On a balmy afternoon at the Securities Industry Assn. annual meeting last month, several brokerage executives were sunning themselves around the pool at a Boca Raton (Fla.) resort. One investment banker pointed to Donald B. Marron, the chief executive of PaineWebber Inc., who was sitting at a table nearby. "Under that navy blue blazer," the banker quipped, "he is wearing a white wedding dress."
Marron doesn't view PaineWebber as a potential bride. But there's no question U.S. and foreign banks these days are busy sizing up the 30 or so largest firms in the U.S. securities industry as potential merger partners. Chase Manhattan Corp., for instance, has done exploratory studies of a number of companies--including Merrill Lynch, Salomon Brothers, Donaldson, Lufkin & Jenrette, and Lehman Brothers.
What's spurring this behind-the-scenes mating dance? The 1933 Glass-Steagall Act inhibits banks from buying brokers and vice versa. But by Christmas, the Federal Reserve Board is expected to enact a rule change that would make it much easier for commercial banks to acquire even the largest brokerage firms. Under current rules, says Sullivan & Cromwell banking lawyer H. Rodgin Cohen, "nothing but the very smallest deals can be done." The new rules, says J. Christopher Flowers, a partner at Goldman, Sachs & Co., "will lead to more acquisitions of securities firms by banks." Merrill Lynch & Co.'s chief strategist, Jerome P. Kenney, rules out his firm but says "the majority of securities firms are likely to be acquired by the end of this decade."
If so, the financial-services landscape will be radically reshaped. Except for a handful of the largest, strongest brokerages, which could stay independent or even buy banks, the brokerage industry with all of its regional diversity could dwindle sharply. Commercial banks, on the other hand, could use broker acquisitions to regain lost market share and bolster their range of services.
There are, however, many obstacles, notably the inflated prices of securities firms given the frothy U.S. stock market. "I don't think there will be a mass rush, because the prices will be very difficult to swallow," says William L. Maxwell, president of capital markets at NationsBank. Further, Congress in 1997 may allow brokers to buy banks. Says PaineWebber's Marron: "We're hoping they'll eliminate Glass-Steagall so that we can make an acquisition of a bank or trust company."
Despite the wall between the two industries imposed by Glass-Steagall, banks are already big players in the securities business. In 1987, the Federal Reserve let bank holding companies do some underwriting as long as it was segregated from commercial banking activities in special subsidiaries. The Fed also limited the percentage of a bank's gross revenues from underwriting to 5% of the total gross revenues of the subsidiary. It has since raised that limit to 10%. By Christmas, the Fed plans to lift the cap to 25%, making it more feasible for banks to buy even large brokerages while obeying underwriting revenue guidelines. And on Nov. 20, the Comptroller of the Currency said that he would give national banks new vehicles to underwrite securities and insurance.
The most attractive investment firms that banks might target are the Big Three: Merrill, Goldman, and Morgan Stanley. But the conventional wisdom is that these are also in the best position to stay independent. Sheer size, large employee ownership, and deep penetration into many banking businesses already give them a lot of leverage on their own. "We see no fundamental reason to acquire or merge with a bank," says Merrill's Kenney.
REGIONAL APPEAL. More likely targets are the two smaller international investment banks, Lehman Brothers Inc. and Salomon Inc., and the investment banks with largely U.S. businesses: Donaldson, Lufkin & Jenrette Securities Corp. and Alex. Brown & Sons Inc. But these firms may not rush to merge either. A.B. Krongard, chief executive of Alex. Brown, retorts: "Alex. Brown has been in play for 196 years. See me in another 196 years."
National retail securities firms such as Dean Witter Reynolds, PaineWebber, and A.G. Edwards & Sons are also possible targets. Steven Eisman, an analyst at Oppenheimer & Co., finds regional brokers with strong investment banking and retail franchises attractive. Most likely candidates, he says, are McDonald & Co. Securities. in Cleveland, Raymond James Financial in St. Petersburg, and Morgan Keegan & Co. in Memphis. William B. Summers Jr., chief executive of McDonald, says no one has approached him about a buyout. And he has no imperative to sell. But he expects "more communication" if the Fed raises the underwriting cap.
Some of the biggest banks, such as J.P. Morgan & Co. or Citicorp, may decide to keep growing their investment banking prowess internally and through targeted hiring. But some other U.S. giants are eyeing national retail brokerages, regional securities firms, and boutique shops. BankAmerica Corp., for one, would consider buying "if the right opportunity comes along to add to our product set," says Robert Slaymaker, CEO of BankAmerica Securities Inc. NationsBank Corp. CEO Hugh L. McColl Jr. recently told analysts he would be interested in buying a small investment banking firm to serve small and medium-size businesses. "We would be interested in acquiring a national retail securities company," says Ronald D. Brooks, CEO of Banc One Capital Corp.
Some big regional banks are targeting similar firms. Says PNC Bank Corp. Executive Vice-president George Lula: "We've looked at regional broker-dealers"--but found little to enhance the bank's fixed-income business. Wachovia Corp. would consider buying a securities firm under the right circumstances, says treasurer Richard B. Roberts. And R. Charles Shufeldt, CEO of capital markets for SunTrust Banks Inc., says his bank might eventually buy to develop equity underwriting capabilities, especially in initial public offerings. "To build would be a very difficult task," he says. "It would be better to figure out a way of buying a boutique or a regional shop whose equity capacity and research capacity can be the core of the business we are trying to build."
EUROPEAN SUITORS? A dozen or so big European banks may fulfill dreams of being global investment banking powerhouses by acquiring U.S. firms. "A European could afford to pay more and likely would pay more," says Raphael Soifer, an analyst at Brown Brothers Harriman & Co. Possible buyers, he says, include Deutsche Bank, Dresdner Bank, UBS Securities, Swiss Bank Corp., NatWest Securities, Barclays Bank, and ABN-Amro.
Bank acquisitiveness could slam into serious hurdles. High premiums paid for companies are tough to earn back. "The business and financial case is not that easy to make," says Chase Vice-Chairman Donald H. Layton. Nor is the cultural case. Commercial and investment bankers have sharply differing views on such matters as risk (banks are more conservative) and compensation. Commercial bankers often resent the higher pay of their suspendered brethren, especially after a record year on Wall Street.
A more tangible barrier is a Fed rule banning banks from owning more than 5% of voting stock in or control of a nonfinancial company. Some investment banks own large stakes in such companies. DLJ's big positions has deterred such suitors as NationsBank.
Finally, hostile takeovers seldom work because investment bankers, who are sometimes notoriously peripatetic, would likely jump ship rather than work for a bank. Says McDonald's Summers: "You would have a lot of dating and romancing taking place. But I don't think there will be any shotgun marriages. It will be a relationship based on the heart."
Still, whether heart or pocketbook, it seems likely more than a few investment bankers will accept the embrace of their erstwhile rivals--bringing down a once insurmountable wall.