First Union/Money Store: The Search for the Bottom (I bet we see alot more like this in the next 4 quarters).
interactive.wsj.com
July 25, 2000
How Money Store Inspired
A Big Change at First Union
By CARRICK MOLLENKAMP
Staff Reporter of THE WALL STREET JOURNAL
CHARLOTTE, N.C. -- For 27 years, Edward E. Crutchfield Jr. was lord
of First Union Corp. He barreled through 90 acquisitions, transforming
First Union from a sleepy local bank into the nation's sixth-largest.
That explains the delicate issue that faced Mr. Crutchfield's protege, G.
Kennedy Thompson, when he was named president of First Union a year
ago: how to deal with the mounting evidence that his boss had made a
major blunder.
In June 1998, First Union had paid $2.1 billion to
acquire Money Store Inc., a big lender to people
with poor credit histories and a constant presence
on late-night television, with commercials featuring
former Baltimore Orioles pitcher Jim Palmer.
But within months of the deal, it was clear that
something was terribly wrong. The unit's profits
were shrinking, hurting its new parent company. "It
was a mess," says David Carroll, who directs First
Union's Internet strategy and who was ultimately
called in to head Money Store. By late last year,
the problems had led Mr. Thompson to launch an
examination of the unit that became known among First Union executives
as the "Search for the Bottom."
Last month, First Union's board voted to support a strategy unveiled by
Mr. Thompson that reversed some of Mr. Crutchfield's biggest moves of
recent years. First Union would shed ailing assets and embrace a new
business plan. Money Store would be shut down, eliminating the jobs of
more than 2,300 people. Two other businesses, mortgage servicing and
the bank's credit-card portfolio, would be sold. The net cost: $2.8 billion,
one of the largest charges ever taken by a U.S. bank.
Mr. Thompson's new blueprint for First Union carries risks of its own. It is
to build a nationwide financial institution focused on investment banking,
asset management and retail and commercial banking. A licensed
stockbroker will be posted to nearly every branch to advise customers on
what stocks to buy or try to interest them in one of First Union's mutual
funds. On Wall Street, Mr. Thompson aims to make First Union an
aggressive underwriter of stock offerings and backer of buyout deals.
Money Store-style lending to high-risk consumers is out.
Other banks have tried to compete with the likes
of Merrill Lynch & Co. and Charles Schwab
Corp., with limited success. Mr. Thompson says
First Union can return to strong double-digit
earnings growth by 2001. Last year its net income
rose 11%, including merger-related charges in
1998 and 1999.
Remaking the strategy of a man who created First
Union was all the more wrenching for a reason
beyond anyone's control: Mr. Crutchfield, 59
years old, had been diagnosed with lymphoma, a
form of cancer that attacks the body's lymphoid
tissue and can spread quickly if not checked by chemotherapy.
After announcing his illness in March, Mr. Crutchfield, who had plucked
Mr. Thompson out of the top ranks of the bank's executives, relinquished
the chief executive position to him, but remained chairman of the board.
Chemotherapy has thinned the ex-bond trader's hair to the point that he
wears a baseball cap at the office. Mr. Crutchfield, who declined to be
interviewed, sometimes explains his hat with dark jokes about his "bad
hair" days.
As the new CEO and aides worked to find a way to fix First Union's most
pressing problems, the 49-year-old Mr. Thompson agonized over how to
do so without "stuffing it in Crutchfield's eye," says another First Union
executive.
Mr. Crutchfield took the helm of First Union in 1973, at age 32, and
embarked on a plan to turn the company into a national powerhouse. What
followed was the breathtaking buying spree that earned him the nickname
"Fast Eddie" on Wall Street.
Money Store looked like another bold,
unorthodox stroke for Mr. Crutchfield and
John Georgius, then president of First Union.
Money Store had a national brand, made
famous by the ads featuring Mr. Palmer and
former New York Yankee shortstop Phil
Rizzuto. Mr. Crutchfield thought Money Store
offered First Union expertise in lending at high
interest rates to borrowers with past credit
difficulties, a group banks usually turn away.
First Union also saw an opportunity to use its
own investment-banking arm to earn fees by
securitizing Money Store loans and selling
them on Wall Street.
Indeed, Money Store was the star of the so-called subprime lending
world. Started in 1967 as a small home-equity lender in New Jersey, it had
grown into a major home-equity and small-business lender. It made $5.9
billion in mortgage and home-equity loans in 1997 alone. By then, Money
Store was planning to move into a new Sacramento, Calif., office building
shaped liked a Mayan pyramid. In addition to high-risk retail loans, the
company was aggressively packaging its home loans into mortgage-backed
securities, which it then sold to investors to finance additional Money Store
loans.
First Union had uncharacteristically botched its homework on the Money
Store deal, bank executives now say. The team of executives it sent to
pore over Money Store's books missed important warning signals. Later,
Messrs. Crutchfield and Georgius left Money Store's management in place
to run the operation. Mr. Georgius, 55, didn't return numerous phone calls
seeking comment.
Accounting Risk
In particular, Money Store's accounting methods, called gain-on-sale
accounting, may have masked problems. A normal practice for subprime
lenders, the method allowed Money Store to book earnings from loans as
soon as they were made, rather than having to wait for them to be paid off,
as banks typically do. The risk is that if loans don't perform as expected,
future profits don't materialize.
As interest rates fell in the fall of 1998, large numbers of Money Store
customers paid off their loans earlier than expected, slashing the company's
profit margins. Money Store responded by cutting its own rates and
lending to borrowers with even more-troubled credit histories, increasing
the vulnerability of its loan portfolio. Making matters worse, the market for
mortgage-backed securities dried up in the wake of financial chaos in
Russia and other overseas markets, leaving Money Store saddled with the
higher risks of many of its new loans.
The first public sign that Money Store was a threat to First Union came in
January 1999, when First Union said its results for that year would fall
short of analysts' expectations because it was eliminating the gain-on-sale
accounting system. Over the next few months, First Union further rattled
investors by reducing its earnings estimates twice more.
Leaving in Droves
At the same time, First Union, which had acquired CoreStates Financial
Corp. for $19.8 billion in 1998, was having problems integrating the
Philadelphia-based banking company into its operations, and CoreStates
customers were leaving in droves. Compounding the problem was First
Union's rollout of its "Future Bank Initiative." The brainchild of Mr.
Georgius, it called for freeing up branch employees from mundane tasks to
allow them to sell banking products. In order to do so, it steered
CoreStates clients who needed help to telephones and computers, rather
than on-site personnel. Customers hated the new system.
Inside First Union, executives say that few were willing to deliver bad news
to Mr. Crutchfield and to Mr. Georgius, then viewed as heir apparent.
Top-level meetings typically included an unwieldy 50 of the bank's ranking
executives. In July 1999, Mr. Georgius unexpectedly retired, and Mr.
Thompson, chief of the bank's capital-markets division, was named
president.
While Mr. Crutchfield, a 6-foot-2-inch former college football defensive
lineman, tended to make quick decisions, Mr. Thompson, the son of a
North Carolina schoolteacher and a textile executive, was more deliberate,
preferring to forge a consensus. "Ed is gregarious, and Ed fills the room
when he walks in," says First Union director Joseph Neubauer, the chief
executive of Philadelphia concessionaire Aramark Corp. "Ken is much
more analytical."
Mr. Thompson named a new executive to oversee the bank's 2,200
branches and promoted two Wall Street veterans to fill his old job of
running the capital-markets unit. In lieu of Mr. Georgius's crowded
management meetings, Mr. Thompson formed a 13-executive operating
committee to act as his eyes and ears.
"We had grown through all of these acquisitions, and we needed to sit
down and strategically look at the company and better define what it is we
wanted to be when the dust settled," he says.
In early November 1999, Mr. Thompson asked Mr. Carroll to take
control of Money Store at the operating-committee level. Later that month,
at one of Mr. Thompson's operating-committee meetings, which Mr.
Crutchfield didn't attend, executives brainstormed on what actions could
be taken to strengthen the bank. An executive broached the topic of what
should be done with Money Store.
The discussion that followed convinced Mr. Thompson that Money Store
and other troubled divisions of the bank needed intense scrutiny. Mr.
Carroll assembled a team of accountants and other specialists to scour
Money Store's books. In December, he toured Money Store's
Sacramento office for the first time. At the end of the visit, Mr. Carroll
says, Mr. Thompson remarked that things looked better, but he continued
to worry "whether it's going to be enough."
Still frustrated with financial surprises coming out of Sacramento, Mr.
Thompson and other top executives decided to "proctoscope the Money
Store," as Mr. Carroll puts it. The bank launched an effort to identify all of
the unit's loans that were almost sure to default and determine just how bad
things were going to get.
The study's conclusions were ugly: Money Store threatened to suck the life
out of First Union.
Mr. Thompson's team determined that credit controls were poor or
nonexistent. Accounting was lax. Marketing costs were too high, and
losses were mounting. It was apparent within months that the total volume
of Money Store loans originated in 2000 would be just $3 billion -- instead
of the $5 billion First Union had expected.
Money Store was "Chernobylesque," says Mr. Carroll. "We bought a
company that was devoid of rigorous processes, credit quality [and] audit"
controls. In late March, Mr. Crutchfield walked into Mr. Thompson's
office, said he had cancer and asked his protege if he was ready to be
chief executive. He was. The next month, at an emotional shareholders
meeting at which directors wore caps in a show of empathy, Mr.
Crutchfield delivered his final address as CEO.
Few on Wall Street expected Mr. Thompson to make big shifts in strategy.
"I don't see Ken Thompson being the type of person, with Ed still as
chairman of the board, who would dramatically change the direction of the
company," said Tom Brown, director of New York money-management
firm Second Curve Capital at the time.
After the shareholders meeting, however, Mr. Thompson entered the
boardroom and laid out his plan. "We are going to do a strategic review of
the entire company," he says he told the board. The directors suggested
that he bring in outsiders to evaluate operations and offer fresh views. To
do so, the bank hired investment banks Merrill Lynch & Co. and Credit
Suisse First Boston and consulting firm McKinsey & Co.
While some inside First Union pleaded for time to fulfill Mr. Crutchfield's
plans for the Money Store, Mr. Thompson's advisers told him the unit was
too far gone: It would take as long as four years to make it profitable.
Accounting models showed the Money Store dragging down the bank in
the meantime. Mr. Thompson had to stanch the bleeding, they said, even if
that meant affronting the bank's 23-member board and Mr. Crutchfield.
In May, Mr. Thompson went to the board's executive committee to report
the results of the review: First Union either had to sell the Money Store or
close it. He outlined the rest of the restructuring, which would include
selling the bank's credit-card and mortgage-servicing operations. Estimated
cost: $2 billion. A shocked board asked him to re-examine all the options.
Undoing Mr. Crutchfield's work wasn't an easy choice. Mr. Thompson
had long relied on Mr. Crutchfield for guidance. Even as the decisions
involving Money Store were made, he leaned on Mr. Crutchfield for help
in winning the board's support, though the strategy implicitly criticized the
older executive.
"He and I talked about that," Mr. Thompson says. "He knew that in some
ways, it was going to look bad for some of the decisions he made." Mr.
Thompson insists the decisions weren't a repudiation of Mr. Crutchfield's
leadership, though people close to the executives say Mr. Crutchfield later
complained that he wasn't being adequately defended by the bank.
Regardless of the pain, Mr. Thompson says, the restructuring had to
happen for the good of the bank. "We just made the decision that the
capital that we would have to invest could be better deployed in our core
business. It sets us up for growth."
By May, Wall Street was sensing that big news was afoot at First Union.
Inside Money Store, word began spreading during the week of June 19
that a major change was imminent.
Mr. Thompson and other executives held out hope that Money Store
could be sold. Investment bankers worked feverishly to find a buyer. But
$50 billion in other subprime assets were already on the block, and a deal
couldn't be reached.
After the stock market closed on Friday, June 23, about 250 senior
managers were told to go to the 12th-floor auditorium at the bank's
headquarters. There, Mr. Thompson briefed them on the announcement
planned for Monday. Each was given a thick folder that outlined the
closing of Money Store and a charge that had now grown to $2.8 billion,
after tax. In case members of the local media were waiting outside, the
managers were told to conceal the folders in brown bags from Dean &
DeLuca, the gourmet food store.
On Saturday morning, Mr. Thompson was back at the office. Dressed in a
button-down shirt and khaki pants, and looking haggard, he sat down to
videotape a 30-minute message for employees to be played Monday
morning. "We are not taking a meat ax to the company," he said. His talk
looked forward, and made no mention of Mr. Crutchfield.
The following Sunday afternoon, the board, including Mr. Crutchfield,
reconvened for final consideration of the restructuring, and the vote for it
was unanimous. Afterward, Mr. Thompson flew to New York with his
staff on the corporate jet. He sat in the leather seat behind the pilots,
sipping a Diet Coke and reviewing details with a lieutenant.
The next morning, a black Town Car took Mr. Thompson on the short
drive from the bank's corporate apartment to the New York Palace Hotel
in midtown Manhattan. At 8:30 a.m., Mr. Thompson walked into a
conference room at the hotel for a meeting with Wall Street analysts to tell
them the news. Money Store was history. |
