Citigroup: A Giant In The Making
When the Credit Suisse banking group last year paid $8.5bn to take over Winterthur, the Swiss insurer, rivals had to sit down and rethink their views of the competitive landscape in financial services. Then Morgan Stanley, already one of the pre-eminent global investment banks, paired off with retail stockbroker Dean Witter in a $24bn merger. And Salomon Brothers agreed to be taken over for $9bn by the Travelers insurance and stockbroking group, forcing competitors back to the drawing board again.
Now all those strategic plans will have to be torn up and worked over again after Travelers, with Salomon still undigested, agreed to merge with the Citicorp banking group to create what is easily the worlds largest financial services conglomerate.
If Credit Suisse/Winterthur and Morgan Stanley/Dean Witter pushed out the boundaries, then Citigroup, as the new Travelers/Citicorp combination will be known, breaks the mould. This is the first move in the global endgame. It is a classic case of thinking the unthinkable, says Alistair Walton, head of European and Asia/Pacific financial institutions at Credit Suisse First Boston, the Swiss investment bank.
The deal will create a group with a market capitalisation of $155bn. That is larger than the entire Mexican stock market. It will have 161,700 employees, and 100m customers in 100 countries. Citicorp shares rose almost 20 per cent yesterday. At the retail end of the market, its activities will stretch from Citibank the closest thing the world has yet seen to a global retail bank to the Travelers and Primerica life and general insurance businesses. In the wholesale market, the addition of Citicorps foreign exchange and derivatives strengths will substantially reinforce the claims of Travelers Salomon Smith Barney division to a seat at the top table of global investment banking.
The creation of Citigroup also redefines the word big in the financial services industry. The group will have nearly $700bn in assets. A recent analysis suggests that banks with $1bn-$10bn in assets a long way short of the $698bn Citigroup will boast have been consistently more efficient and profitable than their larger competitors.
But Sandy Weill, Travelers chairman argues that size is important if you want to be a global player. In a speech to the New York State Bankers Association he said, When a problem happens, its just a pinprick rather than an explosion.
Economies of scale can be harvested from specific operations such as cheque processing, and a large capital base can allow a bank to take on more transactions on its own account. But size also brings management complexity. Technology may be changing that picture. In Canada, Royal Bank of Canada and Bank of Montreal cited the rising cost of IT investment as one of the most important reasons for their planned merger. In industries where the use of IT is especially intensive, mid-sized banks have begun to close or sell off their operations because they could not afford to keep their systems up to date. At the same time, new IT systems are at last starting to enable big financial groups to take full advantage of their extensive customer bases. The economies of scale of developing big financial systems to support your customers now favour the big so much, says Mark Austin, head of financial services consulting at Price Waterhouse.
In the US, Citicorp believes it has identified opportunities to cross-sell annuities and mutual funds through Citibanks network, and to target the banks branch and credit card customers for sales of car, home, life and health insurance. At the same time, Citibank products such as mortgages, student loans can be sold to Travelers Primerica and Smith Barney customers.
Bancassurance, the blending of banking and insurance, is well-established in Europe. But in the US, the Supreme Court has spent the last 10 years arbitrating between the banking and insurance industries as they fought back and forth between the increasingly permeable barriers between their businesses. If the Citigroup deal is allowed to go ahead, it will have to cut through that barrier at a stroke.
That raises questions for other large retail banks, such as NationsBank or the First Union, which have grown for years by lapping up branch networks in neighbouring states as the regulatory barriers to interstate banking have eroded. Large insurers, such as Prudential Insurance of America, will also have to face up to a new rival. It is really changing the competitive environment in the US. We will undoubtedly see some reactions from competitors, says Joost Oyevaar, chief financial officer for the international division of ABN Amro, the Dutch bank with a retail banking network in the US Midwest.
If the barrier between banking and insurance has been under attack in the US, so too has the separation between commercial and investment banking enshrined in the Glass-Steagall act. Citibank is not the first commercial bank to venture across that divide. Former commercial banks such as Bankers Trust and J P Morgan have already transformed themselves into investment banks. Others such as Bank of America and Nations Bank have taken advantage of the deregulation to buy small and specialised brokers.
But the partnership of Salomon Smith Barney with Citibank is in a different league. Integrating Salomon with Citibank will be difficult, but if it works, the combination will pose a serious threat to Wall Streets top investment banks.
Rival investment bankers said that Morgan Stanley, which only last year merged with Dean Witter, would come under pressure to link up with a commercial bank. Goldman Sachs, Wall Streets biggest surviving partnership, will also face once again the question of whether to float on the stock exchange or sell out to a bank. It is only a matter of time before they merge with a major money centre bank, says a merchant banker.
It is not just Citicorps competitors that will find the new company challenging. International banking, securities and insurance regulators have been wrestling with the task of keeping this kind of financial conglomerate on the leash, when its activities cut across their own national and industry-specific jurisdictions. Concepts of financial soundness vary widely between industries, and consolidating capital adequacy ratio for an amalgam like Citicorp will not be easy.
If the marriage works, however, it will have changed the rules for rest of the industry. Its competitors will not be able to rest, even if Citicorp stays where it is. As one of Weills former executives comments: If it succeeds, you will have a gigantic group that will want to do more with capital. With Sandy Weill at the top, the answer is usually buy.