Decision Quality Blog

Day 2 at the BAI Conference. Here are my notes of a conversation between Tom Brown and Dick Kovacevich, former CEO and Chairman of Wells Fargo Bank.

Tom

When I sat down and thought about if I was only going to have one or two presentations, I thought nobody better than Dick. By the numbers, he’s had the best record by far of any of the large cap bank CEOs.

The first maverick decision I can remember him making was at Citi. It was the late 70s. A thing called the ATM came out and he made the decision to flood NYC with them without knowing what the response would be. He moved shared 3x when nobody was moving share.

Along the way, Wells Fargo had such a great record because he made great moves that didn’t blow up.

Dick, how did you do the pressure not to follow the herd?

Dick

I have a fairly analytical mindset. We look at what people are doing, the returns, and the risks. If it doesn’t make sense, it doesn’t make sense. So we avoid those things. However, the reason we were able to do that is that our business model, which is a broad product line and cross selling, allowed us to do well.

Our business model was developed with that in mind. The business is cyclical. It isn’t different this time. My feeling was that the only way to avoid the pressure to follow the pack is to be so diversified it would still be okay, and you could decrease an element that was too hot because you still had alternatives.

We resisted the push to be a one-product company. You just go over the cliff with everyone else.

You have to slow down. We have often slowed down way too soon. I predicted nine out of the last three recessions. We have these alternative investments. We were able to shift resources and do really okay when the markets turned. We think the market rewards consistency.

Tom

You’re in 84 businesses. You’re the smallest in investment banking.

Dick

There is a need for investment banking. Our customers have that need. Our goal is to satisfy all the needs of our customers subject to two things. Culturally compatible with our values and that we can execute it within the values and culture of our company.

The only way you can run 84 businesses is not by command and control, but by decentralized structure. Allow people to run their company with shared values and culture. We don’t avoid problems with permission to do things. We find problems using a strong audit process. Trust but verify.

We will never add a business or do a deal that is culturally incompatible with Wells Fargo. Teamwork doesn’t occur. They don’t agree to our vision and values. Partnering and cross selling won’t work. Our conclusion was that about the only business that doesn’t fit with our business is investment banking. It is a star based business and we’re team. It’s transaction and we’re relationship. Those are basic cultural elements.

Starting in the 90s when commercial banks were buying investment banks and there were lots of deals that could be done, I said these are culturally incompatible. I said six out of ten wouldn’t work. I was wrong; it was nine out of ten.

Tom

You’ve made more acquisitions than almost any other CEO. With the exception of Wells, they’ve all been small. Why was Wells the exception.

Dick

I said culturally compatible. It turns out that we have more in common with small community banks than with large money center banks. There are more of them and almost all have the cultural compatible part.

Two, for many years, other large banks did not pursue small banks. So they were in love with big deals and paid high premiums for these big deals. The strategy seemed to be pay a big premium, and in order to pay for it you had to slash the cost base. They assumed that when the cost went down and it wouldn’t’ affect the revenues. They got the costs out and it did affect the revenue. Bad decision making that started with paying too much.

With community banks, the decision makers were the founders. They care about the stock price. I can’t think of anything they hate more than paying taxes. They have no basis in the stock. What they want is a stock that they can clip the coupons. They want a good stock. What they want us to do is pay them and then never dilute.

Usually it takes five years from meeting them and saying this is what we’ll offer, a relatively low premium, before they finally gave up and said, “Okay.” I’d say 95% of the small banks we wanted to buy, we buy because they didn’t’ have a lot of other choices and they loved the stock . . . when the owner was the decision maker. When you have someone who is just a hired hand, then it was always different. Then it is always about something else.

So it was cheaper, culturally compatible . . . we bought 45 banks in Texas and became the largest bank before the Wells Fargo deal. There is Highway 35. Our acquisitions guy said I just drive down I35 and if there are two or more exits for that town, I pull off and buy a bank.

We were prepared to continue doing that. We also liked fixer-uppers. Businesses with a little trouble due to headwinds, or some management issues . . . most of our deals were done like that in Texas. If you know how to value the problems, you do the numbers and say, okay, here’s the deal.

If you believe like I do that all segments in financial services are cyclical, which is the bad news, the good news is they’re not the same cycle. If you believe that, when do you buy? Top or bottom? It’s not hard. When do most people buy? Top. It’s not hard.

Tom

So why Wells Fargo?

Dick

So we would say, we can’t pay a 40% premium. Maybe not even 10%. If we’re right about he value of the bank, why should I give you 40% premium and only get 10% of the value in the return. That’s not fair.

What happened was a merger of equals. In the case of Wells, I had a choice of paying a 10% premium to do something as big as 100 deals the size we were used to doing. It wasn’t large vs. small, it was paying a premium vs. sweat equity. Secondly, Wells was consistent with our strategy. We never changed our strategy, it was about execution. It was ring around the mid-west and the west.

Wells came up for two reasons or issues. One, as you know Wells Fargo had decided that a narrow strategy in a single geography wasn’t working. So they did First Interstate. What they did was to execute with First Interstate the way they were executing before. It didn’t work.

They then decided they needed help in running multi-geos. And the narrow product line doesn’t work. So, either spend 20 years to figure it out or go with someone who does it well.

So we started talking. I said Paul [Hazen], “We’re going to do the right business decision. Then we’ll talk about the social issues.” As it turns out it took me two seconds to agree that Wells Fargo should be the name. As much as people in the company liked Norwest, It sounded like a mispronounced airline with bad service.

The good thing about the Norwest name was that we could register it because nobody wanted it. Wells Fargo had huge unaided awareness. Not a very big concession.

Another question: Where should we headquarter the company? A state with 12 billion in assets or 40 billion?

It wasn’t easy on the Norwest side. It appeared that we made social concessions, but we never made a deal on social issues that didn’t make rational business sense. So we were able to get through by being rational. I believe this wasn’t about scale, it was about getting into new geographies and about skill. Never about doing deals because we were too small, but because they made sense.

You should never do an acquisition unless the revenue growth of the combined company is greater than the sum of the two if they stayed separate. The only way you know you’re adding value is if the top line is growing. You don’t have to know anything else. If your top line is growing three times the industry, you must be doing something else. Risk adjusted. The market doesn’t just give it to you.

This deal was done on the basis that the combined revenue growth would be much greater because of the skills. Wells was way ahead on Internet banking. They had the best real estate and commercial banking teams. They were in high growth markets. Norwest brought in a broad product line and how to manage geographically.

Question

When you made the decision at Citi about ATMs, how do you make a decision like that when there was no data . . .

Dick

You do testing. You just keep testing the concept. We knew ATMs would work. When I was in the toy business, I brought ten toys home and let my kids play with them. I would look at what they would pick up first. It’s all scientific. Usually you make mistakes in execution. You reduce uncertainty by simulating in test markets to the best of your ability.

We had a lab set up in New York testing language and so on. We had customers tell us the machine was more polite than the tellers. It was all done by listening to customers. Why do you think we put two machines in at a time? 97% reliability wasn’t good enough. If we told people it was available 24 hours, it better be there.

We introduced this thing in April in 1975; we had to redesign every store. It took us a year to get it done everywhere. That was part of the research, how to introduce it. It meant we needed people to show customers how it would work.

In February of 1977 we had one of the worst blizzards in the history of New York. It was awful. I couldn’t make it home. I said, “We have to do a commercial. Even in the worst blizzard in the City’s history, the Citi Never Sleeps.” That was our tag line.

We had a camera crew coming in from Brazil. We were doing an internal film about what it would be like to work in the company. So I went and got the camera crew. It was a beautiful sunny day the day after the blizzard. Customers were coming down Park Ave. on cross country skis coming in to use the ATM. We interviewed them about what it was like. We had a cameraman blowing smoke across the lens to make it look like a blizzard. We were on television within 48 hours.

When we introduced ATMS, the CEO of Manufacturers Hanover said, “I’m sure glad my head isn’t in that noose.” Later he apologized [and later his head was in the noose].

Question

Tough times look like the best time to buy.

Dick

War, pestilence, and famine, I just lick my chops. There is just tons of opportunity. Not only in deals to be done, but customers, spreads, and so on. Our assets are up 100 billion dollars in the past 12 months. We just couldn’t put more assets on. Spreads went from historical lows, none of them made sense, to the end of the year to fair value, to most asset classes are under valued. So we’re buying with both hands. You buy the assets, then the companies. We now have the best share in Colorado by a factor of two by buying the best bank in the worst of times.

Tom

Let’s talk about courage. When you bought Wells, you bought a commercial loan portfolio with huge individual exposures. You don’t like that. How did you get comfortable with that?

Dick

The reason we didn’t take large exposures is we didn’t have experience with that. They had issues because of geographic and product line concentration. I would never have let it get that concentrated. But now it’s much more spread out.

Question

Comment on the future of the retail banking franchise. It looks like we’re still doing brick and mortar.

Dick

You get back to our strategy of a broad product line. 35% of our stores aren’t traditional banks. We have mortgage, financial consultants, insurance, and finance. 40% of all the checking accounts are for near prime or sub prime customers. But we only do prime lending in the bank. We’re going to convert most of Wells Fargo Finance offices into banks. We’re testing it to figure out how to do it most effectively.

The way to preserve the store as an important element is to have more things to do in that store than was traditionally there.

This is just one person talking, but I think that narrow product providers are doomed. Monolines are gone. Next it will be three or four product companies that will be dead [interesting in light of Bill Taylor’s comments on focus and simplicity].

You have to decide. Which kind of company do you want, an easy company to manage with a small number of products that analysts understand with a worse business model, or a superior business model that’s harder to do? Pick your poison.

A broad line company is harder to do, but you’ll always have products in the sunshine. For example, when rates are low, it’s great for mortgages. In a recession when commercial loans aren’t being made, asset-based loans are great.

Money never goes away. It only moves. It move for two reasons: economic cycles or customer life cycles. If you can keep the customer’s money as they decide to move it for either reasons, you’re going to make money.

Second, the cost to sell an additional product to an existing customer is about 10% of selling the same product to a new customer. You have to advertise. Five come in and two buy. You have to set them up on the system.

So who has the margins? It’s not about the product, it’s how you distribute. Why can WalMart beat everyone on cost? It’s not their buying, it’s their low cost of distribution: The logistics of the interaction.

Question

Wells was an early proponent of putting banks in super markets.

Dick

When we merged, they had 900 in-stores, now we have 550. Wells said you could substitute in-store for traditional. I didn’t ever believe that. I think of it as a hub and spoke. They took some stores in the Pacific Northwest. They took a $100 million branch and put it in a Safeway.

Think as an engineer. Ask yourself, what is the percentage of bank customers that shop at Safeway? The easiest answer is their market share. Next, ask which they’re most loyal to? Where they buy food, or where they bank? As much as I like banking, do I think we can compete where they buy food? It didn’t work. So I like hub and spoke. It’s a service proposition. Even that’s questionable.

Question

Talk about your interaction with your senior team.

Dick

If and when I get comfortable with someone to run company, my attitude is I am there to help them run their company. There are things I know, I’ve been around awhile. They come to see me because they have an issue. If I come to see you, that’s not going to be fun. I’m not talking about doing visits; I do that all the time.

I believe that great leaders have confidence in themselves and create confidence in others. My job is to build the leaders such that once you give them a thought or idea, they never have to come back to you. We’re trying to teach and learn so they know what to do so they can do it.

Tags: DickKovacevich, Tom Brown, BankStocks, Second Curve Capital, Wells Fargo, Norwest, BAI, First Interstate, In-Store, Citi, The Citi Never Sleeps