Thirteen years ago a tough-talking former US marine took charge of North Carolina National Bank (NCNB). Today, Hugh J McColl Jnr is one of the most talked-about bankers in America.
Through a series of bold and often ingenious takeovers, he has taken his bank – renamed Nationsbank in 1991 – from 29th to third-largest bank in the US (measured by market capitalization).
Nationsbank now threatens more than regional banking franchises in the southern US. Corporate finance, trading and investment banking are among the bank’s fastest-growing business areas, accounting for roughly a third of its net income last year. Its rocket-shaped, 60-storey head office in Charlotte – the Taj McColl, as it is sometimes known – is symbolic of the challenge it poses to Wall Street firms in bidding for large corporate customers. Depending on how you measure it, Nationsbank now has one of the top two or three corporate client bases in the US.
Some aspects of Nationsbank already look more like an investment bank than the old NCNB. In areas such as loan syndication and corporate-debt underwriting, derivatives and foreign exchange, investment bankers are increasingly having to sit up and take notice of the North Carolina upstart. Over the past three years, over 150 people from Wall Street investment firms and money-centre banks have joined the Charlotte bank, anticipating that within five years – as Depression-era regulatory barriers crumble – banks and investment banks will be on the same playing field. With fierce local rival First Union hot on Nationsbank’s heels, and the more conservative Wachovia not far behind, Charlotte has become the third-largest banking centre in the US after New York and San Francisco.
Buoyed by the influx of new talent and expertise, Nationsbank last year arranged more syndicated loans than any US bank except Chemical and was one of the top 10 underwriters of corporate bonds. At the same time, it is talked about as an aggressive player in the foreign exchange markets and has garnered praise for its international over-the-counter (OTC) derivatives trading operation.
But its broad-based push into investment banking is as risky as it is ambitious. “They’re looking to be dominant in consumer, commercial and capital markets,” says Dennis Shea, a bank analyst at Morgan Stanley in New York. “When you pursue a strategy that has that many layers, you risk becoming unfocused and unable to execute.”
Nationsbank is a “highly focused company,” says McColl, its chairman and CEO. “I’ve been in this business 37 years. This bank didn’t appear out of the air, we built it. I’ve been listening to people tell me I couldn’t do things for 35 years. Last year we made nearly $2 billion. Most of the people that used to tell me they knew how to run things better than I do, don’t even exist today.”
Scepticism is understandable, though. No US bank has yet delivered successfully on retail and investment banking simultaneously. In large part because of the Glass-Steagall Act, the US hasn’t yet seen well-managed institutions that offer a broad menu of products to both consumers and corporations.
But with the advent of deregulation, new technology and secular change in the customer base, banks such as Nationsbank are trying to reposition themselves and move more in the direction of European universal banks. “We have 10 businesses that make over $50 million a year after tax that are neither retail or commercial banking,” says vice-chairman and chief financial officer James Hance. “That’s very much a European model.”
McColl concurs: “Any rational student of the game would see that it takes a great deal of capital to be in the capital markets business. One of the problems that Wall Street is having is that they don’t have enough capital. I’m willing to predict that you’re going to see that at least three and possibly four of the major investment banking houses will be what are thought of today as commercial banks. They’re not secrets – they are JP Morgan, Nationsbank, Chemical and perhaps Bank of America, and they will succeed because they have capital and real-live clients.”
The question is, can Nationsbank succeed?
In certain areas there is no disputing that it has made an impressive start. For example, in syndicated loans (though they’re not strictly speaking investment banking), the bank has come from nowhere six years ago to a position where it is arguably the strongest challenger to Chemical Bank’s supremacy .
The start of Nationsbank’s assault on the syndications market in 1990 coincided with retrenchment following the collapse of the leveraged buyout market. “A number of banks were trying to figure out what they were doing,” recalls Thomas Bunn, head of Nationsbank’s syndicated-loan desk. “There was a niche for a healthy bank with a client franchise to step in.”
“This was no longer the 1980s when you took huge underwriting risks and blew it out to foreign banks. You had to do transactions that were well thought out, well structured and that made sense from a credit perspective. We built the business based on credit and structure and we’ve maintained that focus. Everyone in this group has a very strong credit background. I think that differentiates us from some of our competitors which developed their business in the pure selling mode.”
Rival lenders contend that Nationsbank was dangerously aggressive in structuring loans in the early 1990s. Yet many of those same banks have ended up participating in loans with it. In any event, the North Carolina bank has yet to restructure or reprice a significant transaction, and few would deny that it hit the business cycle perfectly.
“We were either very smart or very fortunate in building our business when you could still get into the top five in the league tables,” says Bunn. “We bought in at the lowest end of the cycle. I’d hate to be trying to climb that mountain now.”
Nationsbank’s corporate client list was enhanced through two big acquisitions. In 1988 NCNB bought First Republic bank which, when it failed, was the largest bank in Texas, with relationships with many large companies, especially in the energy business. The takeover of Atlanta’s C&S Sovran at the tail end of 1991 gave Nationsbank additional size and credibility, along with several key clients such as Alamo Rent-A-Car and Delta Airlines.
But neither bank came with an established syndicated-loan franchise. Unlike Chemical which bought Manufacturers Hanover and then Chase Manhattan, or Bank of America which bought Continental, Nationsbank has built – rather than bought – its way up the syndicated-loan league tables.
Along the way, it has recruited key staff from competitors. Stacey Cook, a New Yorker, arrived from CIBC in 1991 to become head of loan distribution; Mike Zupon and Glenn Stewart came in 1993 from Canadian Imperial Bank of Commerce and Westinghouse Credit, respectively, to spearhead a new push towards financial buyers and buyout groups. Having started with just five staff in 1990, Nationsbank’s syndications desk now has 45 people.
Being a $200 billion operation gives Nationsbank the ability to take larger underwriting positions from smaller banks. “We can walk into Quaker Oats when they’re acquiring Snapple Beverage [in 1994] and lay a cheque on the table for $2.4 billion,” says Cook. “There aren’t many banks who could or would do that. As this business goes to one-stop shopping from a senior and subordinated basis, it is even more critical that you have a lot of capital.” But Nationsbank doesn’t have the same volume of investment-grade business as those banks which grew up in this business. “Ten years ago we were a $12 billion bank,” says Bunn. “We didn’t have a board relationship with these companies.”
Lending at the riskier end
Without a long history of lead-agent roles, Nationsbank has been forced to focus more on the riskier and higher-yield leveraged lending sector – it was the second most active US bank last year in terms of dollar volume and number of deals done (among them the well-received $625 million financing for double B minus rated National Gypsum’s leveraged buyout by Delcor). It also supplies the middle market and various specialized industry groups such as health care, media, energy and real estate.
It is this breadth of coverage that makes Nationsbank probably Chemical’s most-feared competitor, given that most banks operate in niches – JP Morgan, for example, in high-grade lending and Bankers Trust in leveraged financing. “Every time they turn around they see us,” says Bunn. Nationsbank surprised many people last year by muscling in on a $580 million transaction backing Clayton Dubilier’s buyout of Kraft Foodservice and sharing the lead with Chemical.
Nationsbank is steadily capturing more investment-grade business – which now accounts for around 35% of its syndications – from names such as Quaker Oats, Dominion Resources, Jefferson Pilot and the world’s largest retailer, Wal-Mart. Its $4.9 billion facility to back Wal-Mart’s commercial paper programme was the lowest yielding double A transaction done in the US market during 1995.
Besides the fees they generate, syndicated loans are an important door-opener for Nationsbank’s other investment banking products, including the derivatives and foreign exchange instruments supplied by its Chicago-based subsidiary, Nationsbanc-CRT, which has quickly gained a high reputation in some of the more arcane areas of derivatives trading – running swaption positions as big as those of JP Morgan, SBC and CSFB. Nationsbank became one of the top 10 derivatives houses last year following an aggressive 47% expansion of its derivatives contracts to $923 billion in the second quarter of 1995.
Nationsbank’s acquisition of options house Chicago Research and Trading (CRT) in 1993 came at a time when CRT was experiencing difficulty breaking into the expanding OTC market, while Nationsbank was keen to acquire the technology and expertise for a fully-fledged risk management system.
Up to that time, the bank only really brokered risk management products. “The person we’d turn around and sell those products to, was making the lion’s share of the money,” says Nationsbank’s head of capital markets Bill Maxwell. “We had to get away from that.” Nevertheless, the introduction to CRT was somewhat fortuitous. “We really weren’t thinking of acquiring someone to get those skills, we were thinking about building them ourselves.”
Alongside the basketball-court-sized trading floor a third of the way up Sears Tower, former CRT partner Rick Smith, now president of Nationsbanc-CRT, recalls why the deal made sense for CRT. “We had $250 million tied up in the business. But it clearly wasn’t enough for us to develop full-blown customer relationships. US trading margins had been under pressure for some time and long-term it was clear that we had to get customers to leverage our capability.”
An Australian recruited by CRT founder Joe Ritchie from Hongkong & Shanghai Bank in London in the late 1980s, Smith wears an open-necked shirt and sweater to work – casual clothes are still de rigueur in this trading house despite the takeover. CRT, he says, had been trading over-the-counter energy derivatives and treasury options for several years, but when it joined Nationsbank it “moved down the food chain” into swap products, more-customized options and trading in underlying markets such as foreign exchange.
Firms that have had to move in the other direction have found it harder. “Product development has slowed in derivatives,” says William Fall, Nationsbanc-CRT’s head of marketing in Chicago. “Now you need to be able to put together increasingly complex packages of options. This is differentiating the lead core of derivatives houses. Our options expertise is a major reason for our success.”
The aim is for Nationsbanc-CRT to fit squarely within the parent bank’s overall strategic approach to client management, with derivatives sales people in Chicago, Charlotte and Dallas working alongside what the bank calls “relationship managers”. “We’ve been implementing this for 18 months,” says Smith. “The improvement in internal working relationships has been dramatic.” Just over half of Nationsbanc-CRT’s interest rate derivatives and foreign exchange transactions are now done for customers: the goal is to push this figure up to 70%.
Nationsbank’s acquisition of CRT bore many parallels with Swiss Bank Corp’s purchase two years earlier of O’Connor, another state-of-the-art, egalitarian, jeans-wearing Chicago firm. O’Connor has acted like a cuckoo in the nest for SBC, with many of its partners now heading various arms of the Swiss bank’s global investment banking group. By contrast, most senior CRT staff, for example Smith, have stayed put, while a few – including founding partner Joe Ritchie and former chief operating officer Phil Hubbard – have left to do their own thing.
The cultural fit appears to have worked well, though. When Smith had his first meeting with Nationsbank before the takeover, he wore a suit to create the right impression only to find McColl was waiting to greet him in jeans and cowboy boots. “That just about sums up their attitude to us. They’re happy with our casual dress so long as we’re sensitive to their customers.” McColl, furthermore, is commited to technology, and most analysts Euromoney talked to reckon he understands derivatives “well enough”. “He’ll always figure something out to the level of detail he’s happy with,” says Thomas Brown, analyst at Donaldson, Lufkin and Jenrette (DLJ).
Nationsbanc-CRT has about 700 people in Chicago, 150 in London and 50 in Singapore and Tokyo. Around 650 of those are from the original CRT, 200 from the bank and 150 to 200 brought in from outside, among them swaps specialist Duncan Goldie-Morrison, who arrived from NatWest in London three years ago to become global head of interest rate products; and William Fall, who once worked with Goldie-Morrison at Westpac.
In foreign exchange, the most dramatic turning point was the arrival last summer of nine high-powered salesmen from SBC, led by Richard Crosby, who is now in charge of Nationsbank’s global foreign exchange business, based in London.
The original CRT traded foreign exchange derivatives, while Nationsbank had a limited spot and forward capability. According to Richards Roddey, chief executive of Nationsbank Europe, the bank is now close to having a foreign exchange trading operation commensurate with its overall size. “We’ve got all the pieces in place now, it’s making money and the large corporates we’re dealing with know that they can get a good service.” The Nationsbank name crops up increasingly often among competitors. “When the market is whittled down to 10 or 15 major players, they should be there,” says a London-based trader.
Nationsbank has trading outposts in Frankfurt, Paris, Singapore, Hong Kong and Tokyo as well as Chicago and London – an international network inherited from CRT. “With improvements in technology, our client base is becoming more and more global,” says Roddey, “even as you get down into smaller companies. So we like to run a global book. If we want to serve our clients and make money at it, we’ve got to do it 24 hours a day. We can’t serve corporate America and not have an international capability.”
Nationsbank’s core forex clients are companies worldwide that do business in the US in sectors such as energy and media. But because of the bank’s rapid growth and expectation of more to come, it is rated only A+, hindering its ability to serve multinationals that want triple A banks. “We intend to change that pretty soon,” says Roddey.
CRT came with a successful primary dealership in US treasuries which is now done out of New York by Nationsbank’s section 20 subsidiary, Nationsbanc Capital Markets Inc (NCMI). The options expertise in Chicago has also boosted the parent bank’s drive to provide other capital markets services such as debt underwriting. NCMI is one of the few dealers that has the in-house skills to hedge the repackaging of callable debt as swaptions – a factor that analysts believe helped it come ninth last year in Securities Data Corp’s league table of lead managers of corporate bond underwritings, just behind JP Morgan, the only other commercial bank in the top 10.
Griff’s great record
The debt-underwriting business was started in 1993 by John Griff, whose controversial departure from Lehman Brothers, where he was head of debt syndication, made headlines in the Wall Street Journal. Griff arrived with a strong track record in leading bond and mortgage-backed securities underwriting. While he was at Lehman, the firm’s corporate and government-debt underwriting grew from $6.8 billion in 1990 to $42.9 billion in 1992 – enough to push Lehman from sixth to third place in the league tables. But Griff quit over a dispute concerning the Wall Street firm’s bond-buying strategy, which was criticized for being too aggressive and leaving the bank with unsold inventories of overpriced bonds. In 1995, all of Nationsbank’s underwritings were for investment-grade credits, including a significant volume for Nationsbank itself. But this year the bank is making a big push in the high-yield market and has already underwritten bonds for sub-investment-grade credits such as Knoll Furniture and Alvi Systems.
McColl says that Nationsbank is pursuing investment banking activities in order to serve its franchise of middle-market customers. “Our bank has market shares of companies with sales of between $100 million and $1 billion, of anywhere between 26% and 36%, in each of the south-eastern states, plus Texas. In addition we are certainly in the top three banks in the US in terms of relationships with the Fortune 1000.”
Profit is clearly the overriding objective. “If all you want to be is a third-tier bank lending money, you’re not going to make very much,” says Bill Vandiver, head of Nationsbank’s global finance group. “But as you move up the food chain into risk management and advisory products, there are immense opportunities to create wealth.”
“Where we were two years ago,” Vandiver continues, “was a regional bank that corporate America looked at and said, ‘Gee you’re really nice boys and girls down there in the Carolinas but you’re really not very important to us’. We’re now building the capabilities that allow us to become more meaningful to them.”
Many in the analyst community are happy with the strategy. “I would be doing the exact same thing if I were in their shoes,” says Goldman Sachs analyst Sally Pope Davis. “I don’t see how a large bank can serve the Fortune 1000 and more without developing a good capital markets effort.”
According to UBS analyst Brent Erensel, banking in the US has raised the issue of complexity of scale. “Economies of scale in mortgage banking or credit cards are one thing, but complexities of scale in terms of offering a broad product base to your customer and getting a number of relationships per customer has been shown to generate higher returns.”
But given the ever-increasing ability and willingness of even middle-tier corporates to shop around for the cheapest products, there is a danger of the concept of one-stop shopping becoming passé before Nationsbank has properly assembled its all-in line of services. “Do people really value the wrapper around it irrespective of price?” asks a banking consultant at McKinsey & Co in New York. “Companies will only use a regional bank as a one-stop shop if it can deliver a combination of quality and value.” McColl, however, contends that although companies do shop around, “the person who is there has the best chance of getting the business”. He concedes: “You are are going to have to compete on price, on terms, and on execution. But Nationsbank has been able to attract some of the brightest people in the world and we don’t have problems competing.”
Nobody disputes that Nationsbank has hired some very good people. Besides Griff, now vice-chairman of NCMI, others that stand out are head of fixed-income research Paul Schaum, formerly of Bear Stearns, and co-head of the high-yield debt business, Tom White, who used to work for Morgan Stanley.
It is too early, however, to assess whether it has adequate controls in place to offset capital markets risks. And many analysts still think it could become unfocused. “I’d rather see Nationsbank get out of a lot of lines of business,” says DLJ’s Brown. “The vast majority of successful financial services companies are concentrating on fewer lines of business and really doing those well. I actually believe there will be an investment case to be made in time for the breaking up of Nationsbank. I think they’ve bitten off more than they can chew.”
Odious comparisons
Comparisons are made between what McColl is attempting at Nationsbank and the multi-pronged strategy Walter Wriston attempted at Citicorp before backing away. In reality Nationsbank’s strategy is much more focused than that of Citicorp. Unlike Citicorp, Nationsbank has never attempted to be a local competitor for local business overseas. Rather, its international strategy is to operate in niches such as interest rate protection, foreign exchange products and tax-sparing schemes for its segmented, largely US client base. It is also a large international player in energy lending as well as project and utility finance.
“Our strategy is to provide access to the capital markets for our domestic multinational companies,” says McColl, “and to help foreign multinationals who operate in the US with their US type of operations. We don’t want to be an intermediary, we want to arrange financing for our clients. Secondly we want to help our domestic and foreign multinational clients hedge their risk in world markets, in forex, in interest rates and commodities – we do that through Nationsbanc-CRT. We have no plans for a branch network offshore. Our strategy is to finance the exports and imports of the US.”
Nationsbank is not shy of retreating when it feels it lacks a competitive advantage. “The sale of London stockbroker Panmure Gordon last month [for an estimated $50 million] is a good example of where they’ve said, ‘If we can’t do something on a scale we’d like to, we won’t do it’,” says Sanford Bernstein’s Orenbuch. Panmure Gordon was bought in 1987 when the bank anticipated the repeal of Glass-Steagall. Since then it has steadily expanded its underwriting of US equity issues in Europe. According to Roddey, Nationsbank did not intend to sell Panmure but West Merchant Bank had “convinced us that it was more relevant to their strategy than it was to ours. Theirs is a European strategy. Ours is much more North American.”
The bank is now focusing on building an equity business in the US. NCMI has equity underwriting powers but has so far not used them. When it gains more room under section 20 of the Glass-Steagall Act, it seems likely that it will acquire a small brokerage firm as a platform. McColl had talks with DLJ last year with a view to buying a stake in the investment bank, before deciding they were asking too much. “My goal is to buy and build,” he says. “If we could buy a small house that brought to our company the software and the compliance skills in the equity business we would like to do that, and then we would like to build the institutional placing power, distribution piece of it by bringing on good people from other good companies as we’ve done in the debt business. We’d like to see the collapse of Glass-Steagall before we try to do that. So it’s not on the most immediate programme for us. It’s part of our long-term strategy.”
Equity underperformance
Since Nationsbank is already in so many lines of business and the stock market considers some of these volatile, its share price has underperformed. “Capital markets activities are assigned a relatively high-risk profile and a low multiple,” says Morgan Stanley’s Shea. “The question is when is the stock low enough to fully discount the potential risks and when do the potential rewards outweigh those?”
DLJ’s Brown adds: “They’re not getting an adequate risk-adjusted return on equity from their investment banking activities. Soon shareholders are going to start to complain that there’s a lot more value in Nationsbank that they’re not getting.”
Market pressure leads Nationsbank’s management to reject suggestions that it is bent on becoming a money-centre type bank. “Ninety per cent of our business is what we’ve been doing forever,” says McColl, “which is the consumer business and the middle-market business. That’s 90% of our damned business. The critics are focusing on 10% of it and think that’s a problem.”
Because of Nationsbank’s penchant for making large acquisitions, there are always rumours that it is about to make another – another factor depressing its stock. Last year rumour surrounded first Chase Manhattan (later acquired by Chemical) and Bank of America. Either would have colossally boosted Nationsbank’s investment banking efforts.
McColl says that there are no big acquisitions in the pipeline. “Regardless of what anyone else may think, Nationsbank has made nothing but good acquisitions. We will continue to look for opportunistic moves, but at the moment we have no such moves.”
The bank nonetheless looks set to continue to expand at home and abroad. Roddey is adamant that despite the Panmure Gordon sale, the 300-strong London operation will keep growing. More purchases in the US are expected in retail and wholesale but only when they offer good value. “Typically, their biggest acquisitions have always been when companies are distressed,” says Orenbuch. “We’ve always thought their opportunistic strategy is the best one. If you’ve already bought the best company, it’s very hard to improve its performance in order to justify the premium you’ve paid. It’s much easier to improve a lousy company.”
Nationbank’s doubters are outnumbered by those who believe it will succeed in becoming a successful multi-service financial powerhouse. “The analytical community often can’t see what is being created before their very eyes,” says UBS’s Erensel. “The returns are at record levels now, but some of the beauty of what McColl’s doing will last much longer than the next quarter.”
