Why Banks Keep Bulking Up

Buy or be bought. That's the watchword for the banking industry, which is in the midst of the biggest wave of consolidation in its history. At $24.2 billion, the volume of bank mergers announced this year already matches 1991's total. But just as remarkable as the volume of deals is their rationale.

Most deals over the past few years have been predicated on cost savings. But today's deals are different. They consist mainly of strong institutions combining to bulk up to generate new revenues. Above all, they are designed to make possible the capital investments banks must make to be major players in today's financial world.

Banking is becoming a technology-driven business as never before. And increasingly, technology is driving the wave of consolidation. The main reason is that more and more financial products and services, from loans to credit cards, are being marketed through computers and telephones instead of through branches. Other bank services, such as trading and securities processing, are even more technology-intensive. All of this is requiring unprecedented capital investments. A study by Ernst & Young predicts that banks' annual rate of spending on technology will rise 21% between 1994 and 1997. "Technology is a new imperative," says Gerard L. Smith, a managing director in the financial institutions group at UBS Securities Inc., who estimates that $19 billion was invested by banks for technology in 1994, just over half of it by just 52 banks. "Those that can spend on technology are going to dominate the field."

Mergers and acquisitions are the best route to acquire critical mass. That's because the growth in technology spending is far outpacing the growth in banks' earning assets, says Smith. Banks able to make big technology investments gain an unparalleled ability to reach customers nationwide, even though their physical franchise may be limited. Edward E. Crutchfield Jr., chairman and CEO of First Union Corp., calls the advent of new electronic delivery systems for consumer and small-business banking "the single biggest reason" First Union is acquiring First Fidelity Bancorporation, based in Newark, N.J., in a $5.1 billion deal. "This industry is on its way to eliminating the branch as a delivery system," he says. "The cost of converting people to [electronic] banking is in the hundreds of millions. We've now got the opportunity and the wherewithal to convert this system."

BRANCHLESS PUSH. Crutchfield has spent several hundred million dollars on technology over the past several years, including a system to connect all of First Union's branches in a single reporting network. Now, he expects the First Fidelity acquisition to quickly expand his reach but not necessarily in traditional fashion: "The fact that First Fidelity has 700 branches didn't interest me at all," he says. "The fact that they had 2.5 million customers did"--and he will market to them through electronic channels as well as branches.

First Chicago Corp. has similar plans for its $5.4 billion merger with Detroit's NBD Bancorp Inc., announced on July 14. "With more and more products requiring heavy technology spending, you're better off if you can spread the cost over a broader customer base," says Vice-Chairman David J. Vitale. He says First Chicago's payoff will come mainly from selling such technology-intensive products as cash management and risk management to NBD customers. First Chicago's technology spending is now about 15% of total expenses, and Vitale sees that rising, especially in two areas: corporate-client services and electronic retail-banking products. Already, three-quarters of both banks' retail clients do not use bank tellers.

Those few banks that today are able to make big technology investments without bulking up through mergers are already reaping the rewards. Wells Fargo & Co., for one, is reaching across the country with mail and electronic offerings of retail-banking products--even though it does not have branches outside California. In early 1995, Wells began nationwide marketing of preapproved small-business loans through the mail, the first bank in the country to do so, according to President William F. Zuendt.

FALLING BARRIER. Banc One Corp. is also benefiting from technology investment. The Columbus (Ohio) bank has invested heavily in a new credit-card processing system that it's now licensing to four companies, including American Express Co., which will pay $25 million. Bank of New York Co. is taking similar steps in wholesale banking: Since early 1994, it has spent close to $500 million to acquire a dozen securities processing operations, adding them to its own sizable portfolio to gain the economies of scale possible in those heavily automated businesses.

The need for investments in scale and technology is transforming the once fragmented banking industry. Ten years ago, a bank with $10 billion in assets was considered large--but today, $5 billion to $10 billion is a small bank, according to Herbert A. Lurie, co-head of financial institutions at Merrill Lynch & Co. Now, scores of midsize banks, with assets ranging from $10 billion to $50 billion, could lose their independence to the banking behemoths that are emerging. "At the end, you'll have maybe 20 money-center and superregional banks with assets over $100 million, a bunch of [very small] community banks, and some niche banks" that specialize in businesses such as securities processing, says Howard Adler, a partner at Gibson, Dunn & Crutcher. But, he says, "woe to the $20 billion bank" without a core specialty that could assure its survival.

The center may not hold any better on the technology front. Big, technologically strong banks will be able to reach customers across the country. Small community banks will offer little in the way of state-of-the-art electronic banking services, but they will still be able to give consumers uniquely local, personalized service. They "almost have it easier because they can give a degree of service the big banks can't," says Ronald Mandle, an analyst at Sanford C. Bernstein & Co. But there will be little room for banks too big to be truly personal and too small to have electronic offerings that can compete with those from Citibank, Wells Fargo, and others.

How long will the consolidation continue? J. Christopher Flowers, co-head of the financial institutions group at Goldman, Sachs & Co., says that "the psychological barrier to selling your bank is dropping" because nobody wants to be left out of the action. With banks' technology needs expanding daily, the urge to merge can only intensify.

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