Richard H. Jenrette knows what it feels like to hit bottom. As chief executive officer of Equitable Life Assurance Society, he found himself having to mount a publicity campaign in December, 1990, to counter rumors that Equitable was close to insolvency. Since then, he has been working hard to clean up the company's ailing real estate portfolio and raise much-needed outside capital.
But Jenrette won't forget being raked over the coals by the rating agencies. He says his feelings are best described by the famous line from Gone with the Wind, when Scarlett O'Hara swears she will never be hungry again. "With God as my witness, I'll never have credit quality questions again," he vows.
Jenrette is far from the only financial executive to make that promise. Badly burned during the '80s by costly overexpansion and ill-advised investments, banks, brokers, and insurance companies across the nation have developed a zeal for fiscal conservatism. Rampant growth has been replaced by consolidation and shrinkage. Financial institutions are laying off employees by the thousands, selling soured diversification ventures, and often seeking out merger partners.
UNFORGIVING. Although financial executives insist they've learned their lesson, many cynics aren't so sure. They say financial executives often profess prudence during slumps only to shift into overdrive as soon as the cycle shows signs of reversing itself. That could be a big mistake, they say, especially in the slow-growth environment that many predict will characterize the '90s.
This decade will be unforgiving for other reasons. Rivalry among financial institutions will become brutal, as deregulation dissolves anticompetitive barriers. More banks are expected to get equity underwriting powers, allowing them to offer full-service corporate finance services. Brokers, in return, are becoming bankers: Merrill Lynch & Co.'s overseas branches are starting to offer banking services. The most important competitive edge may be credit quality. J. P. Morgan & Co. will flaunt its AAA rating, two notches higher than any U. S. investment bank.
BACK TO BASICS. Those that prevail during the coming melee, though, should be much stronger than '80s players. "American financial institutions have been through a drying out after a night of too much revelry," says Roy C. Smith, New York University finance professor. "There's more to be done, but the survivors of this economic ordeal are getting healthier and more competitive."
Nowhere was the revelry more raucous than on Wall Street. From 1982 to 1987, the bull market, takeovers, and regulatory laissez-faire resulted in rich profits for the Street. From 1983 to 1987, firms expanded their work forces to a total of 260,000 from 205,000, a surge of some 27%. They bought fancy buildings and accumulated big portfolios of risky bridge loans and junk bonds.
And it was on Wall Street that the bubble first burst. After the 1987 stock market crash, firms were forced into desperate retrenching. Employment shrank from 260,000 to 210,000. By 1990, the industry had hit bottom, with an aggregate loss for the year of $162 million. Back to basics is the new credo. Firms have cleaned up their balance sheets. They are cutting back deal divisions and concentrating on their more mundane retail, trading, and underwriting operations. Partly as a result, Wall Street firms such as Merrill Lynch and PaineWebber chalked up strong profits in 1991's third quarter.
Those few firms that were already focused on bread and butter rather than caviar during the '80s are best positioned for the '90s. A prime example is Dean Witter Reynolds Inc., a division of Sears, Roebuck & Co. Sears spent $607 million in 1981 to buy the broker. Although Dean Witter lost money for the next few years, it invested in its retail sales force. On the institutional side, it avoided junk bonds and merchant banking and put its attention on servicing midsize corporate customers and its own retail sales force. Dean Witter has been pumping out steady profits ever since 1986. "We better be taking care of that customer at a lower cost, because if we're not, someone will come along and push us down the food chain," says Philip J. Purcell, CEO of Dean Witter Financial Services Group Inc.
LAGGARD. Bankers got into much more trouble than brokers, mainly because of huge lending misjudgments. As a result, they have had a much harder time getting back on track. Now, under pressure from regulators, many bankers are repairing battered loan portfolios and capital bases and are slashing expenses. Write-offs for problem real estate loans should peak by year's end. Third-quarter earnings already reflect a recovery. The big laggard, however, is Citicorp, which has yet to build adequate reserves to cover its problem real estate loans.
To many bankers, the current wave of mergers offers the surest path to a healthier future. Take Chemical Banking Corp. and its merger partner, Manufacturers Hanover Corp. The two New York banks anticipate a savings of $650 million in the next four years by eliminating offices, people, and technology. Such moves should give the merged bank a stronger capital base by attracting new equity, executives of the two banks claim. "With an improved credit rating, we can finance ourselves more cheaply and our customers as well," says Chemical CEO Walter V. Shipley.
Chemical is already reaping profits through greater geographic diversification, with its Texas Commerce Bancshares Inc. posting record third-quarter earnings. It has stressed its higher-margin business of lending to midsize American corporations. Its ratio of total equity to total assets rose from 5.15% in 1986 to 5.53% in the third quarter of 1991. "We are a much stronger institution for having gone through the transformation from a classic money-center bank that operates in the narrow New York market to being broadly based in Texas and New Jersey," says Shipley.
SOUR DEALS. Gains from mergers may be harder to achieve than many bankers claim, however. Many deals, such as C&S/Sovran Corp., have soured. The Chemical and Manufacturers merger is taking longer than planned, clouding the outlook for its predicted savings.
The comparatively slow-moving life insurance industry has been the last to catch up with market realities. Like the banks, it was badly damaged by real estate loans. Many insurance companies also found themselves with large junk-bond losses. Not until this year did life insurers find they were much more vulnerable than other institutions in one key area: panic withdrawals by customers, whose policies were insured only by often undercapitalized state funds.
The first alarm was the collapse of First Executive Corp. in April, 1991, because of the declining value of its massive junk-bond portfolio. Then, in July, came the demise of Mutual Benefit Life Insurance Co., which hemorrhaged from too many bad real estate loans.
Today, the insurance industry is belatedly repairing its balance sheets and embarking on its own consolidation wave. Phoenix Mutual Life Insurance Society and Home Life Insurance Co. are discussing what would be the first combination of two major mutual life companies. Further, foreign money, which has been flowing into U. S. banks and brokerages, is targeting the insurance industry. In 1990, Switzerland's Allianz bought Fireman's Fund Insurance Co.
RIGHT DIRECTION. Equitable is a perfect example of a large, troubled insurer on the road to recovery. It has attracted $1 billion in capital from French insurer AXA and has embarked on a plan to shift from a mutual to a publicly traded company by selling stock sometime in 1992. Already, the company has a 7% ratio of equity to liabilities, compared with 4.3% five years ago. "I see the industry becoming leaner, pricing its product better, and having more access to capital," says Equitable's Jenrette.
While there will still be setbacks ahead for insurers, bankers, and brokers during the '90s, especially if the economy remains weak, there is a trend toward a healthier system. NYU's Smith believes that those institutions that survive the shakeout will have a global competitive advantage. The reason is that deregulation in the U. S. is much further along than in Europe and Japan, where financial oligopolies are still protected from the full range of market forces. "The U. S. is going through its ordeal first," says Smith. As with a group of reformed alcoholics, the trick for U. S. institutions will be to avoid the ever-present allure of another destructive round of revelry.