Dissecting banking's bigness: mega-mergers in banking are being pushed in part by market forces too impatient to grow new markets and higher returns the old-fashioned way. Is this good, bad, or just a fact of life? (Industry Trends).

SECURITY PACIFIC NATIONAL Bank, Grocker National Bank, NationsBank, Norwest, First Interstate, Great Western Savings, Home Savings--all great banking names from the past that no longer exist. In a society where Corporations live and die by brand-name recognition, shelf space and market share, what happened to these once-proud banking icons? More importantly, what's driving the consolidation trend that has retired these once highly visible brands?

Mergers and acquisitions (M&As) are a means to expand a customer base, breathe life into consumer products and services and create instant gratification for those who require higher rates of return. In today's marketplace, businesses are expected to grow and prosper in a competitive environment that lacks the patience or inclination to follow the "old" business models, which accounted for much of the expansion that took place in the banking industry over the past 70 years.

Expectations of institutional and private investors alike are a driving force behind the business strategies of corporations seeking to deliver higher earnings. Though not a 21st-century innovation, over the past few years M&As have dramatically changed the banking landscape--leaving behind smaller, more community-driven banks and thrifts in favor of large, postmerger corporations whose assets rival third-world countries.

Now, large is by no means a bad thing. Neither does it automatically presuppose inefficiencies or lack of service, as some claim. In America we like things big. We like our cars large, our backyards wide and our fries "supersized." But what about the consumer? Will the trend toward supersizing our banks leave the customer-service orientation of the past intact?

Inevitably, M&As have a side effect that affects all corporations that engage in them: scale. When Bank of America merged with NationsBank, it not only gained in assets, but expanded in every other way from physical space to personnel. These side effects are generally considered a boon, as well as an effective way to merge internal operations--like marketing and human resources--yielding savings in operating costs. They also effectively and instantly create an enlarged consumer base to which new services and products can be sold.

But despite the appeal that high-end mergers and acquisitions hold for successful and growing companies, growth through M&A is no slam-dunk. In fact, it's quite the opposite. Mergers today fare about as well as the average American marriage. Roughly 50 percent end in divorce or some form of separation. They also endure a higher percentage of problems taking much longer to resolve than many anticipate.

Because M&As are here to stay, it is critical to devise a way to measure the likely success or failure of a merger. Such a measure would be extremely helpful to those trying to gauge whether a contemplated union is going to be a good move.

Washington Mutual Inc. (WaMu), Seattle, has become a de facto leader in the M&A game in the mortgage and banking industry. Its track record of growth through well-directed acquisitions has shown signs of working quite well. In the past 15 years, WaMu has purchased more than 30 thrifts, mortgage companies and financial entities, creating a veritable "laboratory" on the effectiveness of growth through M&A.

In an article by George Anders in the January 2002 issue of Fast Company magazine, Kerry Killinger, Washington Mutual's president, chairman and chief executive officer, said, "Acquisitions need to be a by product of your basic strategy We would never want to do scattershot acquisitions and then have to think up strategies to justify them. We believe that the best way to build value is to focus on a few markets where we can achieve national leadership."

On the opposite side of the coin, however, are companies such as Countrywide Home Loans Inc., Calabasas, California, whose growth has been generated largely internally. Countrywide's rapid growth since it began in 1969 has been aided somewhat through M&As, but more by adherence to practical business applications, innovative products, strong marketing outreach, customer satisfaction and long-term commitment to employees.

In part like Hollywood with its reliance on sequels, banks may be relying on M&A with a bit too much enthusiasm. This may have prompted management to have a blind eye in terms of evaluating the long-term effectiveness of this process.

In research conducted in 1999 by KPMG Consulting, 700 international mergers (1996 through 1998) were reviewed for evidence of what has worked and what hasn't. According to a November 1999 KPMG press release, the research showed "[more than] 80 percent of senior executives believed that the deal they had been involved in had in fact resulted in increased value for shareholders. Yet the analysis shows that 83 percent of mergers failed to produce any benefits for shareholders and, even more alarming, over half actually destroyed value. Not only that, but less than half of interviewed directors had conducted a formal post-deal review."

Of the senior executives/directors polled by KPMG (about 107), it was apparent their focus was primarily, though not exclusively, aimed at share value and how investors and stockholders would respond to their efforts. While it is certainly important to tend to your company's overall valuation in the marketplace, it is also critical, during the aftermath of an M&A, to address some of the following key points KPMG found vital to successful transactions.

Hard keys (business activities)

* Synergy evaluation

* Integration project planning

* Due diligence

Soft keys (people issues)

* Selecting the management team

* Resolving cultural issues

* Communication (particularly to own employees)

But across the mortgage and banking industry, perhaps the reason M&As have been steadily increasing is because they are a natural response to the way business is actually evolving in the marketplace. Fast is in. The desire for immediate results and relief is everywhere, and some do not have the luxury to wait and organically grow a business.

But if M&As are to be accepted as a fact of life, then, at the very least, maybe a more orderly approach to them is advisable--not so much in the due-diligence portion of the exercise, but in the philosophy, i.e., the approach taken to determine if an M&A is the correct step to take in the first place.

The courtship

The M&A trend over the last decade or so certainly has not been confined to banking. Daimler/Chrysler, Mobil/Texaco and AOL/Time Warner are just a few of the mega-mergers that have made headlines in recent years. But large automobile manufacturing plants, oil refineries or Internet service providers (ISPs) are not as visible in the community as banks, so the mergers in those fields are not felt as intimately.

Although competition remains a healthy part of the American system, so does the urge to survive. Historically, when two, four or 10 companies are providing the same or similar services, quality control and customer satisfaction become a built-in part of the process. When one company fails to deliver, there's another that will pick up the slack and deliver what is needed and wanted.

Sometimes, however, the need or desire to be competitive can lead to ill-conceived relationships that on paper might appear a match made in heaven but on closer inspection are filled with unanswered questions and legitimate barriers to success.

Choosing the right target and conscientiously evaluating whether it's a good match, beyond just the numbers, significantly increases the chances of a successful merger or acquisition. Craig Tall, Washington Mutual's vice chair of corporate development and specialty finance, was quoted in the January 2002 Anders article in Fast Company as saying, "In a typical year, we may complete two or three transactions. Most sellers want this transaction to be a way to extend their business further than they can take it on their own."

According to the Fast Company article, WaMu has a practice of putting together a diverse team of personnel that carefully reviews all aspects of an acquisition. It does not rely on a team of outside experts until it's time to turn it over to the inside personnel who will actually have to make it all work.

When we think about mergers, we generally think in clear, vertical lines without too much complexity or mixing of products. A good example of this is Oldsmobile, Buick, Cadillac and others, years ago, coming together to become what is now General Motors Corporation. The logic then was clear: a vertical joining of companies that wooed the same customer base--an example of a marriage that apparently worked and over time proved itself capable of change.

But sheer size has ramifications of its own in business. Size can hinder perception at the outer edges of an organization, because those boundaries are suddenly much farther away from management. The internal communication lines, not just the hardware, must be set in place to ensure that adequate and perceptive business data is coming from the new post-merger "frontier."

In today's environment, banks cannot afford to overlook what eventually happened to the automobile industry when the care and attention provided by the smaller independent manufacturers gave way to a one-size-fits-all philosophy of customer service and product quality. The 19705 were filled with cautionary tales of what happens when the pairing of giants creates an entity too large and too full of itself to effectively monitor customer service and quality control.

But banks do not have to follow the same path as the auto industry or make the same mistakes. The 1999 KPMG U.K. study stated, "Too often companies are concentrating on the hard mechanics to extract value from an acquisition. No matter how intensive the planning, how innovative the financing or watertight the contract, the research has shown that it is the soft issues such as people that are key in achieving the realization of value. Less than 10 percent of respondent directors had prioritized the three soft keys at the integration project planning stage, but all those that did, successfully increased shareholder value."

So is there anything wrong with the current trend of megamergers, other than perhaps the tendency to use it too often?

The marriage

In the world of matrimony, a 50 percent success rate is tantamount to the odds of a coin toss--not very heartening when one looks at what is at stake. When large mergers and acquisitions are only proving successful roughly half the time, perhaps it's time to shelve the assumptions that all acquisitions can bring immediate value.

In late 1999, Simon Kwan, an economist at the Federal Reserve Bank of San Francisco, and Robert A. Eisenbeis, senior vice president and director of research at the Federal Reserve Bank of Atlanta, conducted a study that took an updated look at the overall success rate of recent banking mergers. The study, Mergers of Publicly Traded Banking Organization Revisited, tried to determine whether mergers make sense and if it is possible to iron out the problems that one might expect when two large corporate cultures are brought together. Essentially, the study asked, were the details of mergers being thought through?

Kwan and Eisenbeis' findings showed that gains in efficiency were not always found in the wake of these bank combinations. Their study stated that "consistent with the results of earlier studies, the efficiency and performance effects were mixed. Evidence suggests that the better-performing institutions tended to target the higher-performing targets, but the resulting mergers did not significantly improve profit performance or efficiency. In addition, looking at the market's reaction to proposed mergers, there is only weak evidence that the market viewed acquisitions with favor. It did, however, tend to be less optimistic about the savings from mergers when expense ratios were higher. The overall conclusion is that the widely touted earnings, efficiency and other performance and earning benefits of megamergers still remain in doubt."

Of course, this study dates back to 1999 and a lot has happened in banking since then. One point to consider is that recent gains in information technology (IT) and the ever-present scalability factor (the ability to broaden and extend a product or technology to cover an expanding area) have fueled the desire to grow larger corporate infrastructure. But this puts pressure on the IT managers to find and implement technology that actually works in a manner that can effectively coordinate a work force that has expanded by a factor of x.

The massive expansion of personnel pools produced by large M&As has dramatic and unpredictable ramifications that live well outside the financial documentation that heralds the venture in the first place. Simply because the intent is there to make the merger a success, there is no guarantee that the means and know-how will be present within the newly created organization to make it happen.

Consistent with KPMG "six keys" to successful mergers and acquisitions, the more people involved the better. The higher the level of understanding between the two companies, their cultures and work styles, the more effective the union can be. This is the case because it will be based on knowledge of what has worked in the past inside each company, and not simply the application of "canned" best practices from a text or a past and unrelated merger.

"Despite the claims of acquirers, greater overlap of the merging banks' markets does not seem to be associated with better performance," the Kwan/Eisenbeis study states. "This result brings into question the often-claimed expected benefit that the ability to reduce marketing departments or eliminate redundant offices would result in improved efficiency or profitability."

Let's face it: Expectations run high, and Wall Street and other industry analysts do their part in increasing pressure on the newlyweds to perform right out of the starting gate.

In the more pedestrian marriage of "Bob and Alice," moving in under the same roof, alone, can mean continual and fundamental differences in organizational philosophy, confused financial and accounting principles and profit expectations. And at times, there is an unrealistic approach to the time and resources necessary to train or retrain the personnel to fit into the new structure.

By what factor do we increase this scenario when we're dealing with 30,000 employees spread over 37 states?

Change takes time. Assimilating an entire corporate structure, considered on its own merits to be large and significant, cannot be done overnight. Yet market expectations are constant and the demand to perform at a higher level (since the merger, in many cases, was predicated on that must be met.

Growing a family

Businesses live within the peaks and valleys of an economic environment that is ever-changing. Not everyone buys a car every two years, owns a cell phone or owns or wants to own a DVD player--and the thousands of movies and games that go with it. When individual demand for a company's products begins to wane, M&As are viewed as a valid remedy to this shortfall. Mergers provide an "instant family"--a larger and, it is hoped, more receptive customer base that may not have seen or had a chance to decide upon the new services and products being offered.

Our technological knowledge also is rapidly compounding. So is there any wonder that we are getting used to fast, are more at ease with now and have grown into the habit of not looking as closely as perhaps we should at what counts for service as long as it is swift and decisive?

The normal patterns of growth associated with successful companies in the past may not be a model with any significant relevance in today's markets. The creation of industries (e.g., the dot-com sector) can be measured in months and years instead of decades, and can disappear just as swiftly. Corporations today may not have the time, patience and resources to grow their businesses as their predecessors once did, but it doesn't necessarily follow that they shouldn't.

Perhaps they cannot wait for normal learning curves or R&D to bring about new, improved services and products as they once did. It may just be that business, as it is evolving today, demands a new set of rules--where the larger and more liquid corporations acquire the ones that already have in place the next generation of services and products. This new path to growth may be built to completely bypass the normal "growing seasons."

However, it is a benchmark of American industry, banking and otherwise, that we are innovative and entrepreneurial. In the marketplace of the 21st century, despite consolidation of the larger institutions as they struggle with market share and profitability, that entrepreneurial spirit has not been completely abandoned. It can still be found in the mortgage brokerage business--where smaller niche players actively ply their trade and interact with the consumers on a much more personal basis.

While it is common knowledge that these smaller shops and others like them breed innovative ideas and allow people to push the envelope without corporate restraint, will these new mega-banks possess that same sense of experimentation? Widespread banking competition in the past almost single-handedly created an effective means of ensuring quality control and innovative and timely products.

Someone on the front lines will still need to monitor the pulse of the consumer and feed that information back to the mega bank's board room. Today, as the choices available to the public are dwindling, banks must be aware of how the consumers will react to this. If they fail to do so, there will be those waiting in the wings for the opportunity to re-create the past by offering it up the way consumers like it.

The American marketplace is not an easy domain to understand. Our business history is steeped in values and an adherence to traditional models that have worked. We are pressured by time and financial demands to take the road most traveled--to forego the hours in the "kitchen" and simply use the drive-through window.

The banking industry today must be organic. It must move and morph to fit the current demands of the marketplace and adjust to market forces that are as demanding as they are unpredictable. It is an environment where the shares of companies that have never produced a product will be driven up, while the values of others drop because their expected earnings were off by a cent or two.

M&A is the evolutionary equivalent of webbed feet, enabling the user to more effectively swim through troubled waters and arrive intact on the other shore. It's not the most effective or efficient means of growth, nor is it the worst. It is simply a reaction to the way business is being done.

But is growth through mergers and acquisitions limitless? At the current pace, there will come a time when smaller banks and local savings and loans will all be gone and the lesser versions of Great Western and Home Savings will merely be footnotes in history. Ultimately there will be few smaller institutions left to acquire.

Perhaps we merge because we are uncertain about how to build businesses like the ones built 30 or 40 years ago by a different generation in a different time. Or perhaps we are watching the marketplace with its desire for faster/better and reacting to that, rather than building the best company with the best products and services possible.

Or maybe we just worry too much.

One hundred years ago, American businesses were the best in the world, and for the most part they still are. We seem to rise to the occasion and, when necessary, overcome any problem before us with renewed determination and hard work. And as long as we keep the heat turned up on delivering top customer service and quality, we shouldn't have insurmountable problems. As Yogi Berra once put it, "It ain't the heat-it's the humility."

Joe Luca is a business consultant with 15 years' experience and is currently the chief operating officer for Challenger One LLC, an Internet marketing firm in Los Angeles. He has worked in the mortgage industry over the last decade, specializing in the reconveyance and foreclosure areas.