we aren't as interested in acquisitions and expansion - when in fact, we really are. It's just the pace and approach that differs from others.
It doesn't mean their strategy is wrong. It just means ours is more appropriate for our emphasis on quality. If you want to have a premium price-to-earnings ratio and keep it, then you don't want to destroy that by pulling your quality down.
When you look at all the things banks can do without having a branch office presence - credit cards, automobile financing, and home mortgage financing - I think you have to be especially careful today not to pay too much for an expensive branch office franchise, which is really becoming somewhat obsolete.
Over the last two decades branch offices were justified, probably more than any other reason, for core deposit growth.
There was dramatic growth, particularly in the 1980s, with deregulation. That occurred because the economy was growing more rapidly than today [and] because of the flat yield curve, sometimes a negative yield curve, where it was sometimes as advantageous to have 90-day CDs as it was to have 30-year Treasury bonds.
Today the yield curve is more traditionally sloped, and the prospect, I think, is that will continue for sometime. Banks are experiencing disintermediation for the first time with low rates.
Q.: Don't consumers demand the convenience offered by branches?
MEDLIN: Well, I think the convenience means largely being able to make deposits and cash checks and do transactional work, which we can provide through automated banking machines.
I'd point out that the largest financial institution in America, in terms of the money it handles for other people, is Merrill Lynch.
And it does not have branch office networks, like banks, throughout the shopping centers and across the countryside. Merrill Lynch is a little bit of an argument that convenience may not be all that important, that price and service and variety are important.
It sort of goes back to, again: What are you going to do through all those branch offices? What can you do through an "800" number? How are you going to get back the premium you paid for a branch office network?
Technology is probably a more important expenditure today than brick-and-mortar branch offices, because that's where you get the new services. the cost savings, the variety and efficiency of service. I think it's a question of how you spend your investment dollars.
Q.: What kind of technology should banks be investing in?
MEDLIN: I think you have to look at everything a bank is doing and ask whether there's some way it can be automated. Because somebody else is going to be across the street from us or on the "800" number competing with us that's got a more efficient or faster system.
Q.: Are you more concerned about competition from nonbank financial institutions than from other banks?
MEDLIN: I think you have to worry about both. You have to worry about your bank and thrift and credit union competitors, but also just as much about nonbank competitors, who have for some time been selling banklike services out of nonbank networks that aren't brick-and-mortar oriented.
You may need an office of some sort in major cities, but it doesn't necessarily have to be a full-service banking office.
You have to be accessible to people in that city whom you need to visit with, but it may not be a corner lot on a busy thoroughfare where you're competing with Burger King and McDonald's for expensive real estate. It may be an office building somewhere, a professional building.
For commercial banking, you really don't need branch offices at all. You fly to see customers, drive to see them. You hook them up to your computer, their checks are mailed to your post office box, you clear for them, concentrate their cash. You don't need expensive branch offices to do middle-market and larger corporate banking.
Q.: But aren't branches helpful for small business banking?
MEDLIN: With small-business banking, it would be helpful. But again, that small-businessperson may go into that professional center to see you, rather than have to go to the traditional. full-service branch.
I think clearly the franchise value of branch office networks has declined, and probably will continue to decline. So you have to be careful not to pay too much for them - particularly. I think, with savings and loan organizations. All you really get there are deposits. You don't get a broad customer franchise of automobile loans, credit card loans, commercial, and small-business loans.
Q.: Can't you convert those customers to commercial bank customers?
MEDLIN: Our experience in converting savings and loan customers to full service bank customers has not been great. Most S&L customers already have a bank. Their S&L relationship, in most cases, came about because the S&L was paying a higher rate than its neighboring bank. That no longer exists.
Q.: Are potential acquirees, then. overpriced in the current bull market?
MEDLIN: What you have today is a situation where most banks are looking at a stock price that is substantially better than it was a couple of years ago. Earnings are much better.
I think you have to wait maybe two years from now and they might be looking back and saying, "Gosh, our business hasn't grown very much, our earnings haven't grown very much, and our stock is not up." I think we'll get a little more equilibrium in the marketplace.
Q.: Can you squeeze enough cost savings from an in-market deal to justify an acquisition?
MEDLIN: We don't focus on that, necessarily. Is it better to take the customers away from your competitors or to acquire them? If they've got an expensive branch network that is also becoming obsolete, yeah, maybe you can close it down. But you need to pay for those branches and then close them down.
We consider all the options that might be available, including in-market acquisitions. But if we already have a good market presence, that may not be very attractive for our shareholders. Closing down branches and laying off people is not much fun.
All that is a side road to saying the acquisition strategy of the past won't work in the '90s and into the 21st century. You have to look at different things than you looked at in the '80s and '70s to justify acquisitions.
Q.: How do demographics affect your acquisition strategy?
MEDLIN: Acquisition strategies have to be viewed against the backdrop of the future, not of the past.
In the past, we were buying a book of core deposits and customers who utilized traditional services. We have to look to the future, where we're buying a book of core deposits, which is eroding, and a book of customers who are looking for different things than they did years ago.
The baby boom generation is getting into middle and older age. Moving into their 50s, they become savers rather than borrowers, investors rather than spenders. And the 18-to-34 age group does not grow during this decade, when during the last two decades it grew phenomenally.
So there's a quite different demographic profile that banking needs to be aware of, particularly in the consumer area.
