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Big is not so bad.

The crop of new bank names sprouting in Indiana includes a bunch of competitive and well-managed banks.

The banking landscape across Indiana changed dramatically in 1992. Roughly half of the market statewide is now controlled by out-of-state bank corporations, including NBD, Banc One, National City, Society, Norwest, First of America and Huntington. This leaves the remaining market share to the approximately 270 banks still in Hoosier hands.

What are the ramifications for Hoosiers? How did things get this way? While some in Indiana have found the situation alarming, there are reasons why the influx of out-of-state bank corporations may not be such a bad thing. Indeed, the crop of new bank names sprouting in Indiana includes a bunch of competitive and well-managed banks.

Even so, those running banks with names relatively new to Indiana understand why some customers may have misgivings. "Change can lead to uncertainty for customers," says Michael Hammes, Society National Bank, Indiana's northern regional president. "Banking is a confidence-level business. When they see a name change, they don't know what that means for them until they experience it." Hammes and his colleagues believe customers' experiences have been positive.

Banking was a fairly simple business until the '70s. A bank took in deposits and made loans--primarily business loans, with a few consumer loans, mainly on cars. The deposits didn't cost banks much, nothing was paid on demand deposits (checking accounts) and little was paid on savings accounts.

Government regulated how much banks could pay on savings deposits, and the mandated rate was very low. Then banks calculated costs, added a reasonable profit margin, and set the loan interest rate. Banks made money on the "spread." A simple business. Since the cost of money was the same for every bank, and overhead costs per depositor were comparable, loan rates varied little from bank to bank. Competition in this environment was largely a matter of perception.

Between 1975 and 1985, it all changed.

Non-bank competition for deposits and loans became the problem for the banking industry. Often a bank couldn't come close to the car-loan deals offered by GMAC or Ford Credit. Finance companies pecked away at other parts of the consumer-loan business, financing everything from TVs to sewing machines.

The financing arms of companies such as GE took away business from the commercial-loan department, as did commercial finance companies that handled equipment purchases and leasing. According to the Federal Reserve, banks' share of the short-term credit market fell from about 75 percent in 1975 to roughly 50 percent by 1990.

Probably nothing impacted the banking industry more than the competition for bank deposits from the brokerage houses' money-market funds. As a percentage of all bank liabilities, the Fed reports savings deposits fell from about 40 percent to about 15 percent by 1990, and demand deposits from 20 percent to 10 percent.

Banks were left with two courses of action: attract new depositors or lobby with state and federal governments to deregulate the unwieldy banking industry, allowing a more level playing field with other financial services players.

In order to attract new depositors, banks focused on service and opened more and more bank branches. During the '80s, about 16,500 branches opened nationwide. The growth of electronic branches, or automatic teller machines, was even more dramatic. In 1970, Bank One introduced the plastic-card ATM. By 1978, there were perhaps 2,400 machines in the United States. Now there are nearly 100,000.

The ability to use plastic at ATMs and in stores as debit cards (another convenient bank service) forced banks to greatly increase computer capacity and improve information systems. TABULAR DATA OMITTED Banks had to automate quickly or lose customers.

Acquiring data-processing facilities has been expensive for many banks. The cost of new branches and the need for increased computer capacity in order to be competitive have been leading contributors to the growth of bank overhead.

Bank deregulation happened in two ways in the early '80s. Congress passed legislation allowing banks to offer market interest rates on deposits. The other part of the deregulation trend was allowing out-of-state bank holding companies to acquire in-state banks.

Meanwhile, other forces put pressure on the industry. Because banks were now offering higher rates for deposits, the cost of the raw material for loans was going up. Higher rates on deposits forced banks to look at higher-yielding loans: credit cards and other types of consumer credit, and commercial real estate. The Fed reports that from the late '70s to 1990, real-estate loans became the biggest part of a bank's loan portfolio, at 40 percent, surpassing commercial loans at 33 percent.

But there's a reason why these loans yield more: They are riskier. As the years wore on, recessions caused problems with consumer loans. The substantial sums available for real-estate developers allowed overbuilding in some parts of the country and in some segments of the market, especially office buildings. As a result, defaults were inevitable. Loan charge-offs went up 35 percent during the '80s.

To make a complicated story short, rising costs and declining customer base brought about overcapacity. There were too many banks, too few customers to go around, and too few accounts to adequately cover overhead expenses. Banks faced the choice of increasing the spread to cover costs and risk losing customers; keeping the spread as it was and lowering profits, or worse, operating at a loss.

Profitability did, indeed, decline, from about 1.4 percent to near 0.5 percent according to the Fed. And in business, when you have excess capacity, inefficiency and falling profitability, you have consolidation. You fold the less productive into the more productive.

"You have consolidation all the time in other industries," says Indiana University finance professor Dr. William Sartoris. "When GM has overcapacity from unprofitable plants, it consolidates operations in more productive plants. Banking is going through the same things manufacturing has--it just isn't used to it."

Don't believe this country has too many banks? Consider this, Sartoris says. "There are about 12,000 banks in this country and six in Canada. There are just a handful of banks in other countries. Not here."

"You just can't operate 12,000 banks in one country," Hammes agrees. "If you want a healthy banking industry, you've got to allow banks to operate efficiently."

Among the most profitable, best-managed banks in the country are the banking corporations that have come to Indiana from Ohio and Michigan. The average return on assets of Banc One, Fifth Third, Society and NBD is about 1.3 percent. Compare that with the current national average of 0.65 percent. Meanwhile, the average of some of the largest banks based in Indiana (Old National and Citizens in Evansville, Fort Wayne National, and 1st Source in South Bend) is just over 1 percent.

These out-of-state banks became so profitable in part because they were able to acquire banks in their home states well before 1985, when Indiana banks first were allowed to do so. And size does have much to do with bank efficiency and productivity.

Alden L. Toeves of First Manhattan Consulting Group, a bank consulting firm, estimates banks on average will save 25 percent in non-interest expenses (including wages and salaries, data processing and information systems, branch operations) from in-market acquisitions, 15 percent for out-of-state acquisitions.

"Our strategy is clearly to consolidate whatever support functions we can to allow more efficient and effective delivery of our products and services," says Michael J. Alley, president of Fifth Third Bank of Central Indiana. Fifth Third, based in Cincinnati, has more than 250 offices in Indiana, Ohio and Kentucky.

The savings from consolidation of operations can be substantial. First Manhattan Consulting has estimated the cost of operating 100 bank branches to be about $460,000 per branch per year. The estimate of operating 400 branches is $300,000 per branch per year, a 33 percent savings per branch. The annual cost of processing credit-card transactions is 50 percent less for four million accounts than it is for a half million.

Society Bank in Cleveland had an idea what the future of banking would be. Just as soon as the practice became legal, Society became the first bank in the country to set up a holding company--that was in 1956. Soon thereafter it began its acquisition program, since there were no restrictions on intrastate banking in Ohio. By 1978, it already owned 12 banks. By 1985, it had bought Centran, the fourth-largest bancorp in Cleveland, plus banks in Dayton and Canton.

Society's experience is typical of the Ohio and Michigan banks that have entered Indiana. By the time the law was changed in Indiana to not only allow intrastate branching by Indiana bancorps but also to allow interstate ownership, the banks across the state line had nearly 30 years of acquisition experience. Consequently, they were considerably larger, had more to spend on acquisitions, and were generally more profitable.

Every bancorp has its own strategy for acquisitions. In general, each wants a bank in a growing market with considerable market share, either first, second or third in its home market. It doesn't want problems such as a bunch of bad real-estate loans. It wants good management in place.

These are the main reasons Banc One acquired American Fletcher National Bank in 1987. AFNB was the second-largest bank in the state. It had good management, and most of the top managers, including President Joseph Barnette, were asked to stay. Things have gone so well that last year Bank One Indianapolis took over the title of Indiana's largest bank, passing up INB National Bank.

As is the case with nearly every merger, the day-to-day management and customer-service parts of Bank One/AFNB stayed local. The banks always make every attempt to ensure the customer is served the same way after the ownership changes as they were before. "We have common loan policies among the affiliate banks, but we make our own lending decisions," says Bank One's Barnette. "Our products and services are priced locally. We do our own community relations."

Nevertheless, clearly Banc One Corp. wants to be a national bank. It will become the seventh-largest bank in the country--with assets over $75 billion--after finalizing the purchase of Valley National Corp., the largest bancorp in Arizona. With Valley in the fold, 43 percent of Banc One's assets will be west of the Mississippi River.

Another reason Banc One came to Indiana was to come to Indianapolis, where the economy is known to be healthy. "Indianapolis is more recession proof," agrees Larry Peterson, central regional president of Society National Bank, Indiana. "The market here is younger, has more managers and professionals, and is more service-oriented than much of the Midwest."

National City Bank, which like Society hails from Cleveland, liked Indiana and Indianapolis for much the same reason. National City Corp. acquired Merchants National Corp. in 1992. "We're a firm believer to not be in just one market or one investment," says Vincent DiGirolamo, president of National City Bank in Indiana. "We had an excellent year in 1992. But it could have been better if we had taken more risk with our securities portfolio. We didn't do that because we just won't put too much in one thing."

NBD couldn't help being dependent upon one industry for a long time. This was, after all, National Bank of Detroit, started with funds from General Motors. Geographic diversification into a market like Indiana was very important to NBD. "It's not good to have all your loans concentrated in just one area," says Terry Brennan president of NBD/Midwest Commerce Bank in Elkhart. "There's more safety for the holding company, its affiliates, and most importantly, its customers."

There are some definite advantages to being affiliated with a larger banking company. "There are experts in all kinds of banking in the NBD system," says Brennan. "If I need some help with a potential commercial customer in the auto industry, call Detroit. There's an NBD bank in the Chicago suburbs that has expertise in the fast-food business. Our affiliation has meant probably $100 million in loans to Midwest Commerce just because NBD resources are there to tap into."

Hammes says much the same thing about Society Bank. "We have experts within the company that we can bring in to deal with various issues."

Tom Miller, president of NBD Indiana Inc., the successor to INB Financial Corp., says one thing NBD is bringing to the state is full-service international banking. NBD has offices in Europe, the Far East and Australia. "International banking is important to Indiana, considering it's eighth or ninth in exports in the country."

While no one can argue that these big banks are bringing some new expertise into Indiana, what are they doing with the money they make here? Some opponents of the consolidation trend have worried that out-of-state banks are taking deposits out of Indiana, but President Greg Sheridan of The Huntington National Bank of Indiana says that's not necessarily true. In the case of his bank, having an Ohio connection has meant more money for Indiana borrowers. "We've had more loans than deposit growth, so we've had to import dollars and deposits from Ohio."

Money is not all The Huntington has brought into Indiana, Sheridan says. The Central Indiana bank is comprised of what used to be the First National Bank of Danville and the Wainwright Bank & Trust, which together employed 80 or 90 people and had about $100 million in assets before The Huntington came along. Now, the bank has assets of about $400 million and employs 135. "We have provided a lot of opportunities for people in terms of jobs here."

Compared with other out-of-state banking companies, Fifth Third has taken a

different approach to its expansion into the Hoosier state. It has been willing to create market share rather than buy it.

In 1989, Fifth Third acquired New Palestine Bank and changed its name. New Palestine fit Fifth Third's criteria for its strategic objective of growing into Marion County. First, it was a quality small bank, close to Indianapolis, and it was just off the interstate.

"Our philosophy has been to acquire institutions along major interstate highways, which allows easy accessibility and also tends to focus on major population centers," says Alley of Fifth Third.

"Our commercial officers do much more than solicit loans," the Fifth Third annual report says. "Through our relationship approach to selling, they sell all of our commercial products, including leasing, cash management and international services, as well as trust and investment services, deposit accounts and data-processing services."

Alley reports his people made more than 6,500 calls in Indianapolis just last year. "All of our relationship bankers recognized a goal of meeting with customers and prospective customers at their place of business on a very regular basis. This allows us to get to know the customer, to better understand their business."

Fifth Third bankers and trust officers have sales meetings once a month to go over their best prospects. Having these kinds of meetings is a common practice in insurance or other sales organizations, but unheard of in the banking industry.

It must work. In just over three years, Fifth Third has taken New Palestine from being a small-town bank with 29 employees, $45 million in assets and two offices to an Indianapolis bank with 120 employees, $315 million in assets and 11 offices. And it's still growing phenomenally.

Every bancorp believes it operates community-based banks, which respond to local conditions, adapt products to local markets, work with local business and help local consumers. These are things many Indiana-owned banks claim that they still do better than their cross-the-border competitors.

"Our focus is to strengthen links to our customers," says Christopher Murphy president of 1st Source Bank in South Bend. "We have to provide superior service."

Dan Mitchell, chairman of Old National Bancorp in Evansville, echoes Murphy's sentiments. "There's no copyright on bank services," he says. "They're easily copied. You have to do a good job for your customers. Being first is not terribly important. Providing service is."

Mitchell could be right. Old National became the largest independent, Indiana-based bank-holding corporation in the state by making customer service a priority. It has been pursuing its own acquisitions in Southwestern Indiana, Southeastern Illinois and Western Kentucky. After it finishes the purchases now in progress, Old National Bancorp will have 19 affiliates and more than $3.5 billion in assets.

Most of the other holding company/affiliate organizations began when a fairly large community bank created a holding company, then bought banks in smaller towns. STAR Financial did the opposite: it started as a group of 10 small-town banks that formed a holding company. "We have a good niche," says Vice Chairman Carl Erskine. "Our banks know our customers; they tell us what to do." STAR--an acronym of the founders' first names: Sela, Tom, Art, Ralph--has learned from its market to focus on individuals: consumer loans and small business lending.

For the most part, independent bankers believe that all the merger activity has been good for their business. In Valparaiso, Indiana Federal Bank for Savings President Pete Candela sees consolidation as an opportunity. "We can be the alternative. It's eliminated some of our competitors," Candela says.

Says William McWhirter, president of Peoples Bank and Trust in Indianapolis, "It's been good for Peoples. Ninety percent of the people are happy with new owners, 10 percent aren't. It drove some to us. We can't handle all of the 10 percent." Though Peoples is the smallest bank in Indianapolis, "we're still larger than 80 percent of the banks in Indiana." And it's the largest locally owned bank.

McWhirter believes his customers are more "service sensitive." "We have a lot of professionals and closely held businesses. We do a lot of business with doctors. We've put branches in hospitals."

Union Federal Savings Bank in Indianapolis--the city's largest thrift--also hopes to gain from some customers' perceptions that service may not be as good at the out-of-state-owned banks. "Our operational center is here, so it may be a little easier to get answers than, say, going to Columbus, Cleveland or Detroit," says the institution's president, Jerry Von Deylen. The smaller banking customers in particular may be the ones to look for a local connection, he says. "I haven't heard a lot of large loan customers complaining, but we've heard a lot of small businesses complaining."

Small businesses, however, probably aren't complaining about The Huntington, TABULAR DATA OMITTED Sheridan says. "For the federal fiscal year ending September 30, we were the largest Small Business Administration lender in terms of the number of loans of any bank in Indiana. We really try to market to small business."

Joseph Morrow, president of Mercantile Bancorp in Hammond, says competition from big banks is nothing new. "We've always had the Chicago banks. We know how to compete." A key is speed, he says. "We can give decisions more quickly. We know our customers. Our niche is to give efficient service."

Jackson Lehman, chairman of Fort Wayne National, believes it's important that banks do what they know best. "We don't base our business on what the competition does. We'll provide credit and serve depositors and give them the service they've come to expect."

Some of the independent banks are like Old National, Fort Wayne National and 1st Source; they all have some affiliates of their own. However, the management of these banks may be a little different. Lehman of Fort Wayne National--which owns five area banks--says, "Just because we're bigger doesn't mean we know more. We give them goals and let them be a banker. Part of what we buy is carried on the books as 'good will.' We don't want to destroy that."

Murphy of 1st Source adds, "Our banks (six in all) know their destiny. We don't make large changes. We want them to have the same commitment to their communities we have to South Bend."

The out-of-state bank-holding companies also stress the importance of their member banks keeping a local focus. At Society, for example, the Indiana bank is split into regions, allowing many decisions to be made locally. And while the name may not have been around for decades, many of the people have, Hammes says. He, in fact, is a native of the area he now serves, and he worked for the bank that Society acquired when it entered the market, the St. Joseph Bank & Trust Co.

The independents don't see themselves becoming part of the consolidation parade. "I'm here to run the bank, not sell it," Lehman says. But most admit their boards have considered it. "We know we have an obligation to our shareholders."

Morrow of Mercantile tells inquirers not to waste their time. "We like being independent and want to stay that way. But if somebody makes us a crazy offer, we'd look."

Sometimes you get an offer you just can't refuse. INB was selling at $28 a share when NBD offered a swap of 1 NBD share for 1.6 of INB. Miller relates, "After the swap, our stock was suddenly worth $56 a share. Including dividends, our shareholders made $44 a share. Do you think we did well for them?"

Despite what you might think, bank mergers are not easy to do. Banc One's annual report states: "We actually bid on less than two-thirds of the banks we examine and our bids are successful about one-half the time."

Acquisitions in the banking business are done on a "friendly" basis, no hostile actions. "There's a 'gentleman's' code," says bank analyst John Reed of the investment banking firm David A. Noyes & Co. in Indianapolis. "You go out to lunch, play some golf and say 'if you're ever interested, let us know.' It could be years before something is done."

Rick Nisbeth, a bank expert with Indianapolis-based investment bankers Raffensperger Hughes & Co., believes it's the personalities of the principals and the top management that have much to do with whether a merger happens or not. "It's a marriage; the chemistry has to be right."

In organizing mergers, investment bankers sound more like they're running a dating service than a financial organization. Reed says he tries to learn the managements' likes and dislikes. "After the research, I'll think this is a good fit of personalities and I'll call and say I want to introduce you to each other."

Miller says INB had three or four serious contenders besides NBD, but chose the Detroit company because "we knew them. They had been a correspondent bank of INB for years. We felt comfortable with them."

Despite the popular notion that Indiana banks are being devoured by a ravenous group of out-of-state banks, that feeling simply isn't true. Almost all bank acquisitions happen because the management of the smaller institution believes it's in the bank's best interest to be owned elsewhere. The management makes the contacts and seeks the bids.

If the managements are compatible, then the financial analysis starts. The important figure that both sides look at is book value and how much a premium over book value it is going to take to make a deal. Larger banks can afford to pay more, they have more money to work with and, more importantly, more shareholders.

All these bank mergers are done by stock swaps, like the INB/NBD deal mentioned before. Giving out a lot of stock to the stockholders of a bank being bought dilutes the holdings of the stockholders of the acquiring bank, lowering their price. Deals are done to raise share values, not decrease them. Lehman of Fort Wayne National would like to buy some more banks in its area, but, "We look at what we would have to give. We can handle some modest dilution, but not any more."

Old National is swapping stock equal to two times book for the DuBois County Bank, but probably that's as much as it could do. A bigger bank could have offered more, but in bank mergers money isn't everything.

Bankers universally agree that consolidation will continue. Nisbeth believes that because of the consolidation that has already happened, the prices paid may be somewhat less. "Small banks are running out of people to buy them. It was that six banks would be bidders, in the future it will be three."

The community banks of the future will be closely held and family-owned and -managed. 1st Source, Mercantile and Peoples fall into this category. Banking for them is a tradition, not just a business. It's the family, not just the bank, that is tied to the community. The other independents may have a hard time saying no to a really good deal.

Banking is changing. Apart from consolidation, there is an emphasis on becoming one-stop financial centers where customers can make deposits, get a loan, buy insurance, invest in stocks and find help in planning for retirement. Banc One is planning to put one-stop Personal Investment Centers in 400 branches by year end.

Fee-based business like data processing and trust services are a much bigger part of the plans of most banks as they try to become less spread-dependent. Society merged with Ameritrust, another Cleveland bancorp, largely to get its trust business. Fifth Third made nearly $55 million last year from its Midwest Payment Systems data-processing subsidiary.

Banking needs to change. Every banker complains that non-regulated non-bank financial services are badly damaging the industry. The feeling is that if you are a bank in every way but name, you should be regulated like one. The FDIC, in overreacting to the S&L fiasco, raised the deposit insurance payment for all banks, good and bad. It's the only situation where insurance costs the same for those in perfect health as those that are sick.

Banking has changed. Erskine says, "My grandfather would never believe you can withdraw money from a bank on Sunday at midnight, legally."

Or as Nisbeth believes, "Banking's not stodgy anymore."
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Title Annotation:includes ranking of bank holding companies and banks; presence of large banks in Indiana
Author:Miller, C.E.
Publication:Indiana Business Magazine
Article Type:Industry Overview
Date:May 1, 1993
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