Two years ago, a merger between Washington's American Security Corp. and Baltimore's MNC Financial Inc. would have been considered highly unlikely. Today, the merger is generally considered a "perfect fit" in the banking industry.

To many observers, MNC's acquisition of American Security, completed in March, is a example of a true partnership -- a joining of corporate operations and leadership.

"There are a lot of mergers around that you can call into question, {but} I think this is one that makes sense," said Kyle Legg, an analyst and vice president at Alex.Brown & Sons Inc. in Baltimore. "The two headquarters are fairly close, and with the geographic location you can get a lot of cost benefits out of this merger that you can't get out of others."

Indeed, some industry analysts say the MNC-American Security marriage is more like an intrastate merger because of the economic and geographic ties between Baltimore and Washington.

Observed Luther H. Hodges Jr., chairman of Washington Bancorporation: "It fits. Their balance sheets fit. The complementary nature of their business fits."

The merger put Maryland National Bank, the state's largest, and American Security Bank, the District's second-largest, under the umbrella of one holding company. More than any other in the region, the merger effectively eliminated what had been regarded as an artificial barrier for banks.

Industry observers generally agree that the merger is logical and that it gives MNC a strategic advantage in the Washington-Baltimore region. Several industry analysts note that through the merger, near-equals formed one of the strongest banking organizations in the Middle Atlantic area.

American Security Bank traditionally has been a leading source of commercial and real estate loans in the Washington area. Its trust department is also among the largest in the region. Maryland National's consumer-oriented business makes it the largest retail bank in the state as well as in the Washington-Baltimore market. MNC's credit card subsidiary, with 3 million cardholders, ranks among the top 10 credit card lenders in the country.

Moreover, MNC's $15 billion in assets make it one of the country's leading regional bank companies.

Of the regional bank companies in Maryland, the District and Virginia, only Sovran Financial Corp. of Norfolk, with assets of $16 billion, is larger. Only MNC, however, has major banks in both Washington and Baltimore.

A Management Blend The two banks were unusually well suited for a merger. MNC's approach of blending management of the two is unusual, too.

Typically, the top executives of Washington banks that have been acquired in interstate mergers have either been forced out or have quit over differences with the new parent organization. Even when the management team stayed mostly intact, many of the decisions that used to be made at Washington banks are handed down now from headquarters of bank companies as far away as Richmond, Norfolk and Roanoke.

Instead, MNC Chairman Alan P. Hoblitzell and Daniel J. Callahan III wanted to prove that the operation of merged banks could resemble a partnership.

"I had a vision of {American Security} being part of a major institution in the Middle Atlantic area," Callahan recalled. American Security had regained momentum in 1986 after correcting severe loan-loss problems but "we couldn't do it ourselves," he said. "We needed to find a strong partner."

Said Hoblitzell, "Philosophically, we intend to use the best of both institutions. In some cases, American Security Bank had some systems that were better than Maryland National's."

The partnership of Hoblitzell and Callahan -- built on mutual respect and candor -- is one of the intangible underpinnings of the merger, most observers agree.

"This was a friendly merger," said Legg of Alex. Brown. "The managements respect one another."

"When a bigger bank takes over it really takes over, but Alan has such high regard for Callahan that this merger has gone much smoother than most," said industry analyst and consultant Arnold G. Danielson.

One of the first things Hoblitzell did after the merger was establish several task forces composed of managers from both banks. Each group was directed to develop plans for consolidating major functions. Consolidation "goes both ways," Hoblitzell emphasized. "There may be some {functions} that will move out of the District and some will move into the District."

For example, American Security's data processing and operations divisions are being consolidated with Maryland National's in Baltimore. At the same time, Maryland National will convert to American Security's wire transfer system. American Security's trust department will represent both banks.

In the course of that type of consolidation, some egos are likely to be bruised, Hoblitzell conceded. "You're creating a new corporate culture and both institutions have to understand that ... it requires the heads of the two institutions to set the proper tone and that has been done," he said.

"I think you have to be fair, logical and reasonable. Both institutions have to change ... I think we've focused on, and I've tried to be sensitive to, the interpersonal side of this merger."

Callahan agreed. "In a merger I think you have to readjust your working relationship with your board and your staff to recognize the differences the merger brings about," he said.

Skeptics wonder, nevertheless, how long American Security will continue to have the autonomy it enjoys as a subsidiary of MNC. Further consolidation, they speculate, could strip American Security of its independent credit approval authority, for example, leading to wholesale changes in account officers and relationships in Washington's business community.

Most observers doubt that will happen under current management, however. Callahan's and American Security's strong ties to the Washington business community are important to MNC's overall strategy in capturing a bigger share of the so-called commercial middle market. Indeed, American Security's board is composed of some of the area's more influential business leaders.

Making the Choice

That Maryland National eventually narrowed its merger choice to American Security is the ultimate measure, perhaps, of Hoblitzell's confidence in American Security's management.

American Security had built one of the best lending records in the industry, but in 1984 suddenly found itself saddled with an unusually high level of nonperforming assets. Management blamed the reversal on problems with loans in the real estate, shipping and energy businesses. Problems with international loans exacerbated the situation.

In early 1985, American Security Corp. capped one of the worst periods in the history of that holding company when it announced results from the previous year. A fourth-quarter loss of $12 million capped a year in which earnings tumbled nearly $27 million from net income of $31 million in 1983. A loan portfolio riddled with problems showed nonperforming assets of $145 million.

Announcement of the problems at Washington's second-largest bank holding company and its principal subsidiary followed the unexpected resignation of W. Jarvis Moody, who had been chairman and chief executive. Callahan, who was appointed immediately as Moody's successor, predicted a quick turnaround and American Security's return to its accustomed position as a market leader.

Callahan's resolve notwithstanding, the sudden resignation of Moody and the dismal financial results raised serious doubts in the banking community.

In a recent interview, however, Callahan would say only that in the fall of 1984, "This bank, for the first time, truly recognized its loan problems and made some very dramatic changes at the beginning of 1985, starting with management."

The timing of disclosures about American Security's problems could not have been worse. Regional interstate banking was about to shift into high gear, but American Security's problems left it with virtually no latitude to negotiate a merger. Larger institutions were reluctant to buy the bank and its debt burden, while smaller banks were seeking to sell themselves at prices much higher than American Security could afford.

With Callahan as the new chief executive officer, American Security began acting to strengthen itself after pledging to the comptroller of the currency to improve substantially in several areas.

"Our main goal in 1985 was to put the bank back on its feet on a profitable basis," Callahan recalled. "As we got better word got around."

Within a year after its highly publicized problems, however, American Security shrank its nonperforming assets and shored up earnings, making it not only a viable merger candidate but also strong enough to seek out interstate acquisitions. Two years after Callahan's declaration, American Security consummated what analysts and other observers are describing as the ideal interstate merger with MNC.

While attending a bankers' meeting in Florida in the spring of 1986, Callahan and Hoblitzell agreed that they should get together for an informal discussion. The wide-ranging conversation covered topics including their management philosophies and a candid discussion of American Security's problems.

After several meetings, Hoblitzell agreed to strike a deal with Callahan, seemingly convinced American Security's worst problems were behind it.

"The timing was right from MNC's standpoint," Legg said. "They {MNC} hadn't done anything, and they didn't want to do anything that would dilute earnings too much. They were able to strike a deal at a considerably lower price than a lot of people thought. The timing was right because American Security was coming out of its problems."

Although the timing may have been right, observers questioned MNC's decision to merge with American Security so soon after the latter had worked off most of its loan problems. At the same time, American Security drew criticism for not getting more for its shareholders in the transaction.

"I don't think our shareholders would have benefited as well if we hadn't {sold to MNC}," Callahan replied when asked about the price. "We did sell at 15 times earnings, and you don't buy on book value -- you buy on earnings potential." As part of the merger, each share of American Security was converted to 0.81 shares of MNC stock, a deal valued at about $438 million.

A Question of Strategy

In reality for MNC, "there weren't a lot of choices available if {MNC} wanted a major position in this market," observed Elliott Benson, a vice president and director of research at Washington's Ferris & Co.

MNC already had a major position in the Washington market, officials of the Baltimore bank holding company hasten to point out. Although MNC had been a substantial source of commercial loans in Washington, its real strength has always been in consumer banking. Maryland National Bank, MNC's principal subsidiary, operates 90 branch offices in suburban Maryland communities just outside the District.

American Security operates 32 branches in the District but traditionally has been a leading commercial lender. While the combination of the branch networks gives MNC broader coverage of the Baltimore-Washington market than any competitor, observers say the plum for MNC is American Security's huge commercial loan business.

Maryland National -- renamed MNC after the merger -- had considered buying a smaller Washington bank to take deposits in the District, but decided that was incompatible with its interstate banking strategy. That strategy essentially calls for MNC to establish a larger presence in the Washington area as a complement to its core business before expanding further in the mid-Atlantic region.

"Our objectives are to continue to develop the size of the institutions in our basic markets," Hoblitzell said in a recent interview. Owning American Security was a major piece of that strategy, he added. "It was also our objective to enhance our capital for further investment."

Most other banks in the District would not have given MNC immediate access to a large customer base. Only Riggs National Bank, among Washington institutions, is larger than American Security. Riggs' management has shown no interest in being acquired by another big regional company. The National Bank of Washington, the District's third largest, is substantially smaller than either Riggs or American Security, and First American Bank of Washington is a privately held institution controlled by Middle Eastern investors.

Even though he gives the merger high marks, one analyst, who asked not to be identified, said: "If {problem loans} were out of the way altogether, Maryland National would probably had to have paid a higher price for American Security."

Nonetheless, said Washington Bancorporation's Hodges, "It's one of the smartest mergers I've seen. American Security owners didn't sell American Security; they bought into Maryland National."

Regardless of the spin put on the deal, the merger will "make a very strong banking entity that this area deserves," he said. "It probably put our two strongest competitors in the same market."

Gauging the Effect

The immediate question facing MNC, according to several observers, is what effect the merger will have on profits and how long will it take to make up earnings that it might have accumulated if the transaction had not been made.

"We're looking at dilution recovery of about $25 million pretax over a two-year period," said Hoblitzell. About $15 million of that, he forecast, will come from "synergies" of the institutions -- operations, property management, trust and international banking. About $3.5 million is to come from balance sheet restructuring and another $6.5 million from growth and new products.

One analyst who prefers not to be identified declared: "At the time of the announcement of the merger, they said dilution recovery would take about three years. In looking back on it I thought they might be able to do it sooner. They still have over a year to run and I think they can achieve that."

As for MNC'S earnings this year, Legg estimates they would have been higher if the merger had not been completed. "It was a very modest dilution given the size of the the transaction," she added. Ferris & Co. had been overly conservative in its earlier assumptions, leading to an earnings estimate of $4.50 a share for MNC in 1987, Benson said. Based on current expectations for improvement, he now estimates earnings of $4.65 a share compared with $4.99 registered by MNC last year.

Other estimates go as high as $4.90 to $5 a share for 1987. Those figures hinge on MNC's performance in the third quarter, one analyst cautioned. The same analyst "tentatively" estimates that MNC will earn $5.65 a share or more in 1988.

"About the only concern in this thing, and I think that needs to be minimized, is the Latin American loan issue," said one industry analyst. "But {MNC} seems to be undaunted by this, and they're well run."

MNC addressed concerns about Latin debt in its second-quarter report in July. Having become concerned in 1985 about "the full collectibility" of its South American debt, MNC had already begun to build a reserve, shareholders were told. The company said it further increased its reserve to 28 percent last June and that the reserve against Latin American exposure of $223 million is about $63 million, or 1.5 percent of assets.

Given the strong earnings forecast for MNC and a merger in which there "hasn't been a downside," according to Hoblitzell, MNC can be expected to pursue further acquisitions soon in the mid-Atlantic region, probably in Pennsylvania.

"We would hope to be able to grow by the merger route," said Hoblitzell. "We think it's important to adhere to our objective of merging with an institution that has a leadership position in its market."

As of June 30, 1986

TOTAL ASSETS..........$15 Billion

DEPOSITS..............$10 Billion

NET INCOME............$65 Million

Year Ending Dec. 31, 1986

TOTAL ASSETS..........$9.5 Billion

DEPOSITS..............$6.4 Billion

NET INCOME............$91.8 Million

Year Ending Dec. 31, 1986

TOTAL ASSETS..........$5 Billion

DEPOSITS..............$3.5 Billion

NET INCOME............$31 Million