ASSESSING THE MERGER : Pact Now Casts a Shadow on Competition

The bank company that results from the merger of the state’s No. 1 banking company, BankAmerica Corp., and No. 2 Security Pacific Corp. is expected to cast a huge shadow on the California financial landscape, sending lesser banks and thrift institutions scurrying for market position.

The proposed merger, announced Monday, “creates a company that will be by far the dominant financial institution in the state, and that does put pressure on other companies to merge, to realize cost savings and to better compete with the new Bank of America,” said Ronald I. Mandle, senior research analyst with Sanford C. Bernstein & Co. in New York.

The California market is likely to become much more segmented, analysts say, as institutions grab a niche--whether it be in retail branches, corporate lending or real estate financing--and then dig in to hold their ground.

The immediate pressure, everyone agrees, falls on the two banks’ major state competitors for loans and depositors: No. 3 Wells Fargo & Co. and No. 4 First Interstate Corp. On Tuesday, officials of both institutions were maintaining their silence despite widespread speculation that they will be forced into a marriage of convenience by the bigger merger.

Wells is clearly the stronger of the two, having focused attention in recent years on building a strong statewide branch network. But even if combined, Wells Fargo and First Interstate would possess only about 21% of the state’s banking market, far below the 44% share the new BankAmerica would command.

“The way they come out of (the BankAmerica merger), their relative market shares have been reduced,” Mandle said. “In the markets in which they were strong, they will be less strong, and in the markets in which they were weak, they’re weaker.”

“It’s similar to being at the senior prom,” said Bob Chapman, a bank merger specialist at County NatWest. “BankAmerica was standing across the dance floor from SecPac, and they went to dance. Wells and First Interstate are now left on the side, and if someone outside comes in and crashes the party, then one or the other will be left without a dance partner. And that will mean major problems.”

But others will also feel the heat. “If you subdivide California into 56 local markets, (Bank of America) goes from being No. 1 in 28 of those markets to No. 1 in 42 of those markets,” said Katharine Rossow, senior research analyst at Moody’s Investors Service in New York. “That’s a significant increase in their competitive position.”

The merger won’t harm all financial competitors in the state. The stronger savings and loans should be able to hold on to position in their niches, analysts said.

The merger “gives (the S&Ls;) a bigger competitor to deal with, someone with even more marketing clout than before,” Mandle said. “But S&Ls; are very specialized, and the largest ones--Home Savings, Great Western--have competed very successfully by sticking to their biggest business, residential home mortgage lending and consumer savings. And there will continue to be a need for such specialized services.”

Medium-sized banks may also be able to hang onto small business customers who are leery of large impersonal institutions. “They’ll be big enough so that their costs will be somewhat competitive with bigger banks . . . but small enough to provide personal service that some customers need,” Chapman said.

Perhaps most precarious is the future of many small California banks that cannot compete with BankAmerica’s new economies of scale, despite a loyal clientele.

Competitors may benefit in other ways, analysts said. “When you put Bank of America and Security Pacific together, there are a lot of crumbs that flow off the table,” said Donald K. Crowley, associate director of research at Keefe, Bruyette & Woods in San Francisco.

Competing banks could snag defecting depositors--those who may have accounts at both banks, for example. They could also purchase redundant Security Pacific or Bank of America branches that are slated for closure--or whose divestiture might be required by antitrust regulators.

Non-California banks also continue to pose a threat. Some big out-of-state banks may have their eyes on Wells, First Interstate or others in hopes of expanding into the lucrative California market. New York-based Citicorp, the nation’s largest banking company, owns a thrift in California but has its own troubles, which could dampen interest in expanding west.

Meanwhile, foreign banks, especially Japanese institutions, have already staked out a share in specialized markets, particularly lending to small and medium-sized businesses.

BankAmerica has not said whether it will alter its strategy in the state, but analysts believed that it would hew to the same course: seeking to dominate every segment of the market in which it operates, and aiming to become an even more comprehensive financial services company.

Still, analysts agreed that all state financial institutions will be forced to reevaluate their operations. “(It) really turns up the heat on all bank managements and boards to rethink their posture and future,” Crowley said. “I think everyone will look at their cost structure, and also across the street at any synergistic acquisitions that they can do.”

By increasing economies of scale and lowering the merged banks’ costs, the merger raises the pressure on high-cost operators to find partners, analysts said.

This holds true even for major savings and loans. Analysts “have pushed numbers around on the combination of (H. F.) Ahmanson (& Co.) and Great Western, and come out with projections that they could save $300 million to $400 million by merging,” Crowley said. “The same is true with GlenFed and CalFed. I suspect that where there have been some cocktail party chats this could put things on the front burner again.”

But Stephen McLin, a former BankAmerica executive vice president, downplayed the possible effects of a merger on the California market if BankAmerica chooses not to use its cost advantage to undercut the competition.

“My read on it is that B of A will return its billion dollars in cost savings to the shareholders,” he said. “If that happens, the markets stay the same and shareholders of new B of A make lots of money. If they were to put some of it into reducing prices in the market, they can start to underprice and undercut the competition. It depends on how the new enterprise deals with its new advantage.”

He pointed to the past merger of Wells Fargo and Crocker Bank. “How did the Wells-Crocker merger impact the California banking market? The answer is, it did not change prices, service or customer levels, so history shows that a merger has not resulted in materially lower prices for the consumer, just higher margins for the merged institution.”

It’s unclear just how the merger will affect the new BankAmerica’s profitability as measured by the difference between what it earns on loans and investments and what it pays out for deposits and its own borrowings. The margin “could be squeezed,” said Campbell Chaney, a banking industry analyst with Sutro & Co. in San Francisco. “Security Pacific has a weak one currently, and Bank of America has an adequate margin . . . and with the acquisition, Bank of America may see a margin squeeze, even with lower costs. It’s interest income at Security Pacific that is causing the margin to be weak, and not interest expense.”

In the long term, however, the merger could result in improved interest rate margins, said Denise Petsis, an analyst at Argus Research Corp. in New York.

On the cost side, the new B of A hopes to be able to slash non-interest operating expenses by $1 billion a year. The merged bank will also be able to spin off part of Security Pacific’s large loan-loss provisions, which would lower the ongoing costs of carrying poor loans.

HANDICAPPING CALIFORNIA BANKING

Competition in California banking will change dramatically with a merger of BankAmerica and Security Pacific. Here’s a look at some key institutions vying for pre-eminence in the California banking market:

BankAmerica Headquarters: San Francisco and Los Angeles Strengths: The merger of BankAmerica and Security Pacific will create the state’s largest retail branch network; provide a strong capital position enabling it to buy smaller institutions; and allow massive cost savings from consolidating. Weaknesses: Security Pacific’s problem real estate loans are a big question mark; culture clashes or other problems arising from the merger could create management headaches. Outlook: Merger makes it by far the state’s dominant financial institution. Should maintain its financial strength, although Security Pacific’s problem loans turn out to be worse than expected.

Wells Fargo Headquarters: San Francisco Strengths: Well-regarded management has kept costs low; extensive branch network has been expanding through the acquisitions; financial position still relatively strong. Weaknesses: Growing portfolio of problem real estate loans; its concentration in California makes it relatively vulnerable to the state’s economic woes. Outlook: Many experts wonder whether more real estate loan problems are in the offing. May be forced to find a merger partner to stay competitive.

First Interstate Bank of California Headquarters: Los Angeles Strengths: Extensive retail branch network; parent has operations in 14 Western states. Weaknesses: Generally regarded as financially weakest of the big California banks because of extensive problem loans.

Outlook: Merger with a stronger partner may be best for the long term.

Other Banks & Thrifts to Watch Citicorp already operates a thrift in California, but it--and some other giant New York banks--is too busy shoring up its finances to launch aggressive expansion plans in California. The financially strongest large thrifts, including Home Savings, Great Western Bank and World Savings, will continue to be strong rivals for retail business and are expected to expand in California. They will prosper as long as there is strong demand for residential home mortgage lending. Japanese-owned banks in California, including Union Bank, Bank of California, Sanwa Bank and Sumitomo Bank of California, will continue to compete in much specialized markets such as loans to small- and medium-sized business.