When Chemical Bank said it would buy cross-town rival Chase Manhattan, a modestly profitable bank suddenly became Wall Street's darling. But the new Chase needs to boost revenues if the romance
Fifty years ago, the Chase National Bank was the bank of the Rockefellers and the largest bank in the world. It was also the proud standard bearer for America's banking industry.
There's an almost reflexive desire to believe that in creating a new Chase Manhattan Corp., Chemical Banking Corp. chairman Walter Shipley and Chase chairman Thomas Labrecque have recaptured some of that former glory. But that's wrong.
The new Chase will certainly be large, and profitable, too. In the last quarter before the deal was announced, Chemical had a 17.5% return on equity. Chase's ROE was 14.2% - not stellar, but pretty good considering where this bank was a scant four years ago. The $1.5 billion in cost cuts the banks have announced should boost those returns even higher, and Chemical's management predicts that following the merger, ROE will rise to 18% in 1996 and 1997.
But those returns hinge upon the new bank's aggressive downsizing program. Some 12,000 jobs will be lost. Most of those layoffs were already spelled out before the deal. Chemical said it would let 3,700 people go last December, and Chase announced that 4,000 of its employees would get pink slips as a sop to shareholders disappointed in the company's performance.
But the new bank is in dire need of increasing its revenue, and that's a dramatically different task from cutting costs. This is the one aspect of this deal where the whole is not automatically greater than the sum of its parts.
Chemical's Shipley told securities analysts the day the deal was announced that revenues would probably fall in the first calendar year following the merger's completion in March 1996, according to Rafael Soifer, an analyst with Brown Brothers Harriman. For 1997, the post-merger Chase should get revenues back to a level matching the performance of the two banks separately, and by 1998, there should finally be a revenue gain.
"That's a long way off," Soifer says. Who knows what will happen before then?
Some of the inability to jack up revenues beyond the combined total of the two existing banks will be the natural fallout from the merger. For example, some retail consumers in New York will leave for other banks as their branches close. In competitive retail businesses like credit cards and mortgage origination, other lenders may hick up market share while Chase's executives are focused on completing the merger.
The revenue picture is not all bleak. For example, the post-merger Chase will have perhaps 70% of the middle-market lending business in New York, a market share that will allow it to increase prices.
"There is definitely an oligopolistic opportunity to raise prices that is huge," says Richard Bove, an analyst with Raymond james Securities in St. Petersburg, FL.
Yet aside from a few bright spots, there's a much larger problem undermining the post-merger Chase's prospects: Wall Street's steady demand that banks raise revenues comes at a time when revenue gains are few and far between. When the national economy defines recovery as a gross domestic product rising at the tepid rate of 2.5% to 3% per year, what can banks do to increase revenues beyond buying up one another and hiking fees to customers?
"That's the $64,000 question," said one Chase spokesman who would not speak for attribution. "I don't have an immediate answer."
Neither does anyone else.
"Banking is an economically sensitive business," says Soifer. "The mo$t important driver of bank earnings is the economy." But predicting the economy for the next three months, let alone next the three years, is all but impossible. Chase and Chemical just happen to be based in a region that has lagged behind the rest of the country's economy for years, and is likely to limp along for the next several years, too.
Moreover, anyone looking for exact parallels between this merger and Chemical's 1991 union with Manufacturers Hanover Corp. may be disappointed. Three years ago, the economy was emerging from a deep recession, and the post-merger Chemical, like most banks, benefited from the rebound. By 1993, its ROE soared to 16%.
But now the economy is nearing the end of an economic expansion, and Bove believes that all banks will be hurt as nonperfoming loans grow faster than pre-tax earnings for at least the next two years.
"The wind is not at their backs," says Tanya Azarchs, an analyst with Standard & Poors Corp. There could be a boost to revenues "if they really execute this merger well," she adds. "But it's too early to tell."
That execution hinges upon executives at Chemical having learned some valuable lessons from their 1992 merger with MHT. That was truly a merger of equals, where it seemed as if the banks set out not trying to bruise one another's feelings rather than getting down to the business of melding two giant banks as efficiently as possible, says Larry Frieder, a banking professor at Florida A&M University in Tallahassee. Dragging out the merger probably made it more painful in the long run.
Copying Ed and Hugh
To make the merger work, Chase and Chemical executives may need to take a page or two from Hugh McColl's or Ed Crutchfield's merger playbook - just join the banks and get it over with.
Shipley and Labrecque are "not going to get graded on how nice they are," Frieder says. "This is a business. We started out in banking with a lot of nice, friendly, social arrangements." But there was a price to be paid with that approach. In many cases, not enough costs were wrung out of acquired banks to create mergers that were truly accretive to earnings. But the industry seems to have learned its lesson.
Chase is simply going to have to minimize its loss in revenues by merging operations and cutting costs quickly. Then it can go out and seek new business.
That's not as simple as it sounds. The merger's speed, and thus its success, depends on a long list of operational decisions, not the least of which will involve the computer systems and technology underlying each business. In some areas like loan syndication, where Chemical leads the industry, it will make sense to keep its staff and computer systems. The same may be true for global custody, a market where Chase is the largest bank in the country.
But in other businesses, the choice isn't as clear. A prime example is in retail operations. Four years ago, the old Chemical and MHT had incompatible retail systems. That is also the case with Chemical and Chase today. Back then, the retail integration was led by MHT executives who junked Chemical's internally developed system in favor of one from Systematics Inc. and NCR Corp., the system that is still in place.
That conversion had its embarrassing moments. In one highly publicized snafu two years ago, Chemical allowed some $350,000 to be withdrawn from automated teller machines without properly debiting customer accounts.
With this merger, a Chase executive, Michael Urkowitz, is handling the integration of the consumer banking systems for the merged banks. The question is: Will he pick the Chase system he's familiar with, or will he opt for the Chemical system that's already in place?
Right now the banks have nothing to say in regard to the retail system or any other operational aspect of the merger.
"We can't answer any questions of a specific nature," says John Stefans, Chemical's chief spokesman.
Those specific answers will take time, and Chase and Chemical executives will probably need every minute they can get. Once they're ready to give them, the rest of the world can start to judge whether the new Chase is a worthy successor to the old one.