The Next Feeding Frenzy Will Feature Smaller Fish

Who's next? The eye-popping $10 billion alliance of Chemical Bank and Chase Manhattan has sent a message to bankers everywhere: If such titans are fodder for the industry's consolidation frenzy, just about everyone is vulnerable. So if they haven't already been checking out their neighbors--fearfully or covetously--bankers all across the country are now eyeing one another anew.

Yet despite the New Yorkers' mega-alliance, odds are that the most intriguing deals going forward won't be among the biggies. The eight or so U.S. banks with more than $100 billion in assets probably will stand pat for a while and exploit their global lending businesses. Once Chemical and Chase slim down, bank-watchers say, there won't be much fat left to cut in this segment.

"SUPERREGIONALS." Instead, banking's merger frenzy will likely be most fierce in the middle ranks. There, a few dozen outfits with $10 billion to $100 billion in assets and turf that spans one or just a few states are finding they can't go it alone anymore. Revenue growth is too hard to come by in their overbanked markets. "The whole industry is fraught with overcapacity," says Douglas N. Pratt, portfolio manager at Invesco Strategic Financial Services Fund in Denver. "If the big guys are doing it, why shouldn't the little guys do it?"

In fact, many of the 277 mergers announced so far this year--worth some $37 billion in all, according to Securities Data Co.--are among such middle-market players. In July, Detroit-based NBD Bancorp Inc. cut a $5.3 billion deal with First Chicago Corp., for instance, spawning a $113 billion "superregional" that now covers much of the Midwest. Just a few weeks earlier, North Carolina's ambitious First Union Corp. agreed to pay $5.1 billion for New Jersey's First Fidelity Bancorp., creating a $115 billion mid-Atlantic powerhouse.

The goals in these deals vary, depending on the size of the deal. Cutting costs by cutting staff and shuttering duplicate branches, for instance, is a big driver for other recent superregional deals as well as for Chase-Chemical. But the New York bankers aren't trying to spread their reach across more states. "The world is their market," says Wharton School Professor Anthony M. Santomero. By contrast, the superregionals still view geography as crucial, so they're trying to spread their costs over millions of domestic customers, usually in contiguous states.

Of course, expenses do tend to grow. Banks need expensive technology--from home banking to improved automated teller services--to compete. Such costs helped drive Pittsburgh's Integra Financial Corp. into the arms of Cleveland-based National City Corp. in a $2.1 billion deal announced on Aug. 28.

ENDANGERED SPECIES? The latest wave of consolidations almost surely will reshape banking for good. Gerard L. Smith, managing director at UBS Securities Inc., says the trend won't end until the 25 largest banks hold 80% or more of the industry, up from 60% now, and he expects to see the emergence of a truly national bank. The regional bank with assets under $50 billion may be an endangered species.

For investors, however, banking consolidation is a risky bet. Speculators have bid up stocks sharply, driving the Standard & Poor's major regional bank index of 23 stocks up more than 34% for the year, compared with a 22% rise in the broader Standard & Poor's 500-stock index. That's partly why bankers can afford to pay for their acquisitions with stock instead of cash. But with so much expectation built into stock prices, there could be disappointments down the road.

Movers, Shakers, Merger Makers

With the market speculating that more mergers are coming, bank p-e ratios are soaring. Here are some likely buyers or targets:

16.7 Preeminent Alabama bank with attractive holdings in hotly sought-after Florida market

13.1 Virginia bank with a lucrative mid-Atlantic franchise and strong market-research unit

13.4 A leader in check processing and trade services such as export-import financing

15.4 Small Pennsylvania-based bank in a rapidly consolidating region

12.7 One of New Jersey's last midsized independents in a fast-growing market

14.5 Fast-expanding Ohio superregional on the prowl for acquisitions

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