What`s Next for Banking?

The struggling bull market of recent months (or nascent bear market) and the turn of the millennium provided an opportune time to reflect on the future of the banking industry. This quarter we feature Nancy Bush, senior vice president of Ryan, Beck & Co., whose credentials include being voted one of the Wall Street Journal`s All-Star bank analysts in 1997.

Ms. Bush spoke to Bank Director about some of the most pressing issues facing the industry as the new century unfolds: unfettered competition with the passage of the Gramm-Leach-Bliley Act of 1999, consolidation, the search for earnings growth, and the challenges of the Internet and e-commerce.

Bank Director: Perhaps we should begin by looking at the effects of the financial modernization bill.

Nancy Bush: I think there are several big issues facing banks in the coming year. What does H.R. 10 really mean? Not so much from the standpoint of what banks can buy, because, frankly, I think banks have already bought what they wanted to buy. They are pretty much in the businesses that they wanted to be in.

The bigger issue is Are there other businesses that want to be in banking? That is, let`s turn this around. Is there some insurance company out there with enough valuation that wants to buy a bank? Increasingly the brokerage houses are talking about wanting to be banks. There are a lot of implications of this that we don`t really know yet. That`s one issue.

The second issue, of course, is with the end of pooling accounting late next year, are we going to see the predicted tidal wave of deals? At this point, nobody is hearing any rumors. There just doesn`t seem to be any rumblings of imminent big deals.

That`s odd, isn`t it?

It is very odd. And I think it`s perhaps related to topic number three. It`s very clear to me that these banks just don`t know, at this point, how they are going to increase their revenues. It is a big topic of conversation. I don`t think there is a lot of certainty in this industry about the durability of the kind of earnings and revenue increases that we have seen in the past few years.

I think it is increasingly apparent to everybody that banking-in spite of the fact that you can do more now to fix up things around the edges-is still a business where the secular growth rate is really not expanding.

But banks have been doing very well, maybe not recently, but over the last several years.

The impetus behind that was largely consolidation. And when you consolidate a bank you go through a period-we are seeing it at Fleet right now-where you cut costs and generate this air of excitement about the future direction of the company: We are going to do this better. We are going to do that better. We are going to be bigger here, and we are going to be bigger there. And you kind of play out that string, and then you ask, Okay, what now?

I think that is where we are with most of the big deals having been done and the consolidation processes mainly through. It`s as if everyone`s turning around and saying, Okay, what do we do for an encore?

There was so much going on as Glass-Steagall was coming undone, fraying at the edges. Now that the fabric is entirely rent, maybe everything is done.

I think that`s it. What is the next act in the absence of major, major deals? It`s tough, really tough.

And the related issue is, where are banks going to get the revenue for income growth?

Revenues increasingly have got to come from a deeper relationship with consumers. Banks have talked about that for years and years and years and generally have blown it. I think they have got to turn their efforts again to why their customers don`t do more business with them. And that`s hard for banks to do because it`s an admission of failure, particularly in these large banks.

Let`s take First Union, which is sort of the poster child here. They say, We`ve got great products, which they do, and we want to deepen our relationship with customers. Well, how do they do that? They shut down branches. They lessen tellers available at a branch. They generally annoy everybody. So they have got to go back to the drawing board and, whether these CEOs like it or not, take a kinder, gentler approach to their relations with their customers.

Is this a tug of war between customer satisfaction and shareholder satisfaction?

Absolutely. I fault Wall Street in this because we have done nothing-and I include myself in this group-but encourage destructive, short-term behavior. We want the short-term pop. We cannot, for the life of us, see that banking relationships are based on long years.

I think Wells Fargo has done the analytical community a great service in having the guts to say, No, we`re going to take three years to do this deal. We`re going to do it right. Customer retention is going to be our number-one focus. That may not produce the biggest earnings gain next year, but we`re going to do it right. Kovacevich got panned at the beginning of the [Norwest] deal for that approach, but I think people increasingly gained respect for it.

But it`s hard to get up in front of your customers and say, We`re doing this big deal to bring you more services. And then to turn around and tell Wall Street, We`re going to do this big deal so we can cut costs.

Dick [Kovacevich] has in many instances, as he had at Norwest, not done large share repurchases. Those are a Wall Street trick. You like them. I don`t like them. We need capital. So he has really flouted convention, and I think the Street has begun to appreciate that-certainly his stock multiple would indicate that.

Who are some underrated players?

The SunTrust and Crestar deal has done very well and has been much underestimated. Any of the companies that have taken a slower approach and a more customer-friendly approach have done much better than those that have taken the slash-and-burn approach.

Sounds like there is a lesson to be learned here.

Absolutely. I think it is being learned. We have got some real notable-I won`t say failures because of the baggage that word carries in the banking industry-but lack-of-success stories to contemplate now.

Is this one of the reasons that consolidation might be slowing down?

Well, it could be. And it also could be simply a reluctance on the part of many of these bank boards to `fess up to the fact that they have come to the end of the road with their institutions.

End of the road in what sense?

That there`s just not anything more they can do. They can`t grow earnings 11% or 12%. The real rate of earnings growth is maybe 7% or 8%.

That`s going to be a hard message to bring to Wall Street.

A very hard message.

But you accept it?

Well, it depends on the response. If the response is, By God, we can only grow our revenues or our earnings 7%, but we think we should continue as an independent organization because Cleveland`s always had a bank, and Cleveland will always need a bank, I`ll say, You`ve got to be kidding me. Why does Cleveland need a bank headquartered there?

If somebody else can run it better, let somebody else run it better. If the response is, Look, our innate rate of growth is 7%, and we`re going to try to optimize that rate of growth through these steps, and here`s our three-year game plan, and here`s how we`re going to approach it, I`d say, Okay, let`s see if it works.

Do you see any paradigm shift here? Are we still going to have the very large, top-tier banks, the superregionals, and the community banks?

Many managements are finding out that being bigger is not necessarily being better. Increasingly we are seeing these smaller, decentralized organizations become much more successful. So I wonder if some of these superregionals that have become centralized are going to go back to the drawing board on that operating strategy.

What kind of banks do you see developing?

If you look at banks like Comerica-I don`t know it terribly well; I am just beginning to look at it-they are commercial lenders. Period. They have community banks, but that is not the bulk of their business. And they will tell you, We have done very well over many years being commercial lenders. They are going to stay commercial lenders. That is a tough, tough business to be in, but that`s their bread and butter.

So perhaps there`s no one model.

There`s not one model, and that is very, very difficult for the investing public-and I include analysts in that group-to grasp right now. There is not a clear way to be successful in banking. There are some very clear ways to be unsuccessful, however.

So you don`t think there will be a lot more consolidation, even though pooling of interests

accounting will pass?

Unless there are a number of boards of directors out there who finally wake up from their slumber, I don`t think we`re going to see it. Then it becomes very interesting. When pooling accounting goes away, and there can more easily be hostile deals in the industry because a company can buy another company and then break it up and take the banking operations and sell off subprime or sell off whatever it wants to sell, then the whole dynamic may change. So I don`t think it`s necessarily a bad thing that pooling is going away. I think it`s hidden a lot of the ills of the industry for a long time.

One last thing I wanted to bring in: What impact will the Internet have on banking?

It`s huge, but we don`t know. There were a lot of companies presenting at our conference that spoke about e-commerce and how e-commerce is going to change the nature of the world. But nobody knows how yet, particularly with regard to financial services.

We know that you can sell deposit products over the Internet. We don`t know yet if you can sell asset-based products. Can you really sell a mortgage over the Internet?

There are some firms doing it already.

There are some firms doing it, but they tend to be devoting all their energy to that. If banks are going to be successful over the Internet, they need to be able to sell a wide variety of services. The argument around this whole concept is just now beginning. Can consumers identify with a bank through the Internet? Are they going to be willing to trust financial assets to an Internet-based company?

I take it the key word is trust.

Absolutely. Wells Fargo is up to more than a million customers and is adding a hundred thousand customers a month, many drawn from an existing customer base.

You take a name like Wells Fargo, which is one of the few brand names that is exportable on a worldwide basis, but the customer who is out of your geographic footprint still lacks that point of contact. Can you overcome that liability?

If you had told me three years ago that I would do all my book-buying transactions over the Internet, I would have said, You`re crazy. I`ve got this little local bookstore, and I love it. But I haven`t walked into that store in two years. I can go to Amazon.com and find anything I want and have it delivered to my door at a reasonable price. That`s the depth of my loyalty, and I think that is the whole issue.

So you think banks are facing the same thing?

Absolutely. And they better be smart about it, and they better be fast about it. But I still find great reluctance to deal with the reality of their situation on the part of many [banking] companies. And that`s tremendously sad. The world is changing faster than it has ever changed. Their businesses are changing faster. Their customers are savvier. They want more. They demand more. And a lot of banks don`t get it.

Where would you look for a model? What banks have gotten it?

I don`t think banks are the model. We don`t have somebody who can do the next new thing in this industry, or who can even think about it. We don`t have that kind of talent. They`re going to have to find that kind of talent. They are going to have to pay for it. They are going to have to recognize what it takes to keep these dot.com kids happy and give them stock and motivate them in a banking environment. |BD|