First Interstate’s Quiet Turnaround : Bank Spurns Trend Toward More Mergers

All Edward M. Carson has to do is look out his window atop the tallest building in Los Angeles to remind himself of banking’s latest trend. About 18 stories below Carson’s 72nd floor office is the former headquarters of Security Pacific Corp., the bank that disappeared less than three month ago when it was swallowed by BankAmerica Corp.

But Carson’s First Interstate Bancorp has no plans to join the biggest wave of bank mergers in the nation’s history. The chief executive of what is probably the industry’s most-speculated-about takeover target makes it clear there are no merger discussions taking place between First Interstate and other major banks. Nor are there plans to do so for the next few years. For one thing, he said, the pickings are slim among the banks that could be potential suitors for First Interstate.

“If you knew somebody who would make a great marriage and knew that they could afford you, wouldn’t you go check them out? I don’t know anybody,” he said.

While other banks across the country are pairing off in droves, First Interstate is spurning conventional wisdom that bank mergers are inevitable, planning instead to go it alone. Carson and his top lieutenant, First Interstate President William E.B. Siart, are working in a low-profile way to restore the much-maligned bank’s credibility by slashing its bloated costs, cleaning up the troubled loans that began exploding like time bombs in the late 1980s and bolstering a financial cushion that had seriously thinned.

Despite numerous false starts in the past, Carson and Siart are finally winning over skeptics. Shareholders and Wall Street analysts once openly trashed the bank while wishing out loud that someone would come along and buy it. Now, they are using such terms as “quiet recovery” to describe First Interstate’s fortunes.

“They are doing a pretty good job of cleaning things up. Some kudos are entitled to be thrown their way,” said John Neff, portfolio manager of the Valley Forge, Pa.-based Windsor Fund and one of First Interstate’s harshest critics among its major shareholders in the past.

To be sure, First Interstate’s revamping has a long way to go. Despite progress in trimming overhead and cleaning up its bad loans, robust profits aren’t expected for some time. It also has a huge new competitor in the combined BankAmerica/Security Pacific.

And its turnaround remains somewhat fragile because of the stubbornly sick California economy. A recent report from the Federal Reserve Bank of San Francisco notes that the state’s banks will continue struggling with bad loans as the economy stumbles along.

First Interstate executives acknowledge that the state’s economy is the bank’s biggest wild card, but believe that First Interstate is in a better position than most of its competitors because less than one-third of its operations are in California, with the rest spread across healthier Western states. Even still, there is a lot riding on the next six months to one year for First Interstate.

“They’ve pump-faked us before. They realize this time that the market is going to be very unforgiving if they don’t meet their goals,” said bank analyst Lawrence Vitale of Kemper Securities in Chicago.

At this point, the numbers show nearly every indicator is heading in the right direction. Problem loans are down. First Interstate’s capital--the financial shock absorber that protects against losses--has been climbing steadily. And the bank’s historically high costs are finally being slashed.

Those cuts have been deep and painful. About 7,000 workers--or 20% of First Interstate’s work force throughout the West--have been trimmed in just 15 months. To put that number in perspective, consider that it exceeds the number of workers losing their jobs as a result of the merger between New York’s Chemical Banking and Manufacturers Hanover, the second-largest bank merger in U.S. history.

For Los Angeles, the stakes involved in First Interstate’s turnaround have risen sharply now that Security Pacific is being absorbed by BankAmerica. With $49 billion in assets, First Interstate is now by far the largest commercial bank with headquarters in Los Angeles, and the only major regional bank based in the city. The city’s status as a financial center--not to mention about 7,500 jobs in Southern California--could be jeopardized if First Interstate vanished in a merger.

Carson and Siart insist that their drastic moves, which also included a 60% cut in the bank’s dividend to stockholders, are evidence that First Interstate’s rebound this time is for real. If it isn’t, they concede, their necks are on the line.

In January, Carson took the highly unusual step of announcing specific predictions for the bank’s return on assets--the most widely used measurement of a bank’s profitability. First Interstate will earn a profit of 40 to 50 cents for every $100 in loans and other assets this year, Carson predicted, and earn from 85 cents to 95 cents for every $100 in assets in 1993. Such progress would bring the bank close to the industry’s benchmark of excellence of $1 for every $100 in assets.

But more than a few people questioned Carson’s decision in publicly announcing such specific goals, many of them in First Interstate’s legal department. Failing to meet them would be like gift wrapping a shareholder lawsuit for a class-action attorney. But Carson had the final word, and insisted on doing it because he believes that it is more important to restore First Interstate’s credibility.

“Our attorneys thought it was outrageous,” Carson acknowledged. “But the only way you build credibility is to tell people what you are going to do and then do it.”

And what if he misses the target? “Then I’m out on the street,” he said.

It’s not the first time Carson’s blunt predictions have caused him trouble. In mid-1990, while other banks were portraying California as recession-proof, Carson didn’t, issuing instead a pessimistic outlook. Sources said it especially angered executives at Security Pacific, who accused First Interstate of setting the stage for a self-fulfilling prophecy. As it turned out, Carson was right, and most of the state’s banks, Security Pacific chief among them, were hammered by the recession.

Carson inherited the reins in 1990 from Joseph J. Pinola, First Interstate’s domineering regal chairman who led the bank on an expansion binge in the 1980s. It was Pinola who audaciously launched an unsuccessful bid to take over BankAmerica when the San Francisco giant was struggling in the late 1980s before its turnaround.

Pinola also stumbled in Texas and Arizona, which led to huge losses and criticism from investors. Critics said his expansion created a bureaucratic, inefficient institution that spent too much money and ran like a car that never seemed to have all of its cylinders working at the same time.

Buying Allied Bancshares in Texas in 1988 turned into a disaster when First Interstate discovered the bank was full of small- to medium-sized problem loans that it had failed to spot before making the deal. At the same time, First Interstate’s Arizona operation was hammered when the state’s once-hot economy suddenly cooled. (In retirement, Pinola remains a $225,000-a-year consultant to First Interstate, which bank officials say he earns by developing contacts and business.)

A 62-year-old grandfather, Carson has a personality that is the virtual opposite of Pinola’s. Carson might have chosen carpentry as a profession had he not become a banker.

The Beverly Hills resident said he likes to browse through hardware stores. Since 1955, he has spent much of his vacation time building with his own hands a perpetually unfinished family cabin in the mountains in Arizona. During a recent interview, Carson sported a Band-Aid on his hand, evidence of an encounter with a nail while ripping apart a wall to fix a leaky shower in the cabin.

The son of a truck driver from Peoria, Ariz., Carson joined First National Bank of Arizona, a predecessor to First Interstate Bank of Arizona, in 1951. Carson had gone to the bank to hit up its top executive for a donation to build a student union building at Arizona State University, where Carson served as student body president. Carson got the donation--and a job.

Some observers initially viewed the balding, 6-foot-3 Carson as something of a caretaker before another bank could buy First Interstate. Acquaintances attribute such characterizations to Carson’s lack of charisma, which they say causes a lot of people to underestimate his shrewdness.

But that probably works to his advantage, they add, because it allows him to go about his tasks quietly and doesn’t burden him with unrealistic expectations.

“He is very intense and methodical in the way he runs the operation. There’s no flash about it, but he gets there,” said Keefe, Bruyette & Woods bank analyst Donald K. Crowley, who has known Carson for 20 years.

Carson is expected to retire after he reaches 65 in November, 1994. Siart has already emerged as the clear favorite to ultimately succeed him. A former Bank of America executive, Siart joined First Interstate in 1978 when it was known as United California Bank. A Los Angeles native, Siart, 45, earned his reputation heading the bank’s Nevada and California units, and most recently has led the revamping of its once-troubled Texas operation.

Carson makes a point of noting that whether Siart will succeed him is up to First Interstate’s board to decide, adding that the bank has a number of qualified executives for the job. But when pressed, he acknowledges Siart is the front-runner.

“He’s the heir apparent,” Carson said. “I guess the only way he wouldn’t be is if he blows it, and I can’t imagine that. It’s his to lose.”

One of the effects of the cost-cutting by Carson and Siart has been to noticeably cool many of the takeover rumors involving First Interstate. For about four years, the bank’s stock has soared and dropped regularly as rumors come and go that a merger is in the works. Speculation was greatest after BankAmerica disclosed that it would acquire Security Pacific, leading many to conclude it was only a matter of weeks before Wells Fargo would acquire First Interstate.

The conclusion was often based on the logic that the lean and more-efficient Wells Fargo could practically pay for the merger by squeezing overhead out of a bloated First Interstate. (Industry sources say Wells Fargo Chairman Carl E. Reichardt did at least inquire informally about First Interstate’s interest in a merger after the BankAmerica/Security Pacific deal was announced, but nothing came of it.)

Now, Wells Fargo has its own problems stemming from the downturn in California’s economy and especially the state’s slumping real estate market, where it has been especially active. The San Francisco bank’s future is clouded until at least the end of the year, with federal bank examiners now scrutinizing its real estate loans.

More important, Carson and Siart are trimming the fat themselves that once made the bank such a tempting target. This year, Siart said, the bank will lop a huge $280 million off its expenses from a year ago.

It has condensed its sprawling, 13-state operation into what amounts to four regional western banks stretching from the Pacific Northwest through California and across the Southwest. Operations unrelated to the basic banking business, such as a consumer finance unit and an investment banking-like operation, have been sold or are being dismantled.

Also important to the turnaround has been dealing with sloppy lending practices, something that had been a chronic problem. To help shield the bank from future problems, strict limits were put on the amount it will lend to a single borrower as well as the amount it lends to any single industry. The bank now requires anyone involved in evaluating whether potential borrowers are good credit risks to pass a strict test to earn a certificate that Carson signs personally.

Carson said the bank has considered whether it should look for a merger partner as part of its strategic review, and nixed the idea for at least the next few years. First Interstate knows too well the unforeseen pitfalls of mergers from its Allied experience. More dire results would have happened, Carson said, had First Interstate rushed into a merger with another bank also hit hard by problem loans.

“We knew where Security Pacific was,” Carson said, pointing toward the bank’s former headquarters. “We could have merged with them. But what if we would have? We wouldn’t be here today.”

Carson and Siart claim that they are undaunted by BankAmerica’s acquisition of Security Pacific, which has made the San Francisco-based bank about four times the size of First Interstate. They express a kind of bravado that has become common among nearly all of BankAmerica’s competitors, saying that they can steal away some customers who are wary of giant banks.

“If there is either a perception or realization of decreased service, that plays to our marketing effort,” Siart said.

First Interstate itself may be on the acquisition trail soon. The bank may link up with its largest shareholder, the giant investment group Kohlberg Kravis Roberts & Co., to bid on the ailing First City Bancorp in Texas, a deal that would undoubtedly involve some sort of incentives from the federal government.

Carson and Siart won’t comment on Houston-based First City, but tip their hand as to their interest by saying that they want to expand First Interstate’s presence in Texas.

Of all the things Carson is shedding at First Interstate, none seems more important to him than the label “troubled” that invariably gets attached to the bank’s name.

“I get tired of reading ‘the troubled First Interstate.’ We’re well on the road to recovery. I just want it to be ‘First Interstate,’ ” Carson said.

MAKING PROGRESS

After several years of struggle, First Interstate Bancorp is beginning to show signs of renewed strength. Its progress can be measured on several fronts:

Financial Strength Has Improved . . . Basic capital as % of risk-weighted assets 1990 1st qtr: 4.60% 2nd qtr: 4.94% 3rd qtr: 5.29 4th qtr: 5.63 1991 1st qtr: 5.87 2nd qtr: 5.98 3rd qtr: 5.72 4th qtr: 6.28 1992 1st qtr: 7.01 As It Cut Costs . . . Non-interest expense (in millions) 1990 1st qtr: $615.1 2nd qtr: $626.9 3rd qtr: $649.1 4th qtr: $671.2 1991 1st qtr: $659.7 2nd qtr: $652.8 3rd qtr: $745.7 4th qtr: $674.0 1992 1st qtr: $576.9 Reduced Staff . . . Total employees 1990: 35,192 1991: 30,281 1992: 28,306* *As of March 31 And Improved Loan Quality . . . Non-performing assets (in billions) 1990 1st qtr: $2.05 2nd qtr: $1.88 3rd qtr: $1.89 4th qtr: $1.75 1991 1st qtr: $1.79 2nd qtr: $1.78 3rd qtr: $1.98 4th qtr: $1.59 1992 1st qtr: $1.48 Boosting its Stock Price. 1990 1st qtr: 34 2nd qtr: 40.375 3rd qtr: 22.50 4th qtr: 23.50 1991 1st qtr: 33.375 2nd qtr: 31.375 3rd qtr: 31.125 4th qtr: 30 1992 1st qtr: 36.50 2nd qtr: 41.125 Friday’s close: 42.125 Source: First Interstate