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Bank to the future

Richard Kovacevich made his mark at Norwest by being a retailer. At Wells Fargo he has become the banker he never wanted to be.

Richard Kovacevich made his mark at Norwest by being a retailer. At Wells Fargo he has become the banker he never wanted to be.

By Jacqueline S. Gold
September 2001
Institutional Investor Magazine

Richard Kovacevich has spent an awful lot of time and energy trying to be something other than what he is: a banker.

One of his generation's preeminent CEOs, Kovacevich steered the midsize, Minneapolis-based Norwest Corp. through numerous acquisitions to make it what is now the fourth-largest U.S. banking company. He doubled Norwest's size and gained a new name and San Francisco headquarters with the 1998 acquisition of Wells Fargo & Co., executing a rare-for-banking smooth integration. And operating profits held up remarkably well for a long time, considering the economic shocks hitting Wells Fargo's home state of California.

Along the way the bold, outspoken and passionate 57-year-old has been quick to take up arms against a host of perceived enemies, ranging from unfair competition to misguided management practices. Earlier this year, for example, Kovacevich denounced Fannie Mae and Freddie Mac, concerned that the secondary mortgage agencies had grown too big and powerful on the strength of their implicit government guarantees.

But his favorite target has been his own industry. He has spent much of his career trying to distance himself from the pack - as a marketer more than a lender, selling products rather than subsisting on interest rate spreads. "The banking industry is dead, and we should bury it," he declared in 1994. When the big U.S. banks jumped on the 1990s megamerger bandwagon, Kovacevich criticized them for wasting time and money on a futile chase after economies of scale. He preferred, he said, "economy of skill."

That refreshing nonconformity only burnished Kovacevich's reputation as a leader and an innovator in an industry that often lacks both.

Today, alas, he has become one of "them." With the purchase of Wells Fargo, Kovacevich has joined a club he never wanted to belong to, facing a set of challenges on an unfamiliar scale. It was a brilliant purchase at a bargain price, but with it Kovacevich inherited a raft of big-bank headaches. At Norwest he emphasized consumer marketing - particularly his cause c,lbre of selling multiple services to each account holder - and fee-generating activities such as mortgage servicing. The old Wells Fargo was not only a much bigger lender to corporations, but it was also vulnerable to California's economic slowdown. Additionally, the merger presented the inevitable challenge of integrating two distinct organizations and cultures.

In the second quarter Kovacevich found himself in the unaccustomed position of having to explain away a loss. Deteriorating loan quality, the bane of bankers in a sluggish economy, was part of the story. Kovacevich has $50 billion of commercial loans to worry about; that's almost a third of the company's total loans and four times Norwest's commercial portfolio at the time of the merger. Commercial exposure was a major factor behind the 56 percent year-over-year increase in the bank's loan-loss provision, to $427 million.

But that was overshadowed by a whopping $1.2 billion in special charges that, ironically, stemmed from venture capital activity at the old Norwest. Those write-downs, which essentially erased operating income to yield a net loss of $87 million, reversed gains recognized when technology values were peaking in 1999 and 2000. Earnings at Wells had spiked upward, for example, when Cerent Corp. was acquired by Cisco Systems and when Siara Systems was bought by Redback Networks.

Kovacevich defiantly vows to stay committed to the $1.1 billion portfolio that Norwest Venture Capital started building more than 30 years ago, which includes software and Internet services holdings such as Documentum, PeopleSoft, Vantive Corp. and Verio. He worries that mark-to-market accounting rules cause unnecessary earnings volatility that could spark hair-trigger reactions among investors, but by being his vocal self, Kovacevich seems to have quelled any restlessness. On June 7, the first day of trading after the company warned of its venture capital "impairment," Wells's stock price fell only 18 cents, to $48.77. On July 17, after the release of second-quarter earnings, the shares stood at $47.50 and hovered there through August. And Wells's price-earnings multiple of 27 was 13 points better than the industry average.

Kovacevich, who rode into San Francisco three years ago with high hopes of grafting the best qualities of Norwest - its diversified revenue stream and sales- and service-oriented culture - onto the old Wells, has clearly put his personal stamp on the organization. But it's looking more and more like the stamp of a banker.

A marketing huckster in banker's pinstripes, Kovacevich is a man of contradictions.

The Tacoma, Washington, native could have been a professional baseball player; he was drafted out of high school by the New York Yankees. Instead, he entered Stanford University in 1961 on an academic and athletic scholarship. He showed so much promise as a pitcher that he was drafted again, by the Baltimore Orioles. But those dreams were dashed by a rotator cuff injury during his junior year.

The lanky, 6-foot-3 Kovacevich earned three degrees from Stanford: a bachelor's and a master's in engineering and an MBA. Then, in a succession of jobs at General Mills, Citibank, Norwest and Wells, he logged air miles and closed acquisitions at rates rivaling those of the most globe-trotting of corporate chieftains. He went to bat for deregulation as a member and past chairman of the Financial Services Roundtable, an organization of top executives who press for regulatory reforms, and he openly supported FM Watch, a group seeking to curtail the power and privileges of Fannie Mae and Freddie Mac.

But this worldly sophisticate comes right down to earth when on his home turf. He behaves more like the legendary and folksy retailer Sam Walton, intent on revolutionizing distribution methods and turning Wells Fargo's nationwide network of offices into a Wal-Mart Stores-style retailing machine.

The mantra is selling, or, more accurately, cross-selling. That means getting consumers to take, say, a mortgage and a credit card in addition to basic checking or savings accounts. It's one of those things that all bankers talk about; for Kovacevich it is religion. "Selling an additional product to an existing customer saves us about 10 percent versus selling it to a new customer," he says. "Also, the more product somebody has with us, the longer they are likely to stay with us. The longer they stay with us, the more we know about them to sell new products in the future."

Some of the ways in which he proselytizes might seem silly, but to Kovacevich, they work. Wells Fargo's 5,400 offices are called stores, and sales are calculated per square foot. The employees are "team members," and Kovacevich spends much of his time in the field, patting backs and giving pep talks.

"We built a model around selling and serving. Dick gets out into the regions, meets with store managers and commercial bankers. He is really spreading the word, out with the team," says Carrie Tolstedt, who as group executive vice president of California retail banking is a leader in the sales crusade.

Kovacevich has a way of making seriousness fun - and making points by poking fun at himself. At sales meetings he has been known to loosen up the crowds by performing in self-deprecating skits; once he dressed up as Mick Jagger, another time as a Wizard of Oz knockoff - the Wizard of Wells.

Kovacevich has succeeded in striking an unusual pose, and that's to his credit, says James McCormick, president of First Manhattan Consulting Group in New York. "A lot of top executives are not marketing-savvy, not customer-focused, and that's a big problem for an industry with revenue malaise," he notes. "Only a few banks set themselves apart by offering a clear value proposition for the customer, and those that do have a powerful leader like Kovacevich who is willing to step out and move away from the pack."

FOR MORE THAN A DECADE, STARTING IN THE mid-1980s, the upper Midwest was Kovacevich's world, and he pretty much conquered it. But that was small potatoes compared with where he had come from.

Before he was 30, Kovacevich had served as a strategic planner at General Mills in Minneapolis; as chief financial officer of Palitoys, a U.K. company that it had acquired; and as general manager of General Mills' Kenner Toys division. Brought into Citibank in 1975 by John Reed, another nontraditionalist with an engineering degree and no lending experience, Kovacevich initially ran mortgage, consumer finance and other retail operations in New York State outside New York City. Over the next 11 years, he rolled out the industry's largest automated teller machine network, doubled the market share of Citi's credit card business (now the world's largest) and managed the international consumer group, which in 1985 had 23,000 employees at 1,000 branches in 33 countries.

When Walter Wriston retired in 1984 and Reed succeeded him as Citibank's CEO, Kovacevich hoped to lead Citi's entire retail business. But he never got the call because, says a Citibank insider, Reed felt threatened by him. So Kovacevich jumped in 1986, at age 42, from the $150 billion-in-assets Citicorp to the $21 billion-in-assets Norwest as vice chairman and chief operating officer.

Norwest's then-CEO, Lloyd Johnson, was in the second year of a difficult turnaround. Aside from its exposure to the depressed farm economy, Norwest was stuck with $1.1 billion of problem loans to developing countries, a hangover from when it was fashionable for regional banks to participate in those dubious credits. And the mortgage subsidiary, today the No. 1 U.S. home lender and a major profit generator, was losing money.

Norwest differed from most other banks in that it had branches in seven states, thanks to grandfather provisions in laws that long prevented interstate branching. (Competitors had to wait until the late 1990s for those restrictions to be eliminated.) Norwest worked as a staging ground for some of the ideas about financial retailing that Kovacevich had honed but could never fully implement on a grand scale.

He immediately went out on the hustings, visiting each of Norwest's 238 branches within 90 days, talking to everyone from the presidents of subsidiary banks to tellers, whom Kovacevich regards as front-line salespeople. In 1987 Norwest lost $82 million; the next year it posted a record profit of $140 million, and Kovacevich basked in the glow. Elevated to president in 1989, he became CEO in 1993 and chairman when Johnson retired in 1995.

Cross-selling played a big part in the recovery. Norwest's number of accounts per household almost tripled during the 1990s from an average of 1.3 when Kovacevich became president in 1989, helping to counteract the slow economic growth in Norwest's midwestern markets. "How much money do you think there is in Spearfish, South Dakota?" he jokes.

But more dramatically, Kovacevich hit the acquisition trail. Between 1986 and 1993 Norwest acquired 17 banks with $20 billion in combined assets. Then, starting in 1994 with the addition of $3.9 billion-in-assets First United Bank of Albuquerque, New Mexico, Kovacevich upped the deal-making ante. First United, for example, had a subsidiary in Lubbock, Texas, which was the first of a string of acquisitions in that state. (Today Wells is the fourth-largest bank in Texas, with $16.3 billion in deposits and 387 branches.) Kovacevich also added to Norwest's mortgage and consumer finance portfolios and in 1996 bought AMFED Financial and PriMerit Bank, two institutions in Nevada with a combined $3 billion in assets.

He was now a stone's throw from California, the promised land in the eyes of many of banking's empire-builders, a populous and booming crown to any multistate strategy.

The Golden State was also in the sights of First Bank System, Norwest's smaller Minneapolis-based rival, which entered California when it acquired U.S. Bancorp of Portland, Oregon, in 1997 and took that company's name. But that was just a foothold. U.S. Bancorp chairman John Grundhofer was eyeing larger prey - Wells Fargo.

Second in the state behind Bank of America Corp., Wells was vulnerable because it had badly flubbed its 1996 acquisition of First Interstate Bancorp of Los Angeles. In its haste to eliminate redundancies in the two organizations' branch networks, back-office systems and staffing, Wells Fargo had touched off a chain reaction of operational glitches and customer-service embarrassments. These caused cost overruns, serious damage to the bank's historically strong reputation and brand name and, worst of all, market share declines, which are very difficult to reverse. According to a Salomon Brothers report, deposits declined by $2.7 billion in the first half of 1997.

Grundhofer's unsolicited overtures did not strike a favorable chord with Wells Fargo's management. Grundhofer had worked at Wells in the 1980s and was steeped in its cost-conscious cultural values; he went on to establish a reputation as "Jack the Ripper" for the way he slashed overhead at First Bank in the early 1990s.

Kovacevich was a cautious white knight. Despite his seemingly systematic march west through acquisitions, he never thought a Pacific Ocean view was an absolute necessity. Though the banking merger wave was in full force - Travelers Group-Citicorp, NationsBank-BankAmerica Corp. and Banc One Corp.-First Chicago NBD Corp. all came together within one frenzied week in April 1998 - Kovacevich was on no particular quest for bigness. "The reason we had never made a big acquisition was that generally these went at very high premiums," he says. "The feeling was that bigger is better, but to pay for that premium, people had to slash expenses and, in my opinion, ruin the franchise. Not only is bigger not better - bigger is worse over some threshold of size."

Whatever that threshold is, Kovacevich didn't feel he had crossed it on June 8, 1998, when he and Wells Fargo CEO Paul Hazen announced their agreement on a $31 billion deal that brought Norwest's asset size to $191 billion. (Assets had climbed to $272 billion at year-end 2000 but were still well behind Bank of America's $642 billion, J.P. Morgan Chase & Co.'s $715 billion and Citigroup's $902 billion.) Wells, says Kovacevich, was attractive because it was "a great Internet bank, [was] good in supermarket banking [and was] a leading commercial real estate lender."

Norwest's track record as a decentralized multistate bank with a cross-selling emphasis and its decision to adopt the Wells Fargo name and move corporate headquarters to San Francisco were cited as reasons the deal would work better than the First Interstate fiasco.

Analysts, initially more skeptical about Norwest-Wells than about the other big 1998 mergers, now see the deal as a landmark. "Cost savings were not the imperative; revenue enhancement was," says Nancy Bush, director of research at Livingston, New Jersey-based Ryan, Beck & Co. "It was the first deal done that way. No one talks about cost savings anymore, and it's all because of the Wells merger."

Wells also came cheap, at 2.5 times its book value. NationsBank paid more than 3 times book for BankAmerica, Travelers Group paid 4.15 times book for Citicorp, and First Union Corp. set a record at 6 times book for CoreStates Financial Corp. And the Wells people just plain liked Kovacevich, who went out of his way to make them feel wanted. "If they didn't have great management, it wouldn't have made sense to merge in the first place," he notes.

Says Hazen, who spent 31 years at Wells and stayed on as chairman until his retirement in April: "Dick and I had known each other for a long time. Early in 1998 we talked over the phone and had a couple of breakfasts. We were candid with each other. I felt very strongly about the brand value of Wells Fargo." And Kovacevich felt strongly about being in charge. The two toyed with the idea of a co-CEO arrangement, but not for long, Kovacevich recalls: "Citigroup had just done the co-CEO thing, but I don't believe you can run a company as co-CEOs. Somebody has to be in charge."

He also put the integration process on a conservative three-year timetable. (It was finished six months ahead of schedule.) Analysts questioned that plan, too, but again they came around, and now other bankers are following Kovacevich's example. In negotiating the pending purchase of North Carolina-based competitor Wachovia Corp., First Union chief G. Kennedy Thompson similarly proposed a three-year integration pace, deemphasized savings in favor of revenue enhancements and agreed to adopt the acquired company's name.

Since Norwest-Wells closed in November 1998, Kovacevich has made 39 acquisitions, bringing in $40 billion in additional assets, including the $23 billion-in-assets First Security Corp. of Salt Lake City last October. "I've been acquiring all my life," he says, estimating that he's been involved in 1,000 transactions during his career. "I've made every mistake there is to make, so I have very strong feelings [about] how you do deals."

Unlike contemporaries Hugh McColl Jr. at Bank of America, John McCoy of Bank One Corp. and Edward Crutchfield at First Union, all now retired, Kovacevich has yet to overpay or take a hard fall. His old Citicorp colleague Reed is gone, too; Reed's co-CEO arrangement with Sanford Weill lasted but a year and a half. And Wells Fargo's stock multiple gives it currency for more buys. Kovacevich says that he is not interested in further geographical expansion. But he is open to acquisitions across the spectrum of financial services, from banking to insurance to asset management and leasing.

"What we are really good at is acquiring the right bank at the right price," says Terri Dial, 51, a veteran of the old Wells who retired recently after heading the California bank and other units including small business, auto and student lending. "That's how we acquire customers. This is a consolidating industry, and we are going to continue to be a major player."

WELLS WAS STILL LOOKING LIKE A BREED apart in the first quarter of 2001, when it was one of the few big banks to post double-digit year-over-year increases in revenues (up 12 percent, to $5.2 billion), net income (12 percent, to $1.2 billion) and earnings per share (10 percent, to 67 cents). Boosts of 58 percent in Wells Fargo Home Mortgage's profits and 25 percent in the consumer and commercial finance subsidiary had a lot to do with that success. These gains followed a strong showing for 2000, when, despite merger-related expenses, net income held steady at $4 billion, for a 1.61 percent return on assets and a 16.31 percent return on equity. Kovacevich had hit all the cash-earnings-per-share targets that Wall Street watches.

In the face of the recent venture capital setback, Kovacevich is calling attention to a more sanitized "core revenue" statistic that was up by 13 percent for both the second quarter and the first half. And he continues to work hard to diversify income sources and to make plain-vanilla banking a smaller portion of what Wells does.

This year the company acquired property-casualty insurer ACO Brokerage Holdings Corp., making Wells one of the five largest U.S. insurance agencies, and H.D. Vest, an alliance of 6,000 tax professionals who offer financial planning services. Kovacevich has also gotten into investment banking, which he had long eschewed, through the First Security acquisition and its Van Kasper subsidiary.

Wells has set a long-range goal to earn 25 percent of income from insurance, trust and brokerage services, up from today's 16 percent. "One of the big motivations we had when we were building this company was to eliminate volatility," says Kovacevich. "We're not in the banking business. We're not in the brokerage business. We're not in the mortgage business. The conceptual way of explaining it is that we're in the money business. And if we are correct about our diversity, we will have much more sustainable earnings over a cycle."

For all that, Wells is still a commercial bank, a big-time lender with challenges that can divert attention from Kovacevich's consumer marketing mission. He relies on an old Wells hand, Paul Watson, to run the commercial loan portfolio, which on June 30 represented 30 percent of the bank's total loan book of $165 billion. Of $1.6 billion in nonaccrual loans and other problem assets, a figure that had grown $580 million in a year, half is commercial.

Meanwhile, California has not been a cakewalk on the consumer side. Between June 1996 and June 2000, based on figures from Charlottesville, Virginia-based SNL Securities, Wells Fargo's California deposits were flat at $58 billion, and its share of the state's expanding total shrank to 12.78 percent from 15 percent. Bank of America improved to 22.73 percent from 20.39 percent.

Tolstedt, 41, Wells's California retail chief who, like Kovacevich, joined Norwest 15 years ago, concedes that the four-year trend reflects "integration issues" from the Wells-First Interstate debacle. "Our internal analysis shows that we have had market share growth since the [Norwest-Wells] merger closed in November 1998," she says.

Companywide, Wells has not been lacking for deposit growth. The total rose 16 percent in 2000, to $169.6 billion, and is up 5 percent so far this year, to $178.3 billion. By Tolstedt's numbers, California deposits grew 9 percent, loans 16 percent and revenue 16 percent between the third quarter of 1999 and the same period in 2000.

As for the cross-selling that is so crucial to Kovacevich, he wants to sell eight products - checking accounts, credit cards, home equity loans, certificates of deposit and the like - per client. That would be more than double the current 3.7, which is already a full 1.0 better than the industry norm.

That would be some stretch. After healthy leaps in the early '90s, the rate has climbed by only 0.5 since 1996, suggesting saturation. Consumers have never shown an inclination to put too many financial eggs in a single basket. The average U.S. household has accounts with seven financial institutions, and the Internet serves only to promote shopping around, especially for price-sensitive products like credit cards and home loans.

Wells knows the Internet well - it was one of the first banks to go online, in 1995 - and it struggles to cross-sell there, too. After enhancements and a relaunch, Wells's brokerage site tripled its users last year, to 150,000, but that's a fraction of its 3.3 million e-banking consumers.

Leslie Biller, Wells's 52-year-old chief operating officer, acknowledges that not all cross-sales are easy, or of equal value. It's part of his job to analyze the results and keep the effort focused. "Our best stores are in excess of six [products per customer]. Other parts of the company are in the twos and threes," says Biller, who has been Kovacevich's No. 2 since 1997.

Biller plays an important role in the corporate symbolism. His base is Los Angeles, which has lacked a major commercial bank headquarters since the First Interstate takeover in 1996. "When Wells and First Interstate merged, it was a real problem for customers," he explains. "A major employment location was closed and moved up to San Francisco. My living down here is recognition of how important LA is."

That's an example of how Kovacevich attempts to keep people happy. In all, the merger resulted in a 5 percent reduction in positions, but 65 percent of those affected - 2,800 - were working for Wells in other jobs as of September 2000. Those are not draconian cuts in an organization that now employs 117,000. Kovacevich tried valiantly to retain the best of the old Wells Fargo's managers and succeeded with people like Watson in commercial lending and Clyde Ostler, head of Internet services. But attrition happens. Two vice chairmen from Wells - retail chief Joseph Stiglich and chief credit officer Michael Gillfillan - and online banking architect Dudley Nigg departed soon after the merger, as did several Norwest people. Chief financial officer Ross Kari left in July after 18 years at Wells to join myCFO. Kovacevich replaced him with former New York Life Insurance Co. and Chase Manhattan Corp. executive Howard Atkins.

Even as California satisfied some hunger for growth, it also brought on headaches of a kind that didn't afflict the old Norwest. To Kovacevich that's a small price to pay. And if the banker label still stings, at least he is the thoroughly modern variety. "Money never decreases," he says. "It moves in response to life cycles and economic cycles. There is no reason we shouldn't have steady and consistent earnings overall."