An M&A formula for banks.

What are the secrets to successful mergers and acquisitions? For Banc One, they're making good choices in partners, pushing local autonomy and sharing ideas.

John W. Westman, the 51-year-old senior vice president and CFO of the $60-billion Banc One Corp., plays a leading role in the bank's aggressive merger and acquisition strategy.

Banc One's most recent activity is the proposed acquisition of the $3-billion Key Centurion Bank in West Virginia expected to be completed early this year. Its largest merger transaction was the acquisition of the failed MCorp. banks in Texas.

While Banc One's leading identifier of prime merger and acquisition candidates is Executive Vice President and lawyer Bill Boardman, Westman and his corporate finance division are the first to carefully assess the ability of the candidates to match Banc One's rigorous financial standards. Here's how they do it.

FINANCIAL EXECUTIVE: What's the nature of your division's role?

JOHN W. WESTMAN: Our work falls into two areas: preannouncement and postannouncement. During preannouncement, our role is to perform the detailed analysis to determine the value of the transaction from a financial perspective.

The postannouncement activity places us at the focal point of the short-term due-diligence activities. We'll perform accounting reviews and review the audit work from outside auditors. We also act as a network for the nonfinancial reviews that are to be conducted. We pull together a book that identifies any issues we find in due diligence.

FINANCIAL EXECUTIVE: How long does it take to perform this analysis?

WESTMAN: We can do it in an hour if we have the right information. In one case, it took only part of a day. We usually sit down with some key financial people in the other organization and talk about trends in various categories in the operating statement. This gives us information on the key things that matter to us.

FINANCIAL EXECUTIVE: How large a team do you bring in?

WESTMAN: We can operate separately or as a team. We've worked it both ways. Most often, these are the people who are involved: the treasurer, who's been involved in all but two acquisitions since the start of our company, and a CPA, who is a mergers and acquisitions specialist. And occasionally I'll go along and assist. We have other staff in corporate finance who can step away from their day-to-day assignments and help. We usually have to pull together a large team in a hurry. Very often, it's two or three people who do the work.

FINANCIAL EXECUTIVE: How do you present the merger and acquisitions to your investors and stockholders?

WESTMAN: The first people we want to reassure are the rating agencies. Our bondholders are important to us. We will sometimes call our rating agencies with the preannouncement to explain what we're doing and what we see as the attraction financially. We'll also try to explain the transaction in terms of how it fits with our strategies. These contacts involve a lot of one-on-one conversations.

We're trying to build our company so that it looks tomorrow a lot like it looked yesterday. We're trying to buy banks that are run like the banks we've got and have the kind of management we have now. They must also be accretive from an earnings-per-share standpoint.

We think we can make money for our present shareholders--and I would underscore "present." When we can find good banks with good management and have upside potential for our present shareholders, it's easier to make a deal.

We do not do dilutive transactions. One of the reasons our stock commands the value it does is that the shareholders know we're not going to give it away to the next acquisition. If we do, it's the last one.

We have a standard way to approach a transaction like this. We always assume we're issuing new shares for the transaction, and we examine dilution based on new shares. Whether we use shares or cash, the cash has to be raised by selling shares or retaining earnings. We take an earnings-per-share perspective.

We're comfortable showing analysts or rating agencies our internal document. It's a printout of our spreadsheets on how we did the analysis, and we'll walk through them in great detail if the analysts are interested.

But what people want to know is: Does the transaction fit our strategy generally, and how do the bottom lines look? What kind of holes do we see in management? Our constituents give us a lot of latitude because of our record.

FINANCIAL EXECUTIVE: What do you look at in a candidate in terms of financial analysis?

WESTMAN: That depends on whether it's a market-extension acquisition, which involves adding a new city or state, or an in-market consolidation, where we're buying a bank in a city where we've already got a bank. In the case of the former, we look at things like where the revenue enhancement opportunities are. Do we have product areas the candidate doesn't have that would be very attractive for it to pick up? Will we consolidate the data processing, and, if we do, what might that save? What about the cost savings of discontinuing the company's publicly traded position?

Usually, we'll take a very hard look at the composition of the investment portfolio. While we can't have much short-term influence over the kind of loans that each bank is doing in its local market, we can look at the kind of investments that have been chosen and the philosophy used to manage interest-rate risk. We often find there are gains to be made by simply converting new banks' investment philosophies to ours.

For instance, if a bank were buying government securities and we were seeing that mortgage-backed securities would accomplish the same kind of rate risk management, we might be able to realize a pickup in the earnings that wasn't there before. It's usually something that a small bank might not have been totally comfortable doing, but in the context of a larger organization it makes some sense.

The big difference between this type of market extension and a market-consolidation acquisition is in the consolidation review. In consolidations, we're looking at how we're going to put the two organizations together and what overhead and other management savings can be made and what branches can be closed. We'll be looking for a deep reduction in noninterest expense. In market extensions, we're more heavily focused on the revenue side, both for investment securities and products sold to customers.

FINANCIAL EXECUTIVE: How do you decide when and where to consolidate operations?

WESTMAN: Everyone gets involved. We generally consolidate data processing, but other than the item and data processing areas, there aren't a lot of consolidated things going on in this company. Further consolidations get to be a real struggle because we like local autonomy. For example, in Wisconsin, we have a central, indirect loan origination facility that will establish service for customer-dealer lending needs and have those originations revert to the bank that's closest to where the deal is made. That's a Wisconsin decision that may not be the case in other states.

We don't feel the need to be consistent because it's just not our style. Our style is to challenge local managements with what makes the most sense for them. They're free to consolidate with others as necessary.

And we don't consolidate much at the corporate level. We have some oversight capabilities in the area of finance. One example is the area of compliance, where we influence all of our affiliates to adopt standard practices. Another area is advertising: Corporate-level, brandname advertising is consolidated. We have one agency. We produce one set of general purpose ads. We may run locally produced ads for specific products and prices in specific markets.

FINANCIAL EXECUTIVE: Why is data processing consolidated in particular?

WESTMAN: We want to have common systems. We want to be able to offer the same products in most markets. When we convert a bank to Banc One, it's simply cheaper to discontinue using many systems. For a given product we like to support one system.

By consolidating, of course we also can take advantage of economies of scale that smaller banks couldn't get. At the same time, we can establish redundancy in the data processing function and in the networking to reduce the possibility that we're going to suffer from an outage of some sort.

A lot of banks, especially smaller ones, find that managing their own data processing is a pain in the neck and they'd really rather be bankers than DP operators.

FINANCIAL EXECUTIVE: What's the rationale behind the emphasis on local control?

WESTMAN: Local people do a better job of managing trade-offs when they're trusted to make the best economic decisions. So we let them decide how much to pay tellers in their market. We let them decide which advertising to run. We want them to manage to a bottom line in their market. That's more important to us than their adopting common practices that may not produce value for the shareholder.

We rely a great deal on decentralization and on having good managers. There's strength in diversity. If someone makes a mistake in a local bank, it's not going to spread to anyplace else. On the other hand, if someone figures out how to do something especially well, we have a number of formal and informal internal clearing houses and exchanges for good ideas. These forums communicate the success stories to others.

When you give people as much authority and autonomy as possible, they'll make better decisions, and they'll manage those decisions better than had you dictated them. While this style of management provides a level of diversity and contains risks, it doesn't subvert opportunities for sharing good ideas.

FINANCIAL EXECUTIVE: What would be an example of the clearinghouse mechanisms?

WESTMAN: About five years ago, we started what we called the retail conference. It was an outgrowth of some frustration we were feeling about some good things going on that were very hard to communicate. For example, someone could come to the executive management committee and explain some technique that was working in one place, then someone else at the committee meeting would go home and pass the word about it. But, by the time it got to the person who could generate the action, the idea was so diluted that little was accomplished.

We started the retail conference as an experiment. We let the people who had the great stories put on a little show-and-tell. It's an internal trade fair, and the local banks pay for their own travel and expenses. Last year, over 400 people attended. It's become a source of good ideas and a place to exchange information. Occasionally, we'll even base a corporate policy decision on an idea.

FINANCIAL EXECUTIVE: Are there particular financial functions you have to consolidate in a merger?

WESTMAN: Well, there's going to be only one annual report. We don't consolidate accounts payable. We do consolidate payroll. Those things we look at on a case-by-case basis. Our affiliates report their earnings, forecasts and budgets on a uniform system. But the work to develop them is all done locally. The operative word here is standardization more than consolidation. Every affiliate will be using the most up-to-date copy of the financial control system software. But they're basically doing the work locally, and they upload the results.

FINANCIAL EXECUTIVE: How long does it take to absorb a new organization?

WESTMAN: A bank can be on our control system so we can track its numbers and consolidate them routinely in eight or 10 months. It may be a year or two down the road before we convert the bank's data processing because we're backed up or because the firm has a contract that's economically disadvantageous to cancel or for some other another reason. Overall, it's a two- or three-year process.

FINANCIAL EXECUTIVE: What are the top five financial criteria for good merger and acquisition candidates?

WESTMAN: Earnings consistency is real important because it's been a hallmark of our own company. We would be nervous about looking at candidates who had a sawtooth pattern of earnings. We're looking for strong credit criteria--good performance on charge-offs and nonperforming loans.

We actually look for banks that may be performing below where we think they can perform. We may see a bank that's making 90 basis points on assets and feel like it can be doing 130 or 140. That's an important consideration because we will pay a premium for this bank.

Then the question is how do we earn it back. We earn it back if the returns can be driven. We're looking for earnings opportunities. Number one, we don't want dilution in our stock. We need to show our investors that, although we've paid a premium, it's going to be accretive.

FINANCIAL EXECUTIVE: What are some warning signs that would mean you should avoid a merger or acquisition?

WESTMAN: We look very hard for major, nonrecurring financial transactions: Did the bank sell a credit card portfolio? Did it change accounting policy in an area that boosted earnings for a quarter? Did it do anything else that would otherwise mask a poor earnings situation?

We're looking for unusual accounting entries. We wouldn't want to take a transaction in which the credit was in doubt. We wouldn't want to become involved with banks where we didn't know how big the hole was going to be. We also would be concerned if the bank didn't have good financial people.

FINANCIAL EXECUTIVE: How do you assess the quality of the financial staff?

WESTMAN: If you talk to people, you can get a sense pretty quickly of whether or not good financial practices are employed routinely to run the business.

We may ask them to describe their pricing model for commercial loans. If they've got an elaborate scheme that looks at relationship profitability, that does match funding of assets and liabilities, that allocates expenses to products and organizations on a real-world, as-incurred basis, if they've got good management accounting and management accounting is being used to help run the business, that's a big step forward.

On the other hand, if they're missing those things and they're doing things by the seat of the pants, then we have to spend more time seeing if the financial people are able to make the right calls. They'll be looked to by operating management to help guide decisions on bidding for business or pricing.