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Hugh McColl
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American bank merger supremo Hugh
McColl, a former marine, spent the better part of his career
briskly marching his institution from the backwater that once was
Charlotte to the Pacific coast. The resulting colossus straddles
most of the high-growth regions, thanks to spectacular M&A
coups. McColl crowned his career with a stunning achievement: the
1998 link-up with San Francisco's Bank of America.
McColl compared running NationsBank to driving a racing car
at 100 miles per hour and changing tyres without stopping. "You
can't stop running what you've got while you're trying to retool
for the next millennium," says Frank Gentry, one of McColl's
longtime lieutenants and an executive vice-president at the
Charlotte, North Carolina-based bank.
That was a tricky manoeuvre, but McColl handled it with
skill. His bank - now known as Bank of America - tops the heap,
with more deposits than any other US bank. And it's part of the
country's second-largest financial services firm, outranked only by
Citigroup.
Times have changed and McColl's chief lieutenants are no
longer planning major bank mergers. Across Europe, though, a debate
has been raging about whether US-style bank consolidation will
serve as the model for things to come there. "I think there is some
truth to that," says Anthony Santomero, the director of the
Financial Institutions Center at the Wharton School, University of
Philadelphia, "but some of the lessons from the US are being
misunderstood."
The record of Charlotte-based banks is astounding. "No-one
would have suggested 10 years ago that North Carolina would emerge
as a centre for American banking," says Santomero, "but it evolved
that way because a small number of institutions were aggressive and
successful in the consolidation process."
Charlotte banks also had a lot of help from the difficulties
of other institutions, reckons Richard Aspinwall who recently
retired from Chase Manhattan Bank in New York and who serves as a
member of the Shadow Financial Regulatory Committee. One
contribution was repeated stumbling by the old Bank of America. The
Asian crisis and a tough real-estate market in California took
their toll. While this was happening, institutions like McColl's in
Charlotte had been feasting for more than a decade off a robust
economy in America's southeast.
And what of the Old World?
Richard Aspinwall
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In Europe, could a dark-horse
institution from some seemingly unlikely place claw its way to the
top, just as McColl's bank did in the US? "You could make an
analogy between Europe now and the US in the old days when we had
regional compacts and the regional giants were emerging," says
Richard Herring, Santomero's colleague at Wharton. The US began
opening up to interstate banking in the 1980s and gradually
permitted greater consolidation across more of the country.
"There's something like that going on in Europe," says Herring,
"where they're bulking up inside national borders."
It's an astonishing fact that only two of the top 15 US banks
in 1980 - Citi and JP Morgan - still exist with their original
names. Regulators responsible for this area reckon that the same
thing is virtually guaranteed to happen in Europe.
Aspinwall reckons two main forces are fuelling the urge to
merge. The first is something he calls "branding" - jockeying to
take advantage of a trademark name from the top of the league
tables. Chemical, for example, combined with Chase and the brand
they got seemed better than the one they had before. So the
Chemical name is history. Likewise, NationsBank didn't hesitate to
switch to the BofA name because it packed much more punch.
"Consolidation in the US has been very much an attempt to enhance
brand image with bank customers," says Aspinwall.
Secondly, banks also feel much more assured that they will
have access to government safety nets if they become larger,
reckons Aspinwall. He doesn't think this applies to the very
largest institutions. They are already much too big to fail.
Otherwise, though, the larger the bank relative to its peers, the
more assured dealing parties will be that it could tap government
back-up.
That's particularly important in wholesale markets where
government guarantees are implicit. This perception certainly
invaded interbank markets when chaos reigned in Asia. And it's
clear, in retrosp ect, that a crisis of confidence would have
engulfed Japanese banks had there been no implicit government
back-up.
Incoherent marketing
Douglas Breeden
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Aspinwall thinks that both of these
imperatives will to an extent be replicated in Europe. Much more
coherent branding is certainly long overdue, reckons Arnoud Boot, a
finance professor at the University of Amsterdam. European
institutions have failed to pursue consistent branding because
nobody was doing it and there was no competitive pressure. Boot
cites Dutch bank Rabobank. It has been operating a bank as well as
insurance businesses, a leasing company and fund managers under
different and often unconnected names. That's par for the course in
Europe, says Boot.
So, with deregulation allowing cross-border mergers and the
advantages of size in dealing with counterparty risk, big European
banks will almost certainly go after other big European banks. Part
of this stems from the high costs of cutting-edge technology -
these need to be spread over as large a base as possible.
"Innovations in information processing and service delivery
have created potential new-scale economies in certain types of
operations," says David Humphrey, a banking expert at Florida State
University who previously worked at the Federal Reserve. He sees
transaction processing, loan processing and non-traditional
delivery of depository services among the foremost examples.
But the European experience won't be identical to what has
happened in the US. A multi-step process won't work very well
because of the relatively small size of some European countries.
"There's a near frenzy of consolidation, country by country,"
Santomero points out, "so that they can be credible forces within
the European Community. From a public-policy standpoint, I'm not
sure that's a good idea." Consolidation within some countries
doesn't necessarily improve banks' chances for survival. "One of
the things that the Europeans don't quite see," he says, "is that
many Federal Reserve districts in the US no longer have major
banks."
Santomero is not impressed by the model that rolls up every
bank asset into one institution and creates a fortress bounded by
national borders. Most of the institutions that would be created by
such a process would not be viable in Europe because most European
countries aren't viable as single banking markets. "On the other
hand," says Santomero, "rolling banks across the EU has the
potential for creating a franchise that is quite valuable."
Still, Europeans should look before they leap. Most US bank
mergers have failed. The academic studies, at least, show that
substantial cost benefits from US bank mergers have been hard won.
"About as many banks have experienced increasing or constant unit
costs," says Humphrey, "as those that have achieved actual cost
reductions." He thinks that the prospect in most deals is for
little change in unit cost, regardless of pre-merger claims to the
contrary. Savings in one part of a bank generally seem to be offset
by greater inefficiency elsewhere.
"In the US, we have discovered that most mergers don't work,"
says Santomero. "If you view mergers as reducing costs and bringing
economies of distribution, those economies of production or scale
really are hard to find at the end of the day."
Promoters of mergers regularly make inflated claims. The
typical merger, they often predict, will save 33% of costs. But
that's really 33% of operating costs for just the acquired bank.
And operating costs are less than half of total costs. Combine that
with the fact that the acquired bank tends to be much smaller than
the acquirer and the vaunted 33% saving may boil down to a 5%
saving in total costs for the combined enterprise.
But getting even to that requires flawless implementation.
Humphrey, Herring and several industry consultants told
Euromoneythat only 20% to 30% of US. bank mergers achieve
the advertised objectives. "It's really easy to botch these deals,"
says Herring. "There's a lot that can go wrong."
The measure that matters, for Herring and other observers, is
the impact on shareholder value, assuming that government will make
sure the company won't be exploiting monopoly power. "In a number
of cases, the target shareholders have done rather well and the
acquiring shareholders often did not," he says. "But I think you
have to look at the combined shareholders."
The results of bank mergers in Europe appear to have been
more favourable, says Santomero. "In the European case with
universal banking," he says, "an expansion of your footprint means
an expansion of products and, to a greater extent, an increasing
ability to generate earnings. Mergers in the European context may
also be a mechanism for changing employment locations to reduce
high operating costs."
The culture-clash problem
Fed studies by Loretta Mester and others have noted that
banks involved in mergers in the US appear to be the innovators who
spent money to grow and become more profitable. Bigger banks are
also able to diversify more easily in terms of product line,
geography and loan portfolio composition.
But Europe may not be ready to cope with other issues. "One
thing we can say with a pretty high level of certainty," says an
official with an extensive knowledge of US banking, "is that a
merger is going to be successful if one firm comes in, takes over
and imposes its culture on the other firm."
This source warns that mergers of equals don't tend to be
very successful. But cultural domination probably won't play very
well in Paris, or in most of Europe. "A merger of equals is more
likely to be a merger of equals when you go across borders,"
predicts Alan Morgan, a partner at McKinsey in London. He thinks
that cross-border mergers will either take that approach or spring
from a prolonged courtship through interlocking stakes.
Herring points out, however, that the looser sort of
alliances tends to be unstable and hard to coordinate when
interests begin to differ. "Alliances are not going to deliver the
kinds of cost efficiencies that you would expect from a
well-executed merger, he says. "They are also not likely to lead to
an integrated strategy and, I would guess, not likely to be a very
powerful way of generating new revenues through cross-sales."
Edward Furash, a Washington banking consultant, says of
European consolidation: "Very often, these mergers are just too
polite. So nobody knows who's in charge and what's supposed to be
done. With all the turf fighting that goes on, the successful
mergers are the ones in which there is very strong leadership."
Arguments need to be settled quickly. "They can't go on very
long before people get upset and start to leave," says Furash. "The
customers get upset. The CEO must really know what he wants and
can't be deterred from getting there. He needs to be a good
charismatic leader."
McColl's bank excelled by infusing the many institutions it
acquired with its combative culture. McColl went so far as to keep
a hand grenade on his desk to communicate the bank's official
attitude. He later began handing out crystal replicas as corporate
achievement awards.
But banking, even in the US, remains a relationship business.
Some extremely centralized institutions aren't nearly close enough
to their customers. And many significant customers of acquired
banks quickly become dissatisfied and leave. Devising a structure
to identify key customers quickly as well as a strategy to keep
them is clearly crucial.
It's also important to choose the right staff and make sure
they stay on. "As far as customers are concerned," says Douglas
Breeden, who owns two banks and is a finance professor at Duke
University, North Carolina, "one of the key things to watch is the
disturbance of loan relationships. Those are delicate. If loan
officers leave, that can drive away a lot of customers." Breeden
thinks that the same is true for depositors at the retail level.
But there's a conflict. "If you don't consolidate," he points out,
"these deals don't make any sense."
Breeden is also critical of many deals where the management
tries to satisfy Wall Street in what he considers to be
shortsighted ways. Abruptly raising fees and cutting costs has been
a common recipe for disaster.
Europeans tend to think about two strategies for using
mergers to build franchise value. The usual one for large
multinational money-centre banks is to maintain their scale and
scope so that they can be the general universal bank with a large
platform. The goal is to remain among the dominant players in
wholesale markets. That's consistent with the type of activity that
has been going on in the US.
The second approach emphasizes local market dominance or at
least a major presence locally. That has also been a credible
scenario in the US. Local dominance permits a bank to know its
customers better. Small-business lending is more profitable and it
will be safer because the bank understands the customers.
But Santomero thinks that Americans, at least, are starting
to recognize as crucial a third model - focus. It's less driven by
geography and more by products. A focused marketing strategy would
involve offering a small number of essentially the same products
across Europe, but packaged and repackaged to suit local tastes and
sensitivities in particular countries. The bank's franchise then
becomes its expertise in developing those products and meeting
customers' needs. "The focus strategy is least developed and also
the most interesting for Europe," as Santomero sees it, "because it
has the potential for substantially increasing franchise value and,
conversely, for becoming a tool to gain on others in the EU."
New technology will have a profound impact. "It's going to
make them rethink what a segment is, what the value of transactions
within a segment is, and what they have to do to reinforce the
relationship," predicts McKinsey's Morgan. "In a funny sort of
way," he says, "the incumbent bank brand has a transition advantage
as people move onto the net. If the bank says: 'By the way, we can
source the top-quality equity product for you. It'll be under a
different name, but we're going to find it for you.' That might
actually work."
A lack of brand conviction
Morgan's research found high awareness for big-bank brands in
European countries, but no great conviction about them beyond
mainstream transaction products. Therein lies opportunity. "There's
going to be a repositioning of the offer away from that which has
been normal banking in order to reinforce the customer relationship
and wrap more things into it," says Morgan. "That gets to better
marketing, more promotions, more linked offers and more bundles."
Amsterdam university's Boot believes that Dutch bank ING, for
example, has so far realized only tiny synergies, perhaps about 5%,
between its banking and insurance operations. "That 5%," says Boot,
"comes from joint asset management. But in future, banking and
insurance will be one market with a single efficient distribution
channel which, to a large extent, will be internet-based."
That's not so different from the US situation. "Effective
cross-selling has been the holy grail since I was a baby banker 40
years ago," says Furash. "It's been ever sought and never found."
But that may be changing.
Sherrill Shaffer, once a Fed economist and now a banking
professor at the University of Wyoming, points out that customer
data is becoming one of the most valuable benefits of large-scale
consolidation. It's beginning to help big banks with risk
management and cross-selling as well as other marketing. They were
previously limited to consumer credit bureaus for information about
potential retail borrowers. But many key risk-related variables
aren't reported in those databases.
Alternatively, banks could rely on their internal customer
databases. But these have almost always been too small. It's true
there were lots of borrowers and depositors, but only a small
fraction of loans are in default in normal times. So, it was
difficult to make statistically meaningful linkages for throwing
light on default patterns. Citibank was one of the very few banks
large enough to do that. But more and more of the biggest US banks
now make their lending decisions, both consumer and corporate, on
the basis of computerized credit scores. They feel they've reached
the size where that's reasonable.
As for cross-selling, the big banks are starting to track
patterns of payments made by their depositors in their search for
new selling opportunities. Some people invest money every month or
so in particular mutual funds, for example. That type of
information makes it fairly simple to compare the performance of
those mutual funds with that of competing funds offered by the
bank. At least one large bank has been picking up a lot of mutual
fund business this way, says Shaffer. So he and others have
concluded that cross-selling is a viable strategy. "But you need
the scale," he says, "to justify investing in the technology in
order to make it work."
But Mester, Shaffer's former colleague at the Federal Reserve
Bank of Philadelphia, points out that new technology, particularly
the internet, helps customers to shop around. So banks find it
harder to lock in customers.
None of this, however, means that small banks won't survive.
In fact, in the US their numbers have been growing, while
institutions in the mid range - between $3 billion and $10 billion
- have been thinning out. Those in the mid range are too big to
offer the personalized service that's giving smaller community
banks a new lease of life.
Also, mid-range banks aren't large enough to benefit from
economies of scale. So, they can no longer compete on price. Many
small US banks, by contrast, are still highly profitable and owe
their success to customer perceptions of better service and higher
quality. Small banks are much more able to have a relationship with
a customer. And they offer relationship loans, not standardized
commodity loans that can be securitized and taken off the books.
But both products are valuable.
During a recession, reckons Mester, relationship banks are
more likely to continue lending to small businesses. She can't be
sure - the US hasn't had a recession since commoditization of
small-business loans became common. But relationship loans will be
a little dearer during good times. Large banks are more likely to
pull commodity-type loans from small borrowers when times get bad.
But those loans will be cheaper when the economy is doing well.
It's for the businessman to decide what's best for him.
Diversity won't die
All of that points to continued marketplace diversity. "The
trend is toward polarization and a bimodal industry structure,"
says Shaffer, "where you have very large institutions at the top
and a number of much smaller niche players at the bottom. Most
experts believe that's going to be the long-term equilibrium and I
wouldn't be surprised if the same thing happened in Europe."
Getting there won't be easy. National governments in Europe
still have enormous power to obstruct cross-border combinations.
And so far many of them have been willing to ignore antitrust
problems as they push to create national champions. Europe could
pay a price for that. Countries may not seem that formidable when
they have diverse and fragmented industries. But those are
hallmarks of a competitive system. And countries that promote
competition at home tend to be much more successful abroad.
From NationsBank to national bank
James Hance
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James Hance, chief financial officer of
Bank of America, and Frank Gentry, the bank's executive
vice-president for corporate strategy, spoke to James Smalhout
about banking consolidation in the US and prospects for Bank of
America. Hugh McColl, chairman of the new Bank of America, calls
Hance the "father" of the deal that combined his bank, the former
NationsBank, with San Francisco's Bank of America in 1998. From
1986 onwards Gentry was the chief planner at McColl's bank. He
retired at the end of last month.
How do you explain the rise of Charlotte as the largest banking
centre in the US after New York?
Frank Gentry:Laws and regulations in North Carolina allowed
banks here to gain experience acquiring, integrating and running
branches. Geography played a role. Management that was focused,
bold and competent also played a role.
We, as a company, and our competitors at First Union and
Wachovia, recognized fairly early that the industry needed to
consolidate and become more efficient. I think bankers all over the
country tended to recognize that after the 1950s, but we had a
couple of advantages. Charlotte was already a minor banking centre.
We had a branch of the Fed as well as good transportation and we
were a geographical centre for North Carolina and South Carolina.
But that didn't give us an edge over places like Richmond or
Atlanta or Miami or Jacksonville.
What we did have was the ability to operate branches
statewide. Very few states allowed that. So we built large chains
of offices and learnt how to run them before most other people did.
Then we worked hard at trying to get into other states under the
leadership of Tom Storrs. He was Hugh McColl's predecessor as
chairman of NCNB. First, we got into Florida through a legal
authority some people called a loophole. Fairly soon after that,
the southeastern regional compact permitted banks in this region to
go into each other's states. I think that surprised a lot of
people. Florida had been a unit bank state. Georgia had restricted
their banks to counties or to adjacent counties. Virginia had
similar restrictions. Even though Miami or Atlanta might have been
more important banking centres, the banks with HQs there didn't
have experience running multilocation banks. We tended to run them
better.
The southeast compact didn't include Texas, Pennsylvania or
Maryland and so forth. Storrs was accused of stacking the deck so
that the southeast regional compact would cover the largest
possible map such that we were still the biggest fish in the pond.
After reaching that level, I think that NCNB-NationsBank broke out
of the pack with the government-assisted acquisition of Republic
Bank in Texas that doubled our size. Then C&S-Sovran doubled
our size again. Then came the acquisition of Boatmen's and Barnett.
Finally, the merger with Bank of America doubled our size for a
third time.
First Union followed a very similar strategy. Wachovia was
more timid, but we still ended up with two of the top five banks in
the country in Charlotte. We've also ended up with four of the top
25 in North Carolina because there's also Branch Bank & Trust
(BB&T) which more or less came out of nowhere, building through
acquisitions and becoming a regional power. There were local
political and natural advantages that had an effect, but management
helped make it happen.
How do you think consolidation will unfold in Europe and how
will it compare with the US?
Gentry:We don't expect to be a player in Europe and we don't
expect Europe to move nearly as quickly as the US. A large driver
of consolidation here has been to cut costs. That is much harder in
Europe as a result of the social contract and the reluctance to
eliminate jobs. Also, differences in state law that get in the way
of certain things in the US are nothing compared with differences
in national sovereignty.
James Hance:We have watched with great interest for years
Europeans buying American banks and to see the difficulties they
have had with that. At the same time, there has been a lack of
Americans buying European banks.
What would you list as the lessons from banking consolidation in
the US?
Gentry:The merger wave in the US was driven by economics.
The industry as a whole was quite inefficient in terms of the cost
required to generate revenue and in terms of having a recognizable
brand. One problem here has been that banking has been so
fragmented. Chase or Citi or Bank of America may have had the
best-known names, but even they were pitifully weak compared with
Coca-Cola or Gillette or other world-class brands. So we have
created a coast-to-coast franchise under a single brand name that
is in most of the large, fast-growing markets in the US. By
delivering on the promise of the brand and by being able to cut
costs and improve service, we will build something that hasn't yet
been seen in banking in the US or in Europe.
I think that the acquiring company or the two companies in a
merger of equals should go in with a very realistic view of why
they are doing it. They should be clear about how much of the
benefit will come from direct cost reductions, how much from better
service and better products, how much from being able to establish
a pan-European brand across national lines.
It's important to plan carefully and then move decisively. Be
sure somebody's in charge. C&S out of Atlanta is one example
from our own history. It merged with Sovran of Virginia and they
had dual heads of almost everything and didn't really put the two
banks together. Then they ran into a bad real-estate market in the
Washington area. There was a lot of finger-pointing between the
people in Virginia and the people in Georgia. Be sure there's a
clear game plan for what you're trying to accomplish and then
implement it expeditiously.
If we've erred at all, it's been in the sense of acting too
quickly. We've gone into the Bank of America deal much more slowly
because the Bank of America was already a well-run bank. It was a
merger of equals with no premium paid, but we wanted to be sure
that we did it right and got the benefits without losing customers
in the process.
There are trade-offs. I think that the hearts and minds of
the acquired institution are very important and may be the first
constituency to win over. It is very hard for an ex-CEO to be
comfortable being anything other than a CEO. That's why many times
they either retire or they become non-executive chairmen. That may
also be true for the top four or five officers, but there is no
reason - particularly if you're talking about adjacent geographic
markets - why the people who are in charge of delivering services
to their customers shouldn't keep right on doing that.
That worked extremely well, for example, after our takeover
of First Republic in Texas. That was as clear cut as any takeover
because that bank had failed. The FDIC [Federal Deposit Insurance
Corporation] wiped out the top level of management. We showed up in
a very proud Texas environment as carpetbaggers from North Carolina
and had to depend on the Texans to run it. There weren't nearly
enough of us to do it even if we had wanted to. Our then president,
Buddy Kemp, handled that extremely well when he made an early
speech saying that First Republic could have bought us if the price
of oil had gone to $50 instead of $15. It wasn't their fault. The
good news was that they had adequate capital again and could go out
and get new business. They became the strongest bank
in Texas because the bad parts had been removed. It was up to
them to do it.
Interestingly enough, we have a lot of senior managers who
came from Texas who are still with us. That's also true in
C&S/Sovran. The very top officers left, but if you look through
our ranks, less than 10% of our top 500 officers worked for the old
North Carolina National Bank. They all came in some other fashion,
either from the Bank of America or Barnett or Texas or whatever.
Why do deals go bad?
Gentry:I think the assumption that a lot of deals go bad is
probably wrong. There are many situations in which the acquiring
firm paid too much, from the point of view of the acquiring
shareholders. All too often, more than 10% of whatever economies or
savings or opportunities that created economic power has been given
to the shareholders of the selling bank. There can be a success
from the point of view of economy even if the acquiring bank pays
too much, but it will have divided the benefits unequally and
perhaps unfairly between the shareholders.
There's a much shorter list if failure means that the
combined entities turn out to be less efficient and less strong
than the two were separately. There have been relatively few
unsuccessful mergers in that sense.
The exceptions may be cases where there were terrible
problems holding on to customers. I suppose the most notorious
example of that was Wells Fargo's acquisition of First Interstate.
Even there, it's unclear whether there was a zero gain. There may
have been a more modest gain than you otherwise would have
expected, but it certainly wasn't the gain that people expected
going into it. There are also a lot of deals where objectives
aren't met. People usually make very aggressive assumptions about
cost reductions with either no net revenue loss or a revenue gain.
I think they do that in order to justify the price paid from the
point of view of the acquiring shareholders.
Your institution has been reporting a series of large
extraordinary charges for some time. How much longer should
investors expect this pattern to continue?
Hance:Those charges are all related to acquisitions. So,
they continue as long as we have acquisitions or are implementing
the current acquisition.
Gentry:I don't expect us to do any more significant
acquisitions, particularly in the banking industry. We may do some
trimming around the edges of buying and selling businesses or
pieces of businesses. We may exit certain businesses as we focus
more on the best possible use of capital. We may add to certain
businesses by very targeted acquisitions, but I doubt very much
that you're
going to see anything very major or very oriented toward a
traditional bank.
Hance:That doesn't mean that we won't have charges. We still
have the current acquisition to finish. So, we have severance
charges and combination charges involved with closing facilities
and things like that.
In the past, many of your acquisitions have emphasized access to
"cheap money" and new customers. What will be the key motivating
factors in the future?
Hance:Right now, we're not focused on mergers and
acquisitions at all. I want to underscore that point. Our best
opportunities are to finish the transition and combination with
Bank of America. Going forward, the motivating factors for us are
going to be different. They won't be franchise-oriented, but they
will be customer-oriented. They will be product-oriented. They may
be outreach-oriented and technology-oriented.
These deals will involve things that enhance our asset base,
our customer relationships. Future deals will allow us to serve
better or to realize on our existing customer relationships. An
example is our fifty-fifty venture with Marsico Management. It's a
talented firm and we want to bring that talent to bear, if you
will, for our customers.
Gentry:If anything, the advent of e-commerce and the
additional opportunities to establish a world-class brand and so
forth are all very major changes. Those changes are not going to be
complicated by additional mergers. I think that you will see us go
into more situations where we take less than a controlling interest
in a company. We will be joining affiliations and partnerships of
one sort or another. We've never done a lot of that, but we're
finding it more appropriate to the scene we're dealing with now.
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