ALEXANDRIA, VA (April 7, 1998) -- Since the DRIP Port's look at the financial services industry is converging with the major news event of the year in financial services, today we'Il again join other coverage on that merger and its aftermath.
Fool on the Hill: Citigroup Aftermath
In the wake of Travelers Group (NYSE: TRV) and Citicorp's (NYSE: CCI) agreement to merge and form the first universal bank in the U.S. since the Glass-Steagall Act broke up the House of Morgan and Citicorp's forerunner, National City Bank, market players are handicapping the possibilities of other transactions throughout the financial services sector.
One of the hottest stocks yesterday was that of Merrill Lynch & Co. (NYSE: MER), which jumped $10 to $96 5/8 on a strong daylong move. Merrill has taken the stance that it will go it alone, but the market is hedging its bets on this one, as talk of a possible deal with Chase Manhattan (NYSE: CMB) had driven up Merrill shares from around $70 to the mid-$80s before the Citigroup announcement. Talk of these super-mergers begs the question, "What is a bank and what is a financial services company?"
In the introduction to his epic and prerequisite The Bankers, Martin Mayer quotes Citicorp CEO John Reed as saying he expected banking to evolve into nothing more than "a little bit of application code in a smart network." If that's a metaphor, it's quite a bummer to think of each lending officer and teller or even middle market rainmaker as just a piece of replicable code inside a global financial services network. On the literal level, of course, it's true. Consumer banking in the late 20th century is going toward comprehensive financial relationships with consumers. The better that fixed costs of doing business with each consumer, such as information discovery when originating a loan, can be spread over a larger revenue base or cut down drastically, the better profit model emerges from relationship banking.
How about relationships where credit risks are severely reduced, though? Is Charles Schwab (NYSE: SCH) a bank? If you have an asset management account with your broker, then it acts very much like a universal bank. You can write checks on an account where cash is swept daily into a money market fund; you can debit Visa transactions from the account; you can credit transactions against your account with a 30-day grace period on that same account; and you can do all of this with the backing of your financial assets and a 9% credit card rate to boot. That's because you're engaging in collateralized borrowing, where you don't put your assets in jeopardy if you're using the capabilities of the account sensibly. Rather than borrowing, if you pay off the credit balance in the grace period the broker or bank handling this account is really just providing transaction facilitation.
The bank or brokerage isn't exposing itself to counter-party, or credit, risk, which is healthy for its income statement and balance sheet, and you're not paying a high interest rate on your credit card. Acting as an intermediary, the bank or broker receives fees for cash advances at ATMs and merchant transaction/credit card processing and earns interest income on lending out the securities in the account. This business model is lighter than the capital intensive business of traditional banking. Merrill Lynch does much of this sort of lighter business, but weighs it down with some very capital intensive activities, which we'll look at in tomorrow's Fool on the Hill and here in the DRIP port.