EDWARD J. CARPENTER : Interstate Banking’s Upheaval : Consultant Expects Wave of Mergers by Institutions

Next year, the big banks from the East will be allowed to open shop in California, and they’ll be buying institutions here to grab as much of the market as they can in the richest deposit-gathering state in the union, an Orange County industry consultant says.

But to be here on day one, they’ll be negotiating this year to buy one of the state’s 425 banks or one of its 185 savings and loans.

Last fall, Comerica Bank in Detroit, Michigan’s third-largest banking firm, agreed to acquire San Jose-based Plaza Commerce Bancorp, which operates a medium-size bank with about $450 million in assets.

Santa Ana consultant Edward J. Carpenter believes that banks in the state are ripe for merger mania. His firm, Southport/Carpenter Group, represents numerous potential acquirers, from small Eastern banks to large Japanese institutions.

Though California opened its banking borders to 11 western states 18 months ago, Carpenter said, the real impact will come next January, when banks nationwide will be able to operate in the state.

But it won’t be just the big Eastern banks that will be fishing for a good catch in California, he said in a recent interview with Times staff writer James S. Granelli. Watch for medium-size, out-of-state banks, foreign banks and specialty banks to be looking for a variety of banks and S&Ls; in California, he said.

Carpenter, 44, started his consulting business after leaving the research department of Security Pacific National Bank. He holds a joint master’s in business administration from Cal State Long Beach and the UCLA Graduate School of Business, and he also holds a master’s in finance from the Wharton School of Business at the University of Pennsylvania.

Q. How will Orange County consumers fare under interstate banking?

A. I expect 20 new commercial banks from out of the state to enter California, and they’ll be offering a variety of charge card services, trust services and traditional banking services. The consumer will benefit because the history of interstate banking in other states has shown that in the first two years of interstate banking, there is a drop in the average interest rates on real estate construction loans, credit card borrowings and consumer loans, such as auto loans, home refinancing loans and home improvement loans.

Q. Aren’t out-of-state banks already offering many of these services, especially low-interest credit cards, to residents here?

A. They are, but when they want to take a share of the deposit market, they lower their overall cost to consumers. This will be the first time they will be able to take deposits, and in order to gain market share, they’ll drag new depositors in by offering teaser-rate loans.

Q. How is this going to affect bankers here in terms of competition?

A. Some of the banks in Orange County will find themselves attractive acquisition targets, and we expect that approximately 10 banks in Orange County will be sold and/or merged into out-of-state banks within the first two years of interstate banking. We don’t have projections for consolidations within the county, but few of them have occurred in the past and there’s plenty of time for that to happen.

Q. Some industry observers say that with a softening market and a possibility of recession, we’re not going to see a lot of acquisitions by out-of-state banks.

A. That’s just, in our experience, inaccurate.

Q. So regardless of the economy, those that want to buy will buy?

A. Maine had the first interstate banking law in 1981. Maine would not be viewed as a particularly attractive state for out-of-state banks, and banking and the economy in general went into a two-year recession then. At the time it allowed banks in nearby states to come in, Maine had 27 commercial banks. In the first two years, during that recession, 21 new commercial banks entered Maine. So my sense is that California is more attractive than Maine. In other states that had regional banking earlier than California, also during recessionary times in the early 1980s, we witnessed the highest purchase price multiples in banking in recent history. There is no data to indicate that California is less attractive than any of these other states.

Q. For the last 18 months, banks in 11 western states have been allowed to buy California banks. What has California’s experience been under regional interstate banking?

A. There’s been little entry. But California banks, when they had to give an inch, gave an inch to the warriors who wouldn’t fight the battle--meaning that there are no significant large banks outside of California west of the Rockies. The largest banks in the West, outside of California, are either too small, are experiencing significant losses, are not in a position to move yet or already are owned by California banks. So there are no candidates to come into California west of the Rockies.

Q. The law takes effect next January, but shouldn’t we know this summer who’s coming in?

A. We’re going to begin to see a number of stakeout transactions similar to the Comerica deal for Plaza Bank in San Jose. Comerica, a very aggressive and highly successful bank in the Midwest, was looking for growth-oriented business and a consumer state. It bought Plaza Bank at a high price, added capital and used a formula that allows it to pay that high price partly by distributing Plaza’s earnings to shareholders between the deal date, which was earlier this year, and the trigger date next January. Numerous transactions like that are being negotiated and some of the more attractive banks are being taken out of the marketplace.

Q. Another Michigan banking firm, Michigan National Corp., owns Beverly Hills Savings in Mission Viejo. Do you expect Michigan National to convert the S&L; to a bank?

A. They have made statements that they would eventually see this as their banking system in the West. They, like many banks, have discovered that there are not many larger banks available in California. In fact, if you looked at the 14 largest banks in the state, control of seven has been acquired in the last five years. The majors--Bank of America, Wells Fargo, Security Pacific and First Interstate--are large multibillion-dollar banks. There are only a few smaller multibillion-dollar banks--like City National and Imperial--that would be attractive targets and their stock already is trading at prices that are beginning to look like interstate purchase prices.

Q. Are their stock prices high because a lot of speculators expect buyers to come after those banks?

A. Correct, but after you get through that first 14, there are less than 25 out of 525 banks in California with between $500 million and $1 billion in assets that could be purchased. There are more banks than that in that category, but they already have been purchased.

Q. But they could be purchased again?

A. Well, if they’re purchased by a large Japanese, German, French or Canadian bank, they’re probably not going to be resold. And that is, in fact, the case on all of those purchases.

Q. The biggest bank in Orange County is less than $300 million, and that’s small. Do any of the 39 banks here really expect to be acquired or face stiffer competition?

A. The larger banks in Orange County, those over $200 million in assets, have two different kinds of markets. CommerceBank, for instance, is a business bank. It deals with commercial companies that are medium in size and its marketplace is largely companies in the greater Los Angeles metropolitan area. It has a loan production office in Long Beach and a branch in Costa Mesa, as well as the main office in Newport Beach. It’s a business lender bank with surprisingly few accounts. CommerceBank has less than 20,000 accounts, unusual for banks of that size. But each account has a balance of between probably $50,000 and $75,000. It is not likely that CommerceBank will lose its share of the business market, and it is typically more difficult for an out-of-state bank to acquire middle-market business customers than it is to acquire consumer accounts. And that’s why CommerceBank becomes a tremendous acquisition candidate. In fact, any business bank that’s over $150 million in assets in Orange County and has a five-year track record is an attractive candidate to certain interstate banks.

Q. And the other market for the county’s larger banks?

A. The rest of the banks--some of which have larger branch systems and have a mix of business and consumer accounts like Eldorado and Sunwest--will find that they are going to have to be very competitive with their consumer accounts to hold them. And they’re going to have to work harder to hold their consumer accounts than their business accounts.

Q. So they are not likely merger candidates, unless they merge themselves.

A. They are likely candidates if, as consumer banks, they reach $500 million in size. Now, $500 million is roughly the amount of business that you need to acquire to run an aggressive advertising campaign. That and a branch system of at least 10 offices. Now Eldorado would fit that category if it raised capital and continued to grow.

Q. What happened to the notion that a bank had to have $1 billion in assets to attract an out-of-state suitor?

A. If we had $50-billion companies in the state, you would have to be a $1-billion bank to be attractive. But the major out-of-state banks now are all looking at the $500-million number because that’s where their minimum break-even point is and because the $1-billion banks just aren’t available. We’ve heard Chase say it, we’ve heard Citicorp say it, we’ve heard many of the major interstate acquirers all say that $500 million is the minimum that they can acquire and still make money.

Q. Meantime, California’s four major banks are picking up sizable banks?

A. Yes. Security Pacific, Wells Fargo and First Interstate have been running around the state paying unusually large prices to acquire them. They’re beginning to consolidate market share to make less opportunities available for the interstate banks to acquire, and they’re beginning to pay interstate prices. And if you look at some of these acquisitions, you see duplicative coverage. In Southwest Bank, Security Pacific bought a bank with branches virtually next door. The majors are buying these banks for three reasons: To increase market share prior to interstate banking; to eliminate the possibility of major market share entry by the big boys out East, and to position themselves as acquirers for the remaining banks in the state that might want to be sellers.

Q. Will the Eastern banks, finding little available above the $1-billion range, buy two or more $500-million banks to build up market share quickly?

A. That’s exactly right. There just aren’t any statewide systems. They might buy Pacific Valley up north and come down here and buy Santa Monica bank or Metro Bank or Lincoln National or Guardian.

Q. We hear about the major Eastern banks wanting to open up in California. But aren’t there a lot of other banks that might be interested?

A. Everybody finds it comfortable to talk about the big buyers because the big buyers are not unwilling to discuss their intentions. However, there’s a plethora of banks in the $2-billion to $10-billion category that are looking in California. I really can’t name them because they’re clients. But I can say that banks with specialties, certainly in Florida, Georgia, the Carolinas and Virginia, operate in communities that are very similar to Orange County. Those bank holding companies are real estate lenders and they’re looking at Orange County and other parts of Southern California as a duplicative marketplace to theirs. Banks in the Northeast also are mortgage lenders and they’re looking for niche lenders here.

Q. What you’re painting now is a picture of almost any bank with good loan production, any bank with some specialty, being a target.

A. As long as they have a valid, five-year history of success. I think the point to be made is that when we have a recession, our level of recession is significantly lower than other states. And now we’re seeing our market being buoyed by foreign as well as U.S. investors. There is no state in the union that is producing half of the real estate loan volume that’s being generated from Fresno to the Mexican border. You have to be here if you want to be in the lending business.

Q. Do foreign banks have easier access to California than out-of-state banks?

A. Not really. The International Banking Act of 1979 provided that a foreign bank had to elect one home state for full-service banking and could be in one other state with more limited services. The Japanese banks, except for one, picked California as their home state and New York as their second state. Fuji Bank elected New York as a home state, so it does not have a full-service capability in California. It wants to be here.

Q. Now it has to wait like everyone else?

A. Right. When interstate banking is triggered in California, the foreign bank can take its New York facility and open branches to California. There’s a whole flood of foreign banks--Canadian, French and especially South American--that want to be here. Major league acquisitions will happen.

Q. What about the state’s savings and loans, which hold more than 25% of that industry’s deposits? Are we going to see any big S&Ls; go down?

A. You bet we will. We’re negotiating currently for four healthy S&Ls; that hold in excess of $10 billion in assets each. In total, we’ve got over 20 negotiations going on for S&Ls; in the state. What the banks have learned is that if they use the savings and loan culture as a separate vehicle within their holding companies to originate mortgages, they can create a very nice subsidiary.

Q. From what you’ve said, most interstate banking activity will occur over the next two years. How many banks will be coming into California by 1995 and what kind of consolidation will there be in the banking industry in that time?

A. We expect that, within the first five years, of the approximately 425 commercial banks in California, 175 will sell or be merged either with each other or with out-of-state banks. Of the 250 banks remaining, 150 are in rural communities that are not particularly attractive for acquirers and 100 will have built fortress walls and will be fighting off the entrants from out-of-state. There are about 185 savings and loans. We believe through natural attrition--failure, merger or other intrastate activities--that 75 savings and loans will disappear. Of the remaining 110 S&Ls;, we believe that 50 will merge with out-of-state banks.

Q. That doesn’t sound like a very big S&L; industry here.

A. Except that the total assets in those 50 S&Ls; will be dramatic.