An Inside Look at 1st Interstate’s B of A Merger Strategy

First Interstate took its bid to acquire BankAmerica directly to BankAmerica’s board of directors in the belief that the board has lost patience with management and can ultimately be convinced of the offer’s value to shareholders.

First Interstate’s strategy for the merger has been code-named “Operation Goldcoast,” with BankAmerica referred to as “North” and First Interstate as “South.” It appears to depend on what First Interstate officials see as an internal power struggle between BankAmerica Chairman Samuel H. Armacost and President Thomas Cooper.

Officials at First Interstate’s Los Angeles headquarters believe that the shifting balance of power at the company will weaken management’s ability to fight the takeover and will strengthen the board’s hand.

This picture emerges from discussions with officials of both banks and investment bankers involved in the proposed merger. The offer, disclosed Monday by BankAmerica’s board, is worth about $2.8 billion.

The four-page letter containing First Interstate’s buyout offer was addressed to the board “in care of” Armacost. It stressed the friendly nature of the bid and assured the directors--many of whom are pillars of the San Francisco business community--that BankAmerica would retain its name and its San Francisco headquarters.

The letter, a copy of which was seen by a Times reporter, also said that the current boards of the two banks would be combined if the merger takes place.

BankAmerica is the parent of Bank of America, the nation’s second-largest bank. It has reported nearly $1 billion in losses in the past year, mostly because of bad loans in real estate, agriculture, energy and the Third World.

BankAmerica’s board has come under fire for apparent inaction in the face of the flood of losses and other bad news at the banking company. Directors have been named in 20 shareholder suits claiming that they failed to adequately represent the shareholders’ interests. The board’s insurance against shareholder suits was canceled last year, and the bank is supplying coverage through a wholly owned subsidiary.

The letter from First Interstate said the combination would restore the stature of BankAmerica and put it in the forefront of the inevitable march toward interstate banking. Unstated but implied by the offer was that it would reunite the nationwide banking company assembled by Bank of America founder A. P. Giannini. The company now known as First Interstate was the interstate banking unit of Bank of America until it was spun off in 1958 to comply with antitrust laws.

The letter said the merger would strengthen the bank’s underlying capital, allowing it to resume growth. BankAmerica has been forced to shrink by selling numerous assets--including its San Francisco headquarters building and several profitable subsidiaries--in order to maintain capital levels required by federal authorities.

The letter also informed BankAmerica’s directors that First Interstate officials had had “confidential preliminary discussions” about the deal with federal bank regulators and that no insurmountable objections had been raised.

First Interstate, the country’s ninth-largest banking company, owns 23 banks in 12 Western states, including First Interstate of California, the state’s fourth-largest bank. Its chairman and chief executive, Joseph J. Pinola, is an ambitious former BankAmerica executive, as are several of his top lieutenants.

BankAmerica disclosed the First Interstate offer on Monday, despite First Interstate’s request that the matter be kept secret while negotiations were under way. A source knowledgeable about BankAmerica strategy said disclosure of the offer was an indication that the bank was likely to reject it.

“If you wanted to do it, you meet with the people and hammer out the deal,” the source said. “You don’t put out a goddamn press release.”

The source also contended that BankAmerica directors were weighing the offer primarily to protect themselves against further legal action.

However, the BankAmerica press release said the board of directors requested additional information about the First Interstate bid. “Thereafter the BankAmerica board will consider the proposal,” the statement said.

Investment Bankers Meet

Officials of the two companies’ investment bankers met Wednesday in New York to discuss the board’s questions.

The investment firm of Salomon Bros. is representing BankAmerica; First Interstate’s adviser is Goldman, Sachs & Co.

Salomon Bros., in a Tuesday letter to Goldman, Sachs, asked First Interstate’s advisers to provide more details on the proposed deal, including information about:

- Expected cost savings to be realized in the merger.

- Projected earnings for the two banks, separately and in combination.

- Whether First Interstate plans to dispose of BankAmerica assets.

- Protections available to BankAmerica shareholders if the combined banks’ performance does not meet expectations.

- First Interstate’s projected asset and earnings growth.

- First Interstate’s five-year financial plan.

Meanwhile, in First Interstate’s first public comment on the deal Wednesday, the bank said in a statement: “The proposal, which is made on a friendly basis, is intended to offer an alternative which is not only fair but attractive to the shareholders, employees and customers of both companies.”

The statement also said: “First Interstate and its financial advisers believe . . . that BankAmerica shareholders would be better off under the First Interstate proposal than they would be on a stand-alone basis in the absence of some extraordinary transaction such as this.”

The statement offered additional detail on how the complex financing package would work. BankAmerica shareholders would receive 0.22 share of First Interstate common for each BankAmerica share, as well as one share of a new “participating perpetual preferred stock.”

The preferred stock would pay annual dividends of 40 cents a share beginning in 1992, First Interstate said. The bank expects to classify the preferred as primary capital for regulatory purposes and intends that it remain outstanding as a perpetual capital security.

Performance-Based Payout

The preferred’s dividends from 1987 through 1991 would be based on the performance of the combined bank. However, no dividend would be paid unless a certain earnings threshold is reached.

That threshold is designed to avoid dilution of the value of current First Interstate shares.

Under the First Interstate formula, BankAmerica would have to contribute about $330 million in earnings by 1989 to trigger the preferred stock’s payout. First Interstate expects that savings realized by eliminating overlapping branches and other operations could provide $240 million of the required BankAmerica contribution.

BankAmerica has said it expects to record a net loss for this year and modest profits next year. It hopes to resume healthy earnings growth in 1988.

BankAmerica’s investment bankers interpret the value of the preferred stock differently, contending that it would not pay dividends unless BankAmerica can earn $500 million by 1989, which now appears unlikely.

“If that’s the case, then the stock (will be) selling for $35 to $40 a share. So why do the deal?” one knowledgeable source asked. BankAmerica is currently trading at less than $15 a share.

“The only reason you do the deal is if you assume the bank’s not worth anything. And then why would Pinola want it?” the source said. SHARE OF BANK DEPOSITS IN CALIFORNIA

As of Dec. 31, 1985 Bank of America 34% Wells Fargo (including Crocker) 19% Security Pacific 15% First Interstate Bank of California 8% Other 24% Source: Findley Report