Mega Banks Don't Represent the Industry's Real Future

Just what does Wells Fargo's massive bid for First Interstate say about the banking industry, its customers and the local and national economy today and tomorrow?

It says that in a shrinking industry--like the railroads of old--big companies are consolidating and taking out capital. Wells Fargo hopes to wring $700 million in savings out of the union with First Interstate, by closing branches, laying off employees and combining operations.

But the giant companies created by deals like Wells-First and the pending Chemical Bank-Chase Manhattan merger are not necessarily stronger for being bigger.

Wells Fargo will use the savings from this deal to buy in stock over the next few years. But as its basic banking business isn't growing, the company will have to make another acquisition and another as the years go on.

Meanwhile, there will be a place for small, specialized banks to serve business and consumers. In fact, some of the most successful banks today are small and focused on serving specific industries.

To be sure, it's not good for Southern California that San Francisco-based Wells Fargo is taking over First Interstate. Most of the roughly 7,500 post-merger job cuts are likely to be in the Southland. And the area will lose a headquarters' emphasis on pumping out loans locally and engaging in community work. The headquarters of a big bank makes a local economy more buoyant.

Indeed, it would be better for Southern California if an out-of-state company such as Nationsbank bought First Interstate--fewer jobs and less capital would leave the area.

But the loss of First Interstate's headquarters will be offset somewhat by the emerging pattern in which all banks will break up into separate companies based on function--links in a chain of "outsourced" services.

The time is approaching, says Don M. Griffith, a Los Angeles investor in small banks, when a bank's role will be as contact point for customers, offering services provided by others--such as letters of credit, currency transactions or loans on which a separate company handles credit checking, funding and paperwork processing. The model is the supermarket, which offers an immense variety of goods provided by others.

The software program Quicken may become the biggest consumer "bank" in the country, offering deposit and investment accounts and loans through personal computer networks.

This is not futuristic bubble gum but a clearly emerging trend.

Consider these statistics as a backdrop to Wells Fargo's $10.8-billion bid for First Interstate. There are now 10,168 banks in the United States where 10 years ago there were 14,496 banks. But over the same period, the number of bank branches has risen to 55,304 from 41,907.

That reflects bank kiosks opening in supermarkets, with one person and a personal computer doing what branches with windows and tellers used to do.

And yet household savings deposits in banks are down over the last five years. People are putting their money in mutual funds.

Business too is deserting the banks. Commercial and industrial loans from banks now total about $690 billion. But commercial paper outstanding, a vast money market in which corporations lend to each other based on credit ratings, is now $650 billion and growing faster than bank deposits.

The emergence of that money market--formed by corporate treasurers putting spare cash out to earn interest--along with the advance of computers have transformed finance. For example, GE Capital Services now has $154 billion in loans and other assets and is larger and more profitable than Wells Fargo and First Interstate combined. Inventories of large retailers everywhere are financed by GE Capital, local banks having lost the business years ago because expenses for personnel and facilities made their costs higher.

Lately, banks have responded by cutting expenses. First Bank System, a Minneapolis company operating in 11 states, has developed an automated credit check enabling customers to obtain an auto loan by telephone. Cost of making that loan is $7.30 compared to $41 if the loan were handled manually.

That's why employment in banking, and in financial services generally, is declining. But perhaps the banking category should be broadened to include companies that devise the software that allows car loans to be made over the phone.

In any event, the more interesting competitive response of some banks has been to decide that the scarce resource they really have to offer is brainpower.

Silicon Valley Bancshares, based in Santa Clara with a branch in Newport Beach, lends to small, high-tech companies, some of which are "pre-profit," says its president, John C. Dean. The bank provides cash management and other services to those fledgling companies because it understands their business--and because they leave deposits in non-interest bearing accounts. That gives tiny Silicon Valley a cost advantage even over Wells Fargo, Dean says.

Imperial Bancorp., a Los Angeles-based bank with under $3 billion in assets, specializes in lending to entertainment companies, garment manufacturers and health care organizations in Southern California. "We specialize and add value because we understand their business," says George Graziadio the bank's chairman and co-founder.

The stock market seems to agree. It accords Imperial Bancorp a price of 19 times earnings and Silicon Valley a 15-times earnings ratio for their stocks traded on Nasdaq, while limiting Wells Fargo and First Interstate to 13 times earnings even at their deal-driven current prices.

So what advantages do giant banks have? Well, size makes them less risky than smaller institutions and allows them to participate in major credits across a region or the nation, notes analyst Raphael Soifer of Brown Brothers Harriman investment firm.

Also, "as they cut costs, they could lower fees and gain customers," says Graziadio of Imperial. But that's not likely. Instead, Wells Fargo and other giants will use the savings of consolidation to buy in stock, giving shareholders a reward.

Then to boost their stock price the next time they'll make new acquisitions, ultimately forming the four or five "national" banks that experts have predicted for decades.

And yet small banks and the personal computer mean far more to the future of banking than the giants being formed in today's big deals. Big deal, indeed.

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