Chemical's new formula
The merger between Manufacturers Hanover and Chemical defied conventional wisdom.
Two wrongs don't make a right, runs the cliche. Mergers between equals don't work: put together two medium-sized banks with problems and you get a big bank with even bigger problems. Instead, the new Chemical Bank's swift, successful turnround has astounded bankers and analysts while impressing customers. Peter Lee reports on why the competition is starting to tremble.
Every spring, Manufacturers Hanover used to throw a dinner in New York for members of its international advisory board. Traditionally it was a low key affair. But this year's bash, following the consummation of the Chemical Bank merger – the largest between two New York banks in 30 years – was a much glitzier occasion. Big names from outside the bank were on show, like former Federal Reserve chairman Paul Volcker and Chase Manhattan patriarch David Rockefeller.
"People like that would never have attended in the past. It was our coming-out party," says a former Manufacturers Hanover executive, now a member of Chemical's new management committee. There was a note of incredulity in his voice, the tone of a long time second-division player who cannot quite believe he is suddenly in the big league.
A month earlier, Chemical had come out with a $1.57 billion offering of common equity, the largest ever by a US financial institution. It was a roaring success and had to be increased from 50 million shares to 57.5 million to satisfy demand. The rating agencies had quickly come out with their upgrades for the new bank – long-term deposits up to A3/A from Baa1/A- and senior long-term debt up to Baa2/A- from Baa3/BBB+. On June 12, Moody's again raised Chemical's senior long-term debt rating, this time to Baa1. John McGillicuddy, chairman and chief executive officer, says: "We have set our standard to be AA in 1994."
At the end of March, Chemical capped a tumultuous quarter by producing even better results than its new army of fans on Wall Street had been expecting. Firstquarter net income at $260 million was ahead 44% on the corresponding period of 1991. The merger had been sold on the basis of cost-cutting and Chemical had shown it was ahead of the game. The pleasant surprise in the first-quarter figures was strong revenue growth. It derived $810 million of non-interest revenue, compared to $697 million for the corresponding period of 1991, with a particularly strong performance in trading and foreign exchange.
Initial scepticism about the merger was widespread and well-founded in the sorry track records of the two banks. They were thinly capitalised, inefficient and with little sense of purpose beyond the struggle to keep afloat. "We were two banks on the 'B' list who were slipping to the 'C' list," admits one member of the management committee. Now the same managers have implemented a politically delicate merger of equals and are creating a force to reckon with amid the wreckage of the US banking industry.
When the merger was officially announced last July, few major figures In New York financial circles were genuinely surprised. Senior Manufacturers Hanover and Chemical executives had been privately discussing the idea of a merger with friends and contacts on Wall Street for some months. One source at a US investment bank recalls Walter Shipley, then chairman and chief executive of Chemical Bank, raising the possibility at the lunch table, early in 1991. "I told him: Walter, you have to ask yourself, 'Can I be brutal?' I will never forget the way that he looked at me and replied, 'Yes, I can be brutal.' It left an enormous impression on me. And he has proved it." The senior management of the bank initially promised annual cost-savings of $650 million by 1995. Most outsiders doubted Chemical could deliver. They believed that, with neither management team dominant, politicking and compromise would prevent ruthless job-cutting. In the event, Chemical increased its annual cost savings target to $750 million between announcing the merger in July 1991 and issuing its common stock prospectus in January 1992. By the end of the first quarter of 1992, it emerged that the bank was ahead of schedule on its target of cutting expenses by $225 million for the year. It now expects to realise $280 million of savings by the end of 1992.
The bank has already reduced staff by 4,300 from pre-merger levels, putting it three-quarters of the way to the original target of a 6,200 reduction in head count. The betting now is that Chemical will again increase its absolute cost-cutting target, perhaps to $800 million. Walter Shipley, president and chief operating officer, seemed to drop a broad hint on this when second quarter results came out at the end of July. He noted that the figures put the bank "well on the way to exceeding the $750 million in annual savings we have targeted for 1995".
Many analysts now believe Chemical has a realistic chance of achieving its target profitability ratios of more than 1% return on assets and between 15% and 16% return on equity. That would propel the bank out of the Chase Manhattan and Citibank peer group towards the JP Morgan bracket. "Who would have though that it would be running so smoothly, that they would be ahead of the savings not only in dollar amounts but in timing?" muses Thomas Hanley, banking analyst at First Boston. "It is almost a miracle."
Can Chemical keep up the pace? The merger provides a once-only chance to drive down non-interest expenses and management is fully aware that it must not lose momentum. "So far, it has been a 'Desert Storm' mentality, with everyone knowing what has to be done and focused on getting on with the job," says vicechairman William Harrison. "The danger is of falling back into a peacetime frame of mind."
The bank has been stung by criticism that it has been quick to purge the lower levels but has preserved too many senior management jobs. Joseph Sponholz, former chief financial officer of the old Chemical and now charged with financial control of the merger implementation, denies this charge. He claims 21% of pre-merger $150,000-plus earners have gone, compared to 15% of the $50,000-$100,000 bracket.
The trick for Chemical will be to lose the right people at the right time. It may be useful to hold on to some senior to middle managers while the integration proceeds and to sacrifice them later. Ironically, Sponholz himself does not appear to have a long-term future with the bank, having lost out to Peter Tobin, formerly Manufacturers Hanover's chief financial officer, in jockeying for the new CFO spot.
Senior executives, even when talking off the record, decline to show any weariness for the bloodshed. They are growing accustomed for it. Management teams at both banks had been engaged in cost-cutting programmes before the merger was announced. "If I had to, if I thought it was the right economic decision, I would sack my best friend," says one member of the management committee. It is an unrehearsed, throw-away comment, and all the more striking for that.
Though none would openly admit as much, its rivals are now scared of Chemical, a notion that a year ago would have been laughable. Says the head of loan syndication at one money-centre rival: "It's the talk of the market – what do we do about Chemical?" Suddenly, the bank is throwing its weight about. The syndication head adds: "They are saying to other banks: 'If you want into this credit you have to reply within six days.' And they might say you have six days to come into a deal and then turn around and close syndication after just three days."
No bank is going to start a retaliatory boycott of Chemical deals because it is now such a dominant arranger. "They have done a very good job," admits one rival. "They have tied together syndications, private placements and structured finance under one man [James Lee], ridden roughshod over the relationship managers and produced a very powerful financing group with enormous marketing clout. It is not as if they try and jam the market with rotten deals. At least, they bring no more of those than anyone else does."
Nowhere has the bank's resurgence been more startling than in syndicated loans. Last year, Chemical ranked second in the worldwide arranger rankings with $69.6 billion to its credit and a 13.6% market share, compared to Citicorp in first place with $77.7 billion and a 15.2% share. In the first half of this year, Chemical arranged $44.4 billion of loans, way ahead of Citicorp in second place with $25.4 billion. Chemical's market share is at 21% compared to 12% for Citicorp, 7.3% at JP Morgan, 6.9% for Chase and 6.5% at Bankers Trust.
In the home market, Chemical's dominance is even more pronounced. Its market share of loans arranged for US borrowers during the first half of the year is nudging 33%, over two and a half times that of its nearest rival. This concerted push in syndicated lending is a crucial part of Chemical's battle plan in the wholesale market. It intends to win customer loyalty by doing something few other banks will – actually lending money. True, Chemical eventually sells down its loan commitments aggressively, like most other loan arrangers. But it does not sell down to zero. And what distinguishes the bank is its capacity and willingness to underwrite large loans to guarantee that its customers get their money. Companies like that.
Anixter Brothers is an Illinois-based manufacturer of telecommunications systems with just over $1 billion in annual sales and about 3,500 employees. Chemical recently arranged a $275 million refinancing credit for the company. Initially, following the merger there was some disappointment within Anixter Brothers over the departure of a key account relationship officer. However, Kevin Burns, treasurer at Anixter Brothers, was quickly impressed. "Chemical delivered a sizeable commitment when they said they would and on the terms they said they would. You cannot put too high a price on that."
In fact, the new Chemical Bank would very much like to put a price on it. The bank is becoming more aggressive about using its ability to deliver credit as a lever to prise other more lucrative business from its customers including cash management, foreign exchange, risk management, and private placements. And it seems to be succeeding.
McGillicuddy says: "The mistake that the bankers of yesterday made, that this bank made and I made, was that we were so concerned about taking care of the customer that we never demanded adequate compensation for the service. And renting your balance sheet is a service." Burns, like many treasurers contacted by Euromoney, contemplates doing more business with the new Chemical as a result of the merger. He envisages offering some more cash management business to the bank. “We want to ensure that we are rewarding a supplier of a scarce commodity – credit.”
It is a message constantly repeated by US corporate treasurers. Companies are keen to reward their loan arrangers and bank lenders. They now realise how vital access to bank credit is. It is becoming standard practice with corporate treasuries to allocate service business – cash management, foreign exchange – among lending banks. Lenders have the right to pitch in any area where they are genuinely capable. And, all other things being equal, a lending bank will have preference over an outside commercial or investment bank.
Chemical is supplying the right service at the right time. JP Morgan and Bankers Trust are pursuing a strategy more narrowly focused and defined by type of client and type of service. Put simply, they tend to offer investment banking services to larger companies. Chemical is aiming to be a more broadly based bank. And the merger has pushed it ahead of its two most obvious rivals – Chase and Citibank – at least in the US, if not internationally.
Chemical Bank is winning customer goodwill by supplying credit as an underwriter, but it is not tying up large amounts of capital in loan participations. Its final commitment to the new Anixter Brothers refinancing was less than the combined participations of Manufacturers Hanover and the old Chemical Bank on the earlier loan.
A sample poll of corporate treasurers at roughly 20 large and small companies which had pre-existing relationships with Manufacturers Hanover and Chemical shows that the majority view the merger positively. They intend to do more business with the new bank. One or two were neutral and saw no change but they were not inclined to do less business because of the merger.
And it is not just middle-market companies that are impressed by the new bank. Mackereth Ruckman, treasurer of Time Warner, is pleased to see a new, strong US bank competing for business. He intends to transact more foreign exchange, cash management and interest-rate hedging business with Chemical. Ruckman says: "Their improved credit rating certainly, helps, but also we are receiving better, more co-ordinated coverage."
John Clerico, treasurer of Union Carbide Industrial Gases, a spin-off from Union Carbide which is in the early days of establishing a relationship with Chemical, predicts that it too will do more trust business, cash management and hedging with Chemical. He adds: “We have not yet used them for private placements but may well do so in the future. Investment banks are not the only people who can arrange placements.” Chemical ranks seventh in the league tables of arrangers for US private placements, the highest ranked commercial bank.
A number of those contacted by Euromoney are already looking forward to the day when Chemical receives its section 20 public securities powers. The general view is that, as a relationship lender, at the very least it will be allowed the chance to pitch for bond and equity issues.
The bank is even winning some international M&A advisory work as a result of its lending relationships with US clients. Freeport McMoran, a firm which had strong ties to both banks before the merger, has retained Chemical to advise it on an acquisition in Spain. Robert Wholeber, treasurer of Freeport McMoran, supposes that, had it not been for the merger, the business would have gone to one of the company's international banks. "We would have considered them, but I doubt we would even have got a pitch [from the old Chemical, or old Manufacturers Hanover.] The sense I have, after the merger, is that they [Chemical] now have an interest in being a player in the global markets.”
The bank is now working on nearly 60 M&A mandates. McGillicuddy claims: “One of the most exciting aspects of the merger is the increase in our investment banking capability. For the first time, we have a little breadth and depth.”
Inevitably, some competitors cry foul. One investment banker active in crossborder private placements complains at the “despicable” methods Chemical employed to win a recent competitive bid for a mandate from a UK company raising debt in the US. He says: “Chemical told the company: ‘You can give this business to whoever you like. And by the way, we notice that your line of credit with us is up for review in a few months’ time’.”
The investment banker’s complaint against Chemical is mischievous. There are laws in the US, contained in amendments to the Bank Holding Company Act, which forbid banks from threatening withdrawal of credit to win other business from companies. But it is not the kind of criticism that will make management at the new Chemical blush. An aggressive attitude is exactly what they are trying to instil.
Mark Solow, head of corporate banking and finance, says: "We are trying to make all our people understand that, unlike before, they are now working for a very strong institution, not an average one. They can negotiate differently." He adds: "Sometimes we will demand certain business as our cost of doing a transaction. We will say: 'OK we will underwrite your $500 million transaction but we want a shot at the swap'.'' There is an important difference between demanding business and demanding a shot at business. And, according to its customers, Chemical is doing no more than insisting on the opportunity to bid for more profitable transactions than simple loans. Says one US corporate treasurer: "Their people have not become over-bearing, they do not deliver ultimatums. But they are cross-selling more actively. I would be disappointed with them if they were not doing that."
The clear message from US companies is they are pleased that Chemical Bank staff now hustle for a living. It is in their interest to encourage competition among strong, capable banks. Previously, better rated US banks have been able to demand higher margins and US companies faced the choice of either paying up or transferring business to foreign banks. Some US companies became uncomfortable with that trend, as banks in Europe and Japan began to suffer credit quality problems of their own. There is a concern within US companies that, in difficult times, foreign banks inevitably will prove less committed to the US market than the domestic banks.
Far from being offended at Chemical Bank suddenly twisting their arms for more work, US treasurers are goading them on. The tantalising message is that, within any group of relationship banks, business is up for grabs. One treasurer says: "I will tell Chemical: These are the kinds of services I want – letters of credit, for example – I am hearing a lot from Citibank, but I haven't heard squat from you. Aren't you competing here?"
Most US treasurers agree that the fear and anxiety which must have preoccupied many bank staff in the early months of the merger did not appear to affect their work. Complaints about Chemical are rare. A number of companies mentioned that changes in account coverage officers were sudden. The bank might have given its customers more warning. One or two felt the number of Chemical Bank staff now working on their accounts should not be allowed to fall any lower.
By and large, customers are happy. The competition is squealing. And senior managers say they are ready to sack their best friends. Chemical Bank stockholders should be delighted, and probably are. The share price rose from $18 before the merger to $35 after the second quarter results. Even following the recent mini sell-off in bank stocks– a star-performing sector in the first half of the year – many analysts are still very bullish on Chemical, targeting a price of $40 to $50 in the next 12 months.
One or two analysts are beginning to suggest that the bank has proceeded so quickly and so well with the merger that it may hit the acquisition trail soon, probably into Jersey or Connecticut. The bank now has a currency, in the form of its high market capitalisation, which will enable it to negotiate future acquisitions from a position of strength. McGillicuddy emphasises that pushing on with the merger is still the top priority. The retail branch network has yet to face the trauma of integration and job cuts. But he does not rule out acquisitions. "Obviously we are looking at things, but I don't think you will see us do anything before the end of the year, except perhaps on an opportunistic basis."
It looks too good to be true. The nagging question for shareholders must be: if the old Chemical Bank and Manufacturers Hanover were in such a mess, can the new Chemical Bank really prosper under the same old management?
So far, Chemical has enjoyed its share of luck. The double discount rate cut in December 1991 sent financial shares soaring and smoothed the way for a successful stock offering. That massive boost to capital ratios and the subsequent improvement in credit ratings have proved pivotal. A hefty slice of Chemical's eye-catching trading performance in the first quarter was attributable to this. New customers find the bank an acceptable counterparty for the first time. Existing customers are increasing the amount of foreign exchange and derivatives business they will transact with Chemical.
But it has not all been luck. The merger of equals, which outsiders suggested would be impossible to implement, has been well managed. One smart move was to involve as many business managers as possible, right through the organisation, in carrying out the merger. Instead of relying on a separate, wide-ranging merger task force to impose job cuts, business managers were required to make those tough decisions personally.
The survivors cannot grumble about savage cuts imposed from on high that have arbitrarily swept away former colleagues and friends. Many of the survivors have had their own fingers on the trigger. That creates a bond which may ultimately be stronger than any residual hostility between the old Chemical and old Manufacturers Hanover camps. Outsiders who attend conferences involving first-time meetings between the two camps report, not bristling hostility, but mutual reassurance. "It does not matter which side we come from originally, if we are both still here we must both be doing something right," is the theme.
At the senior level, enormous care has been taken to set the tone for dealing with the “social issue” – US merger and acquisition jargon for the battle to run the show – throughout the bank. This concern explains the departure of Thomas Johnson, the president of Manufacturers Hanover at the time of the merger announcement and a former president of Chemical Bank. Johnson had made a name for himself as a determined cost-cutter at Chemical Bank. At 50, he was the publicly acknowledged successor to John McGillicuddy, the 61-year-old CEO of Manufacturers Hanover. He was also the single most highly-regarded manager at either bank. Johnson seemed destined for the top spot, if not immediately, then in a couple of years.
Instead, he was paid, and paid handsomely, to walk away. Rumour has it that Johnson left Chemical Bank with a bruised ego and several million dollars. It suited the new management to install McGillicuddy as the chairman and CEO and to name 56-year-old Walter Shipley, former CEO of the old Chemical Bank, as his successor from January 1, 1994. Naming Johnson, a Manufacturers Hanover man, as number two and successor to McGillicuddy, would have upset the delicate balance between the two banks. Johnson would not stay on any other terms.
According to McGillicuddy: “Tom [Johnson] knew that Walter [Shipley] and I had talked in 1989 and that those talks resuming was a risk he had to take." McGillicuddy says he has no regrets. "The office of the chairman works well with four people." They are: McGillicuddy, Shipley, Harrison and Edward Miller, vice-chairman in charge of the retail bank. "I do not think it would work well with more than four." It is almost impossible to tell on what basis titles have been allocated within the new bank. The bank claims that jobs were awarded solely on ability. But politics obviously played a part: look no further than the chairman's office. Out of Shipley, Johnson and McGillicuddy, McGillicuddy would probably rank third on any list drawn up according to ability.
The wholesale side of the bank shows how difficult it is to read whether considerations of expediency or merit predominated. William Harrison, the vice-chairman in charge of wholesale global banking is from the old Chemical Bank. The three people who report to him are all ex-Manufacturers Hanover – Mark Solow, head of corporate banking and finance, Donald Layton, head of Asia, Europe and capital markets, which encompasses global trading; and Donald McCouch, head of developing markets.
In corporate banking, four out of five people who report directly to Mark Solow are from the old Chemical Bank. One of these, James Lee, head of loan syndication, has retained quite a number of Manufacturers Hanover staff. This has surprised some people in the loan market, where Lee is renowned for the autocratic manner of his rule over the Chemical syndications department.
Does all this prove that managers are steadfastly refusing to retain their old cronies? Or does it show a careful balancing act, designed to prevent dissent breaking out between the old Chemical and old Manufacturers Hanover people? According to one member of the new management committee: “I now recognise what a high risk process this [a merger of equals] is and why people say it is difficult. If it wanders off-track and gets gridlocked, it could take two or three years just to get out of that. Emotions are pretty high and you have to negotiate everything.”
Chemical would like the world to believe that, from the negotiation process, it picked the best people for each job and this just happened to produce a balance of old Chemical and Manufacturers Hanover people, reflecting complementary strengths. To be fair, there are some useful fits. Manufacturers Hanover was smaller but retained more international reach and a sharper focus on providing corporate-finance services to large companies. Chemical was more dominant among middle-market corporations with a strong loan syndications and sales group. Manufacturers Hanover was good at derivatives; Chemical was strong in foreign exchange.
Still, it will take many more quarters of consistently strong results before Chemical publicly establishes that it kept the best people in each area. For example, the single most impressive division at either bank outside the US was probably Chemical Bank’s foreign exchange dealing desk in London. But the treasury function has fallen to former Manufacturers Hanover managers under Donald Layton. Herbert Aspbury, the new Chemical Bank group executive for Europe, is also ex-Manufacturers Hanover and some of Chemical’s forex traders have left in disgust.
In the first quarter of 1992, Chemical’s combined revenues from own-account trading and foreign exchange amounted to $228 million, up 37% from the corresponding period of 1991. That is more than either JP Morgan or Bankers Trust earned from trading in the same period, a result that attracted admiration and suspicion in almost equal measure. Was Chemical taking large open positions? Layton says not and claims the bank is more oriented to sales and market-making than naked risk-taking. But Layton also admits: "We were indeed surprised ourselves. We of course have normal ups and downs in this kind of business and it is a huge organisation." Sure enough, in the second quarter of 1992 combined trading revenues were down again to $170 million. Within that, foreign exchange trading profits dropped to $49 million compared to $95 million in the first quarter of 1992 and $66 million in the second quarter of 1991. Peter Tobin explained to analysts that the sequential quarter decline was due to "less effective risk management", as well as lower volatility and lower volumes. Conversations with head-hunters active in London and New York confirm that foreign exchange is one area which has yet to be sorted out.
Chemical hopes to benefit in the future from becoming a more acceptable counterparty in longer dated derivatives. Harrison describes non-forex trading as the single biggest revenue opportunity for the wholesale side of the bank. Some companies, which would not normally engage in interest rate swaps of more than seven years with any bank rated lower than AA, are making an exception for Chemical. Longer-dated derivatives are more lucrative for banks because of the risk. Harrison claims that profitability within the global bank measured by risk-adjusted return on equity already exceeds 20%, well above internal hurdle rates. But Chemical will face questions about the quality of its earnings for some time to come.
The bank does seem to have passed the point of potential disruption from former Manufacturers Hanover versus ex-Chemical rivalry. "They scarcely refer to it any more," says one outside consultant. "People line up on issues along the traditional lines – bankers against traders, risk-takers against the more conservative types – not according to which bank they come from."
The potential for disruption now boils down to possible overlap between areas run by outspoken, aggressive, performance-driven individuals – for example, between James Lee, in charge of structured finance including acquisition finance, private placements and loans; Robert O'Brien, head of the corporate banking division including managing relationships with major corporations; and Darla More who heads restructuring and reorganisation, reporting to O'Brien.
Mark Solow says: "There is a new generation of bankers here who are not out for a comfortable life. I am going after the same kind of people that Goldman Sachs goes after, and we are paying in ways we have never paid before." He adds: "If you want to see people hustle, well they are hustling like never before." Solow tries, a little unconvincingly, to soften the implications of this: "You can be outspoken and aggressive, without being arrogant."
Top management seems to be setting a good example on maintaining harmony. The harsh judgement is that, when McGillicuddy retires, he will not prove a great loss. Shipley defers to his chairman but is probably already running things. "He [Shipley] won't push John [McGillicuddy] when he does not feel strongly about things," says one source. "But when Walter does feel strongly about an issue, he goes right to the wall and he does it rather well. He is harder-nosed than people seem to think." Another source from outside Chemical who knows Shipley describes him as a man rejuvenated by that rare bounty in life – a second chance. "Do not underestimate his capacity to get things done."
Beneath those two, the vice-chairmen offer contrasting styles that appear to work together. Edward Miller, head of regional banking, retail and operating services, is gregarious and closely attentive to processes. William Harrison, head of wholesale global banking, says less but his words have an equivalent impact. He likes to delegate. "His style is to lay back, ask questions of his people so they open up and only make his opinions known fairly late in the process," says one source. He styles himself as an uncomplicated guy from North Carolina. Though appearing blunt, even cold, Harrison seems capable of inspiring loyalty.
One analysis of the Chemical Bank merger is that it marks the beginning of a turnround for American banks in general. McGillicuddy predicts that consolidation of the US banking industry will continue, but not through more mergers of money-centre banks. "I think there will be marriages between money-centre banks and super-regionals. I think this bank will be part of that process by the end of the decade."
Meanwhile, has Chemical's huge stock offering achieved anything more than to buy the bank a little time, a head start, while rivals such as Chase and Citibank struggle to fix themselves? Some inside Chemical Bank incline towards this view. Harrison takes a bolder position: "I do not think that any of our competitors will change dramatically enough in the next three or four years to impede the goals of this merger. We have momentum and critical mass."
But have the people running Chemical really learned from the mistakes they made in the past? Even if the competition fails to catch up, doesn't the record – developing country loans, highly leveraged transactions, commercial real estate – suggest that the bank will find a way to blow itself up? Mark Solow hammers the point that the bank intends to underwrite a lot of loans, not book a lot of loans.
He chairs a deals management committee meeting weekly to challenge any exposure of more than $25 million to a single credit. "Concentration risk is the lesson the industry continues to forget. I am not afraid to say 'no' to anybody. No one customer or relationship is so important that you should do the wrong sort of business with them." He adds: "This can no longer be an industry in which people are scared to make mistakes. You cannot always take the safe way out. And if we make mistakes, let's make small ones." For what it is worth, at least they are saying all the right things.