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Banking's brave new world
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November 19, 1997: 3:39 p.m. ET
Cleaner balance sheets, technological costs fuel consolidation, analysts say
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NEW YORK (CNNfn) - Although investors are questioning the valuation of First Union Corp.'s proposed combination with CoreStates Financial Corp., banking analysts generally believe consolidation will accelerate because of a benign business outlook.
Charlotte, N.C.-based First Union formalized plans to acquire CoreStates of Philadelphia for $16.3 billion. At $81.40 a share, First Union is offering 5.3 times CoreStates stock's book value.
As the largest banking merger in history, the proposed transaction eclipses NationsBank Corp.'s pending $15.5 billion bid for Barnett Banks, which valued the target bank's stock at 4.1 times book value.
"The new level that they're talking about is 5.3 times book, where the level over the last 10 years has gone from 1.8 times to 4.1 times. I would call it a quantum jump," said Charles Driggs, banking analyst at Safeco Asset Management, who has covered the industry for the last 14 years.
Industry observers don't doubt the banking industry has reached a critical period of consolidation as expressed by CoreStates Chairman and Chief Executive Terrence Larsen at a news conference Wednesday. (363K WAV) (363K AIFF)
"I think we're approaching a point where size is really important. Critical mass is important, and if you can't find a merger partner to get that critical size you're likely to go yourself," said Hal Schroeder, analyst at Keefe Bruyette & Woods.
Yet what has allowed larger, money center banks to pursue regional banks with more vigor has been the self-policing industry practice of cleaning up the balance sheets. With less exposure to bad debt, the companies no longer represent such a risky investment, Safeco's Driggs said.
"I think the attraction of the group is there is no large problem area which was a problem in the past," the 29-year-veteran analyst said.
Prior to the savings and loan crisis of the late 1980s, banks set aside less than one dollar in reserves to cover every one dollar of non-performing assets. But since that crisis, as well as soured loans from lesser developed countries in the early part of the 1990s, regional banks have taken a more conservative approach.
"They didn't mandate it but it was a feeling that you should have had at least one and a quarter times (non-performing assets) in reserves," Driggs said.
Now, most regional banks have reserves of about 2.5 to 3.5 times their non-performing assets.
In addition, analysts believe the need to bring banking into the Information Age (as well as the costs associated with those technologies) will also fuel the partnerships.
"In fact, if you tie in the year 2000 issue, you may actually see an acceleration in the process," Schroeder said.
"We're right in the middle of the planning process for 1998, and as banks look at the costs they're going to be incurring in 1998, they have to step back and think: Do we really want to go it alone?" he said.
Driggs said he views regional banks in the Midwest, such as Mercantile Bancorp (MTL) of St. Louis, as prime takeover candidates. Schroeder, though, has targeted regional banks in the Southeast such as Winston-Salem, N.C.-based BB&T Corp. and CCB Financial Corp. of Durham, N.C.
-- by staff writer Robert Liu
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