Why Bank of Boston Deal With Shawmut Came Apart

Bank of Boston Corp.'s intense effort to acquire Shawmut National Corp. two months ago seemed to grind to a halt because regulators insisted that more equity be pumped into the deal. But it turns out another factor was the real roadblock.

Just six days before the merger was to be announced, Shawmut's investment adviser, Morgan Stanley & Co., balked at the terms, according to people familiar with the matter.

A Question of Fairness

Morgan refused to issue a so-called fairness opinion that would say the price was adequate for Shawmut shareholders. It maintained that concerns about the quality of Bank of Boston's loan portfolio demanded a higher price.

While the deal is not dead, Morgan's stance clearly crippled it. Shawmut has since hired Price Waterhouse to examine Bank of Boston's portfolio, and merger talks are on hold until the end of December, when the accounting firm is expected to complete its review, sources said.

Morgan's objections put on ice one of the worst-kept secrets in banking history. Usually, merger negotiations are carried out in strict confidence, but the fact that Bank of Boston was talking with Shawmut became common knowledge early on.

CEO to CEO

The talks, code-named Stanley Cup, were held in Boston's Meridian Hotel and over the telephone - largely between Ira Stepanian, Bank of Boston's chief executive, and his Shawmut counterpart, Joel B. Alvord. In honor of their local hockey teams, Bank of Boston was called the Bruins and Shawmut was code-named the Whalers.

The tentative agreement called for Bank of Boston to pay 0.87 share of its stock for each share of Shawmut. At current share prices, the deal would be valued at $1.8 billion. It also called for $625 million in capital to be raised in a stock offering.

A Sept. 9 press conference was planned to announce the merger, and press releases were being drafted. But when Morgan Stanley balked Sept. 3, the press conference was canceled.

Another clash developed over a meeting scheduled Sept. 5 with regulators, including William Taylor, then the top banking regulator at the Federal Reserve.

Fear of |Secondary Role'

Sources said an argument developed over what was to be presented at the meeting. Shawmut's executives were "very sensitive not to be taking a secondary role," according to one source.

Shawmut's Mr. Alvord had come under regulatory pressure this year to improve loan quality, while Bank of Boston was said to be on better terms with examiners.

Morgan's failure to issue a fairness opinion worsened matters. (Merrill Lynch & Co., representing Bank of Boston, said the deal was fair to shareholders of that company. Such opinions are required before a deal can be announced.)

"There was a big concern on Shawmut's side that their shareholders were not getting enough in the deal," said a source, "considering the loan quality at Bank of Boston."

The diplomatic bridges carefully erected between the corner offices of the two companies began crashing.

A Strategic Leak?

The meeting with regulators was rescheduled to Sept. 23. Meanwhile, press reports appeared saying that BankAmerica Corp. was in negotiations to buy Shawmut.

"Bank of Boston thought it was being double-dealt," according to a source who was working for the bank. Shawmut would not comment on the rumors, but other sources described them as untrue.

Some sources contend that Bank of Boston then sought to spur the deal by leaking its terms to newspapers, which printed them Sept. 20. The strategy, according to the sources, was to induce Shawmut shareholders to pressure management to make the deal. A Bank of Boston spokesman categorically denied making leaks.

Publication of the terms infuriated Shawmut officials, however. The two parties, growing increasingly embittered, went to their scheduled meeting with top officials of the FDIC and the Federal Reserve the following week.

Regulators were less than impressed by the presentation and urged Mr. Stepanian and Mr. Alvord to raise more capital to finance the deal.

Meanwhile, a published report incorrectly said that regulators had approved the deal, which Mr. Taylor subsequently denied.

While the companies still hope to merge, sources close to the deal expressed doubts about its chances of completion.

Both companies returned to profitability in the third quarter, for the first time in a year, and its improving condition has given Shawmut increasing independence. "They're more inclined to go it on their own as time passes," said a source.

For their part, senior Bank of Boston officials have repeatedly denied that the company has any hidden loan problem.

The bank has $1.7 billion in nonperforming assets, equal to 7.6% of total loans plus foreclosed real estate. Bank of Boston has reduced nonperforming assets during the last four quarters. Its reserves are a healthy 83% of its nonperforming loans.

Separately, it has about $255 million in so-called renegotiated loans, which pay an approximate yield of 8%. Some analysts classify these loans as nonperforming, while Bank of Boston does not.

Shawmut has $1.5 billion in nonperforming assets, about 10.3% of total loans plus foreclosed real estate. Its reserves equal 89% of its nonperforming loans. Its stock was trading Wednesday afternoon at $10 a share, down 25 cents.

Some analysts suggested that, with more than $3 billion in nonperforming assets, the merged bank would have to take a huge, one-time charge to clean its books. "To come out of the starting blocks quickly," estimates Gerard Cassidy, an analyst at Tucker, Anthony in Portland, Maine, "that number would be at least $500 million and could be up to $1 billion."

"That would have to be replenished by shareholders' equity," he added.

Both banks have been under tight regulatory supervision since late 1989.

Loan quality is not the only roadblock the merger faces. As previously reported, Bank of Boston and Shawmut have been asked by regulators to present a plan to raise up to $1 billion in total capital - a figure that would greatly dilute existing shareholders.

But legal and investment banking sources said that the capital issue was never a deal breaker: Both companies think that shareholders will accept the huge levels of dilution because the deal ensures the ultimate stability of their stake.

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