Survival Tactics

By Kenneth Cline

BankBoston CEO Chad Gifford hopes his merger with Fleet produces a long-term survivor. But integration and performance challenges loom ahead.

Charles K. "Chad" Gifford looked at his stand-alone options, didn't like what he saw, and decided to seek the protection of a large merger. It remains to be seen whether the new Fleet Boston Corp. can meet investor expectations, however. And in this era of charter implosion, even the powerful combined entity can't be assured of long-term independence.

Chairman and chief executive of BankBoston Corp., Gifford signed a deal on March 14 to sell his company to hometown rival Fleet Financial Group, Inc. The transaction, initially valued at $16 billion, will create a $180 billion-asset behemoth, the nation's eighth largest bank and easily the dominant force in New England. At the very least, the deal ensures that Fleet Boston will be a player when the next round of big bank consolidation occurs. "I wanted us to play an active role in consolidation," Gifford says, "rather than at some point just disappear into a large company."

That does not mean Gifford and his team will be powerless. Gifford has been guaranteed the CEO job in a couple of years, and 10 of his directors sit on the 22-member board. So the BankBoston contingent should indeed have an important say in the future of the new entity. Gifford, 56, says he's "extremely confident" he did the right thing. Still, he surely must occasionally pause to consider what he gave up. What's gained in diversification may be at least partially offset by a loss of focus.

With a pedigree that stretches back to 1784, BankBoston is the oldest commercial bank in the United States. Over the years, it built up expertise in several specialized areas of corporate lending, including the film industry and high tech. It is also the only regional bank with an extensive international presence -- mostly concentrated in Brazil and Argentina.

This unique culture and franchise will inevitably be diluted as it merges with Fleet, a brash upstart that grew from a series of big acquisitions cobbled together during the last two decades. Norstar Bancorp, Bank of New England Corp., Shawmut National Corp. and NatWest Bancorp are among the institutions that submerged their identities within the Fleet merger machine.

While Gifford and Fleet CEO Terrence Murray have styled this deal a "merger of equals," Fleet is clearly the dominant entity, having paid a 13% premium for the BankBoston shares. Fleet executives occupy six of the top eight management positions.

On the upside, the merger provides increased diversification and scale, as well as the promise of greater, more stable earnings power. "I look forward very much to proving that we have a company here that's going to show revenue growth that very few companies can show," Gifford says. But colossal mergers are no panacea, as demonstrated by earnings hiccups at First Union Corp., Citigroup and BankAmerica Corp.

Gifford himself has expressed reservations about size in banking, in fact, noting that smaller institutions can be more nimble and less bureaucratic. Immediately prior to this merger, he had been arguing strenuously to analysts and the media that BankBoston's current business mix had the potential to produce above-peer earnings growth. So why sell -- or at least, why sell now?

Gifford insists the deal was "not structured from a position of weakness." But analysts say earnings disappointments and lagging stock market performance clearly had a lot to do with his decision to sell. Last year's emerging markets crisis increased investor apprehension about earnings volatility in BankBoston's Latin American and capital markets units. "I felt additional size was important," Gifford says. "Our businesses were somewhat handicapped by the size of our balance sheet."

The Fleet/BankBoston deal does shelter BankBoston's volatile business lines within a stronger balance sheet and richer earnings mix. Fleet, in turn, gains critical mass in large corporate, private equity, and investment banking activities, while taking out its biggest retail competitor. The icing on the cake: $360 million in annual after-tax cost savings.

So far, so good. But perversely, this merger only increases the takeover allure of the combined entity, whose commanding New England presence would beautifully complement a national franchise. "In many respects, the combined company now becomes more attractive in the next round of consolidation because of the dominance it should have in the market," says Salomon Smith Barney analyst Henry "Chip" Dickson.

One other factor influencing the future of Fleet Boston is the success of its integration efforts. Any failure to mesh the two constituent organizations would severely limit future strategic options. "You always have to be worried about execution risk," Dickson says.

A "Normal" Succession

By negotiating an orderly, predictable succession plan, Murray and Gifford have already taken one big step to ensure a smooth integration of Fleet and BankBoston. An 80% majority vote of the board would be required to overturn Gifford's planned accession to the CEO job at yearend 2001, according to the merger agreement. Since that would require the acquiescence of at least five BankBoston directors in addition to all of Fleet's -- an unlikely scenario -- Fleet Boston probably won't experience the type of turmoil recently seen at BankAmerica and Citigroup, where heirs-apparent resigned under pressure.

"There's a high probability of a normal succession," says Advest Group analyst Anthony Polini.

With that issue resolved, or at least deferred to 2001, the top executives can focus on the nitty-gritty integration issues, such as organizational structure, systems consolidation, and headcount reduction. Having led BankBoston through a difficult merger with BayBanks Inc. in 1996, Gifford is keenly aware that integration issues can deflect management attention away from business development. "You are forced to look internally for a period of time as you put operations, systems and people together. And the danger of doing that is you lose market momentum," Gifford says.

Most of the critical systems integration work is being postponed until next spring, giving both companies time to finish purging Year 2000 computer bugs. That leaves three conjoined challenges to tackle this year, according to Gifford: begin realizing promised cost saves while minimizing disruptions to customer relationships and creating a new corporate culture.

On the retail side, the combination of Fleet and BankBoston represents a classic in-market merger, with all the job-cutting that entails. Branch networks of the two banks overlap in three states, with the densest concentration in Massachusetts. Consolidating them will help the new company shed 5,000 employees, or 8% of its total workforce worldwide. To satisfy antitrust concerns, Fleet Boston will also divest itself of a further 270 offices and $13 billion of deposits.

Such upheavals will inevitably expose Fleet Boston to the danger of alienating customers. The risk is exacerbated by the fact that both banks have just emerged from other large transactions, particularly Fleet. Credit Suisse First Boston analyst Michael Mayo estimates that 70% of Fleet's customers are relatively new to the bank, having come aboard during various mergers over the last five years.

Mindful of other recent deals that "fell short of original prognostications," Gifford says he and Murray were careful not to over-promise. To begin with, the two executives formulated what Gifford describes as "realistic" cost savings targets. They didn't formally project any revenue synergies at all, although they strongly suggested these would be forthcoming in areas such as investment banking, corporate banking and asset management.

By taking a conservative stance, the executives clearly hope to provide an upside surprise for investors. Although analysts say they would welcome such a development, they are not banking on it. "The potential is certainly there in this merger," analyst Mayo says. "But the biggest risk is plain old execution. The completion of a merger this size depends on doing a million things correctly."

As for creating a new corporate culture, Gifford promotes the new company as a blending of Fleet and BankBoston. He is sensitive about press reports that portray the deal as a Fleet takeover. While it's true that Fleet executives will occupy six of the top eight management positions in Fleet Boston, Gifford says forthcoming announcements will reflect more balance between the two sides.

Restoring Momentum

The roots of the merger can be traced back to July 1995, when Gifford succeeded Ira Stepanian as chairman and CEO of BankBoston. Stepanian had been ousted by the board following several failed merger negotiations, one of which involved Fleet. Murray then went on to acquire Shawmut, which increased the competitive pressure on BankBoston.

Unfortunately, the integration of the two companies did not proceed smoothly. By BankBoston's own admission, service problems proliferated and expenses got out of control. By the end of last year, BankBoston's retail efficiency ratio was an unacceptably high 65%. Recognizing the problem, Gifford appointed vice chairman Bradford H. Warner as head of retail in early 1998.

Warner had little retail expertise, having come up through the wholesale side of the bank, but he enjoyed a reputation as BankBoston's "Mr. Fix-It." He brought in new executives to inspire fresh thinking about the use of technology and commenced the basic work of improving staffing models and redesigning business processes.

But getting the retail efficiency ratio down to the mid-50s, closer to the industry norm, was going to be a multi-year project. The attraction of the Fleet merger is that it essentially gives BankBoston a fresh start on the retail side, allowing it to accelerate the cost-cutting it was going to have to do anyway. Integrating the two branch networks will not only produce substantial expense savings, but also upgrade BankBoston to Fleet's higher standards. Fleet, for example, has spent about $40 million on a data warehouse project, putting it far ahead of BankBoston's efforts in this area (BankBoston, on the other hand, has a more advanced online banking operation).

Not surprisingly, Fleet Boston's retail operation will be headed by Fleet's second-in-command, Robert J. Higgins. As for Warner, he's been put in charge of the combined company's investment operations.

While the BayBanks transaction proved problematic in some respects, Gifford did improve capital management at BankBoston through the use of advanced performance metrics. He began with a program called "Managing for Value," which was essentially a set of guidelines for increasing risk-adjusted returns. Gifford says, "It's an internal discipline for me and my cohorts, to look at our businesses and say, 'Are we investing in the right ones, and are we managing them properly?'"

The company used two metrics to gauge its progress: risk-adjusted return on equity and Economic Value Added. Businesses that failed to meet strict hurdle rates were culled from the lineup. Over the past three years, divestitures included national consumer finance, indirect auto lending and mortgage banking. Capital was re-deployed into areas deemed offering higher returns, such as Latin American branches, capital markets activities and asset management.

Investors responded well to Gifford's disciplined approach to value creation. The company's stock appreciated 84% from yearend 1996 to July 1998, when it reached a peak of $59 a share. Unfortunately, the triumph was short-lived.

The Road to Merger

The first harbinger of trouble came in February, when Ricardo Carrasco, the head of BankBoston's International Private Bank office in New York, fled the country after allegedly making $66 million in fraudulent loans. Although Gifford subsequently reorganized the unit, the episode suggested a lapse in risk control. Then, in the third quarter, international markets were roiled by the Russian currency devaluation, which hit BankBoston on several fronts.

And on top of all that, the global turmoil made investors more sensitive to BankBoston's unusual dependence on Latin America. By October, BankBoston shares had fallen 57% from their 52-week high, to $25.75.

Gifford and Murray began seriously discussing a merger in January, resuming negotiations that had lapsed in mid-1998. This time around, Gifford says, he and Murray were able to agree on a common vision for the new company. "Terry and I are locked at the hip in terms of what we're going to create around here," he says. Murray could not be reached for comment.

Gifford says no single issue convinced him to sell. Instead, he cites a combination of factors: continuing consolidation in the banking industry; his frustration at being unable to "unlock the value" in BankBoston's franchise; and the consequent attractions of a larger, more diversified company.

If the merger partners execute well, the new Fleet Boston may indeed emerge as a long-term survivor in the industry. And assuming Gifford does attain the CEO position, as planned, then he will have fulfilled his objective of retaining some control over BankBoston's destiny. Says analyst Mayo: "This is New England's last, best hope to have a surviving bank headquartered in Boston."

Mr. Cline is Senior Editor of Banking Strategies.

Copyright © 2003 by Banking Strategies, published by BAI.

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