Waiting For Glass Steagall To ShatterKelley Holland and Leah Nathans Spiro and Phillip L. Zweig
Ihor W. Hron sounds a little like a kid in a candy shop when he talks about where to take Midland Insurance Co. next. The Columbus (Ohio)-based insurer just converted from mutual to public ownership, and now, with greater access to the capital markets, Hron, Midland's president and CEO, is mulling potential acquisitions. He figures he may buy a couple of insurance companies over the next 18 months or so--and then, he says, who knows? If regulations allow, "we would not close our eyes to a deal with a bank."
Hron is not alone. Investment bank Donaldson, Lufkin & Jenrette, currently owned by Equitable Cos., has recently talked to banks about being acquired. And across the country, financial services executives are starting to plan for--or at least daydream about--the increasingly likely repeal of the decades-old barriers created by the Depression-era Glass-Steagall Act and other regulations. The result could eventually be a dramatic remaking of the financial services industry.
PILEUP. Although many restrictions have fallen by the wayside in recent years, rules still generally prohibit mergers between banks and such financial institutions as securities firms and insurers. Congress and the Clinton Administration are now advocating reform of Glass-Steagall, and the consensus among financial services experts is that the regulations will be gone by the end of 1996. Senator Alfonse D'Amato (R.-N.Y.) and Representative Richard Baker (R.-La.) are even proposing that banks, securities firms, and insurers be permitted to combine with each other and with nonfinancial companies.
The potential ramifications will be gradual but substantial. "It won't be a stampede, but there will be some major transactions which will change the competitive landscape," says CS First Boston managing director Richard E. Thornburgh. The big will definitely get bigger, as size becomes more important to remain competitive. It's even conceivable that a big foreign bank such as Deutsche Bank could buy a major American firm, perhaps Merrill Lynch, Goldman Sachs, or Morgan Stanley. And as financial companies diversify, corporations will find they can choose between many more financial services providers and often obtain lower prices.
Not everyone will benefit, however. Many insurance agencies, mutual insurance companies, and small banks and brokers will likely lose market share to big players and will be bought up, not necessarily at generous prices, or pushed out of business. Kenneth A. Guenther, president of the Independent Bankers Assn., who is vehemently opposed to Glass-Steagall reform, labels the D'Amato proposal "a formula for massive economic and financial concentration."
Overly aggressive acquirers, though, could also get hurt. Past attempts at diversification in financial services have tripped up scores of companies, including Sears Roebuck, American Express, and Prudential Insurance. And if too many companies pile into the same businesses at once, they will squeeze out the profits.
Still, the likely winners stand to win big. Citicorp, Merrill Lynch, American International Group, and other financial services behemoths have an edge because they already have experience in a variety of financial services businesses they were not specifically prohibited from entering or where they found regulatory loopholes. Some large, well-run regional banks such as Minneapolis' Norwest Corp. have taken similar steps and are also positioned to gain.
Corporate executives are also eagerly looking forward to regulatory reform. Buel T. Adams, vice-president and treasurer of CBI Industries Inc., an Oak Brook (Ill.) diversified industrial-gas company, calls the prospect of the dissolution of Glass-Steagall a "win" for business. In particular, he expects lower prices from investment bankers as commercial banks make growing inroads on Wall Street. "The most exorbitant fees companies like us pay are for investment banking services," Adams says.
Smaller financial services players will not fare nearly as well. For example, insurance agents are up in arms about the prospect of deregulation. Comprising one of the most costly distribution systems for financial services, agents would be vulnerable if banks with lower-cost sales networks started issuing and marketing the same products they sell. Currently banks are generally barred from issuing their own insurance products, which cuts the potential profit.
Small insurance companies are also at risk. Says one lobbyist for a major insurer: "If you go down the ladder, you quickly reach a point where people view this as a threat--especially the mutuals" because they don't have the same access to capital. That's partly why companies such as Midland are trying to demutualize and go public. Robert D. Bates, chairman and CEO of Guarantee Mutual Life Co., a $1 billion insurer in Omaha, says he aims to go public because "you need greater mass to be able to compete and grow" as competition intensifies.
Brokers are equally vulnerable to the likely wave of takeovers. Oppenheimer & Co. is currently talking to ING, the Dutch bank and insurance giant. Firms with strong national networks of brokers, such as A.G. Edwards Inc. or Edward D. Jones & Co., are also attractive. Both Benjamin F. Edwards III, CEO of A.G. Edwards, and John W. Bachmann, CEO of Edward D. Jones, say their firms aren't for sale. But the appetite of acquirers is unmistakable.
Mutual-fund firms could also be more vulnerable as more companies diversify. Small outfits are obvious targets, but bigger ones could be as well: Experts say T. Rowe Price Associates, with $58 billion under management, has wide appeal thanks to solid fund performance and earnings. A spokeswoman says the company plans to stay independent.
EQUAL FOOTING. As for banks, consolidation has been rapid for several years, but experts expect the pace to accelerate. Once again, small institutions are most vulnerable. Larry G. Mayewski, senior vice-president at insurance-rating agency A.M. Best Co., predicts that strong insurance companies could go after banks for their distribution networks. Well-capitalized superregional banks such as NationsBank Corp. and Banc One Corp. could also be more active buyers. Foreign banks could step up their U.S. expansion plans as well.
Not all the smaller players are worried. At the right price, "getting taken out may be a good deal," says William B. Weaver, co-head of the financial services group at Lehman Brothers. Some believe that they can compete successfully even against bigger rivals. William E. Martin, president and CEO of Pioneer Bancorporation in Reno, Nev., and a former deputy comptroller of the currency, says that technology enables his institution to offer the same products that financial supermarkets could offer. "Our computer runs just as fast," he says. "There are no products that [Bank of America] can introduce that I can't."
Nor is it clear that the financial-supermarket builders will be all that proficient. Many, such as Prudential Insurance, have run into big trouble diversifying. Cultural reasons loom large. Irving W. Weiser, CEO of broker Dain Bosworth Inc., which is 40% employee-owned, warns that his industry "does best when left to large employee ownership and entrepreneurship. It doesn't fit particularly well in a more structured environment."
But mainly, the trouble is simply poor judgment. "Just because you find a way to acquire a whole new line of business doesn't mean you're going to be able to do it profitably," says William F. Ford, professor of finance at Middle Tennessee State University and a former president of the Federal Reserve Bank of Atlanta. "Most of the financial disasters have been cases where people had the right to get into a new line of business and botched it."
Michael J. Murray, executive vice-president and head of corporate banking for BofA, questions the widespread interest among acquirers to get into investment banking. "Tell me again, boys and girls, why you're dying to get into a business that just had a terrible year. There's a lot of pretty sobering history to investment banking." But as the pace of reform accelerates, financial institutions will have to exhibit a lot more discipline than they normally do to make sure that history doesn't repeat itself.
Who Wins and Who Loses If Glass-Steagall Is Abolished
DIVERSIFIED FINANCIAL SERVICES GIANTS such as Merrill Lynch, Travelers Insurance, and Citibank should have the scale and expertise to increase market share.
BIG CORPORATIONS will have more financial companies vying to offer them similar services, and possibly package deals, which will lower the cost of borrowing money or issuing stock.
LOSERS SMALL BANKS AND
BROKERS will lose market share to more big competitors. Some will also be vulnerable to takeovers by banks, insurers, and securities firms seeking new distribution channels. Potential acquirees include national brokers A.G. Edwards and Edward D. Jones. But with more bidders, sellers might be able to command higher prices.
INDEPENDENT INSURANCE AGENTS will face intense competitive pressure if more insurance products are issued and sold by banks and brokers looking to get into new lines of business. Rivals' distribution costs are significantly lower.