Security Pacific on Move to Gain Respect It Wants

Security Pacific Chairman Richard J. Flamson III was asked in a recent interview to describe his biggest mistake since assuming the bank holding company’s top job nine years ago.

“Not buying First Interstate,” he said.

Flamson quickly caught himself before revealing details of his tentative efforts in the late 1970s to buy Los Angeles’ First Interstate Bancorp, which itself recently failed in a bold bid to buy the much larger BankAmerica, based in San Francisco.

But Flamson also disclosed that he had discussed a merger with San Francisco-based Wells Fargo at about the same time. The Security Pacific-Wells Fargo talks broke down because of doubts about legal and regulatory approvals. The discussions also foundered on the question of who would run the combined company--Flamson or then-Wells Fargo Chairman Richard P. Cooley, now head of Seafirst Bank in Seattle, Wash.

In his brief comments on possible California acquisitions, the 57-year-old Flamson revealed more than he intended about high-level intrigue in California banking and his own strategic vision of the future of the financial services business.

Although thwarted in his ambition to pull off a California mega-merger, Flamson last week reached agreement to buy Rainier Bancorporation, parent of Washington state’s second-largest bank. The $1.1-billion all-stock deal will add $9.2 billion in assets to Security Pacific and solidify its position as a major West Coast retail bank.

The Rainier acquisition is the second-largest U.S. bank merger ever, based on dollar value. Security Pacific paid a rich price for Rainier, an institution generally regarded as Washington’s best-run bank. But for its money Security Pacific gets a large deposit and customer base and a steady new source of income.

The merger, Flamson crowed last week, “produces the premier bank in the region, with major strengths throughout the Pacific Rim.” Flamson asserted that the deal puts in place the last big piece of a geographical jigsaw puzzle that he has been working on for the past two years.

And, ironically, it means he will be competing once again with his old nemesis, Dick Cooley.

Flamson believes that in the increasingly competitive banking business, and especially with the onset of full interstate banking in the next few years, it is imperative to reach a critical mass of size and market share. Companies that fail to do so will be devoured.

The acquisition of First Interstate, if Flamson could have pulled it off, would have increased Security Pacific’s California market share by 50% and given it a presence in 18 states stretching from Indiana to Alaska.

A Wells Fargo deal, had it happened, would have more than doubled Security Pacific’s share of the Northern California banking market and brought tremendous cost savings from the elimination of overlapping operations within the state.

As it was, Flamson was forced to devise a different strategy. He set out briskly to acquire banks in neighboring states and to diversify into businesses only marginally connected to traditional deposits-and-loans banking. Today, Security Pacific earns two-thirds of its profits from such non-banking lines as insurance, discount brokerage, real estate and a variety of investment banking and capital markets activities to which it refers as its “merchant bank.”

Fourth Leg of Stool

With the Rainier deal, Flamson has in place the fourth leg of the stool he’s been hammering together in his 55-story Bunker Hill workshop. Within a couple of years, he expects each of the four businesses--Security Pacific’s bank in California, the interstate bank network, the financial services supermarket and the merchant bank--to contribute a quarter of the parent company’s profits.

The strategy’s risks are substantial, ranging from dilution of management talent to simultaneous slumps in several geographical areas or lines of business.

In part because of those risks, and in part because the company has had difficulty communicating its vision to stock analysts and portfolio managers, investors have not rewarded the firm with a stock price that matches its performance.

The problem, company officials complain, is that nobody understands Security Pacific.

The Los Angeles bank holding company should not have to labor in anonymity. It is the nation’s sixth-largest banking firm; it has a stellar record of profit growth and return to shareholders over the past dozen years; it is aggressively pursuing a variety of exotic global financial operations and is a fast-growing power in the country’s richest banking region.

Still, a Security Pacific public relations executive recently lamented, stock analysts, investors and the media have no idea what the company is.

“They think we’re a railroad,” she complained.

Gets Little Attention

Blame it on East Coast chauvinism, blame it on Security Pacific’s deliberately low profile, blame it on the media’s preoccupation with big bank mergers and with Bank of America’s recent travails. But, until the widely publicized Rainier acquisition this week, Security Pacific has definitely not received the attention it feels it deserves.

“We just keep chugging along,” Flamson said. “We keep our heads down and don’t press. We’ve got a pretty good reputation.”

It’s just that sort of modesty that contributes to Security Pacific’s splendid dullness.

Here is the chairman of a company with $62.6 billion in assets that has outperformed all but a handful of the nation’s best banking firms over the past 12 years, talking about his company’s “pretty good” reputation.

In a way, Flamson’s self-description matches the judgment of most stock analysts about Security Pacific--it is a solid performer that does everything well but nothing superbly. It has yet to reach its potential, most analysts believe.

Flamson may be restrained from boasting by the lessons learned from his California competitors over the past several years.

Bank of America, once top dog among the nation’s banks, was humbled by bad lending, short-sighted management and unforeseen external events. First Interstate overreached in trying to take over B of A and must now try to strengthen its reputation and its California market share in smaller steps.

Crocker National Bank, San Francisco, once an aristocrat among California banks, faltered and was first taken over by a British bank, then sold off and consumed by Wells Fargo.

Wells Fargo Lauded

Only Wells Fargo has emerged from the bruising new world of deregulated banking with its California market position and its image enhanced. It is the current darling of stock analysts because of its brilliant absorption of Crocker and the single-mindedness of its top management.

Mindful of his competitors’ problems, Flamson has decided that Security Pacific’s future depends on diversification of products and sources of income. The company must expand its customer base in California and the western United States, he believes, while positioning itself to play in the global capital markets game.

Flamson is pursuing both strategies with his checkbook. In the past 18 months he has bought Arizona Bancwest, Phoenix, making Security Pacific the third-largest banking concern in prosperous Arizona. He has staked out turf with smaller bank acquisitions in Canada, Western Europe, Northern California, Nevada, Oregon and Washington.

Security Pacific currently controls about 13% of the California retail banking market, placing it third in the state behind Bank of America and Wells Fargo. Security Pacific has a healthy 20% market share in Southern California, but only 5% up north, where Flamson wants to improve the bank’s position. He plans to do it by buying profitable small banks in selected markets, such as upper-middle-class Marin County.

All has not gone smoothly, however. Flamson’s attempts to buy San Rafael, Calif.-based Westamerica Bancorporation, a banking firm with $1-billion in assets in the wealthy and trendy northern suburbs of San Francisco, failed because the two companies could not agree on a fair price. They traded threats of legal action but recently declared a temporary truce.

Deals in Other States

In neighboring states, Security Pacific has taken advantage of loopholes in interstate banking laws to establish toeholds by picking up troubled banks. The company has agreed to buy Orbanco, Portland, Ore.-based parent of faltering Oregon Bank, for $52 million; Nevada National Bank, Reno, for $31 million, and tiny Harbor Security Bank in McLeary, Wash., for an undisclosed sum.

Flamson said the company intends to establish Security Pacific as a West Coast “super regional” bank built around a strong California base. But he ruled out, for now, buying into Texas’ troubled economy. Fears that Security Pacific would take on the well-publicized problems of a major Texas bank holding company cooled many analysts’ view of Security Pacific’s future.

But Flamson said in a recent interview that he is no longer looking in Texas.

“Circumstances have changed,” he said. “I’m not satisfied that the economic situation (in Texas) is going to turn itself around in the near future.”

On the capital markets side, Flamson has invested heavily in new people and facilities to make Security Pacific a player in international securities trading, corporate finance and the high-velocity world of interest rate swaps, debt-for-equity deals and loan selling.

Security Pacific is trying, overnight, to become a power in a game that has been played for decades by such banking giants as Citicorp, J. P. Morgan & Co. and Bankers Trust New York, as well as the global investment banks of New York, London and Tokyo. It is an extremely competitive field with slender profit margins and hard-to-break institutional loyalties.

Nonetheless, Flamson is determined to lead his bank onto the field. And he is willing to pay top prices to put together a competitive team.

The bank two years ago hired a swaps team from Citicorp, the nation’s largest bank. The four-person group is led by Stephanie Warren, now 40, who was lured by a reported $500,000 annual salary.

Interest rate and exchange rate swaps are complicated financial transactions in which borrowers trade loans to obtain more favorable interest rate terms or to hedge against currency fluctuations. An intermediary banker brings the two borrowers together and collects a fee based on the size of the transaction.

Typical Transaction

In a typical interest rate swap a company with a short-term, high interest rate loan might exchange it with another company holding a long-term, lower interest rate loan in order to reduce its quarterly payments. The transaction might include some cash or other considerations as well.

A currency swap works much the same way. A firm holding notes payable in, say, Brazilian cruzados might exchange the notes for a loan denominated in Swiss francs because of the Swiss currency’s higher relative exchange rate stability in relation to the dollar. The second firm might want to hedge its Swiss franc loans with loans in a more volatile currency that might pay a higher rate of return.

Security Pacific also brought in “rocket scientist” Helen Peters and two assistants from Merrill Lynch at reported high six-figure salaries. Peters, whom Security Pacific has set up in an independent office outside New York City, is a data whiz who analyzes financial market trends and charts investment strategies for the bank using ultrasophisticated, high-speed computer programs.

Flamson will not discuss the salaries paid to Warren and Peters or whether there are any other newcomers whose pay approaches his (Flamson was paid $956,400 in 1985).

He did acknowledge that the price of a ticket into the game is high. “It’s very expensive, but I don’t mind the compensation levels. It’s either produce or get out.”

Some observers said Security Pacific is wading into merchant banking too deep and too fast.

Questions Strategy

“They’re coming in late, at the tail end. We can’t understand why they’re putting so much money into such a low-margin business. They seem to be taking a headlong dash into the securities business,” said the head of capital markets activities for a competitor bank.

Security Pacific’s merchant bank is the least profitable of the company’s four main lines of business, measured in terms of return on assets. The unit’s profitability trails similar operations at Security Pacific’s major bank competitors by 50% in some cases.

“They’re in a world of giants,” said banking analyst George M. Salem of the Wall Street firm of Donaldson, Lufkin & Jenrette. “They’re on the playing field with all the great investment banks of the world. Does Security Pacific really need an investment banking strategy when they have so many favorable domestic opportunities?”

Flamson’s response is that the merchant bank can serve as an adjunct to Security Pacific’s domestic operations. Corporate customers will be able to use the bank’s global trading capabilities, while the bank can also profitably package and resell loans that its domestic banks originate.

This so-called securitization of loans is one of the hot new numbers in banking, and many analysts believe that its dangers are not yet fully appreciated by bankers or their regulators.

“The risk is for people to go too far, too fast and take these opportunities faster than they can measure what they’re doing,” said Donald E. Guinn, chief executive of Pacific Telesis and a member of Security Pacific’s board of directors. “But Security Pacific is very disciplined about this, about the way they analyze these businesses, so they don’t buy a bad deal.”

Shifting Its Focus

Guinn said management acknowledged to the board recently that it wanted to slow its expansion in international banking and devote more resources to buying domestic banks that are closer to Security Pacific’s core business.

Last week’s acquisition of Rainier was the most dramatic recent evidence of that strategy. And it was a tangible step toward creation of the company that Flamson plans to pass on to his successors when he retires sometime in the next decade.

“We think in 1990-91 there’s going to be a real change in banking on a national basis,” Flamson said. “Full interstate banking and major consolidations in the industry are absolutely inevitable.”

A few years further out, Flamson said, consolidation will occur on a global scale as a handful of monster banks from the United States, Europe and Japan will come to dominate world finance. Flamson said Security Pacific either will be one of them, or will sell out at a handsome premium.

“We are pointed toward that event and we firmly believe it will take place. Our job, between now and then, is to continue to build shareholder value, because that’s the day of reckoning. We know we’re going to sit down across the table some day. And that’s when our shareholders will be paid.”