LONDON -- One of the battleships of British banking is being overhauled.

Confronted with sagging demand for loans and more-de-manding customers, $230 billion-asset National Westminister Bank PLC is turning itself into a broad financial services group at home and is expanding investment banking operations abroad.

"The U.K. market is a mature market, faced with slow growth and highly competitive," observes Lord Alexander, the bank's chairman. "We've had to refocus the business."

In Britain, Natwest is adding or expanding sectors such as life insurance, mortgages, trade finance, and personal asset management.

Corporate finance, trading, and capital markets have also been regrouped within Natwest Markets, the company's investment banking unit.

Internationally, the bank is building corporate finance and securities-related activities through Natwest Markets. Private banking is handled through its Coutts & Co. unit.

U.S. Unit Expanding

Simultaneously, Natwest is shedding its retail businesses in Australia and France, while maintaining those in Ireland, Northern Ireland, and the United States. National Westminster Bancorp, the company's $22 billion-asset U.S. operation, recently agreed to acquired both Central Jersey Bancorp and Citizens First Bancorp as part of a push to become a major player in the New York-New Jersey market.

The parent company's current reorganization is the latest in a series since the 1968 merger of Westminster Bank, National Provincial Bank, and District Bank that created Natwest.

In the 1980s, Natwest expanded into investment banking, just as Britain allowed commercial institutions to acquire merchant banks.

Still, the latest move constitutes a major upheaval for Natwest, which until recently viewed itself mainly as a relationship-oriented provider of domestic retail and commercial banking services.

'A Cultural Change'

"What they have attempted to do is to separately develop business outside the environs of the clearing bank," observes Nick Collier, a banking analyst with Morgan Stanley & Co. in London.

"But it does present a cultural change within a commercial bank with a much more bureaucratic structure that is used to doing lending business."

Executives admit that overlending in the 1980s forced much of the change on Natwest. Like other big British banks, Natwest has been criticized for encouraging customers to borrow too much, thereby helping trigger high inflation and a recession the British economy is only just beginning to come out of.

"Banks facilitated imprudence," said Lord Alexander. "But some good lessons have come out of that and businesses, particularly small business, don't want to borrow more than they have to."

Logical to Bypass Banks

The growing ability of customers to tap capital markets has also forced Natwest to change. "Clients have decided that capital markets can produce funds at lower costs than their bankers," says Martin Owen, chief executive of Natwest Markets, the group's investment banking unit. "Bypassing the banks became logical."

Net earnings, or profit attributable to ordinary shareholders after taxes, increased more than threefold last year to $874 million from $246 million a year earlier, as provisions for bad loans fell 30% to $1.9 billion from $2.7 billion in 1992.

Nearly half of before-tax operating profits - $680 million out of $1.48 billion - came from Natwest Markets.

Analysts say earnings should improve further this year, mainly as a result of cost cutting and reduced provisions for bad loans. "The level of income growth on traditional banking products is quite slim, so most of the gains will come through improved productivity," Mr. Collier predicts.

Risk Controls Tightened

Although Natwest executives argue the bank's income held up better than that of some other big British financial institutions, they acknowledge that problems have forced the bank to tighten credit assessment and risk controls.

One of the chief goals, says Derek Wanless, group chief executive, is to improve return on equity from 10.8% in 1993 to 17.5% "in the medium term."

On a retail level, that mainly means reducing operating expenses by closing unprofitable branches and reducing losses from bad loans.

On a wholesale level, the bank is globalizing operations and reducing the number of its clients. With the customers it does keep, Natwest plans to expand the services it offers, to cover lending, treasury, underwriting, and financial advisory work.

If Natwest's retail banking strategy can best be defined as opportunistic, its international expansion is far more focused and revolves mainly around Natwest Markets.

The goal, say executives, is to leverage the bank's large presence in London to develop business in continental Europe, the United States, and Asia, particularly in equities.

In an example of the sort of business Natwest hopes to do more of in the future, it recently managed a $1.3 billion global equity issue for the Commonwealth Bank of Australia.

Arranging more big-ticket deals means building a bigger international network. Much of the push to expand Natwest Markets is occurring in the United States and Asia.

In the United States, where Natwest Markets already employs nearly 1,000 people - 570 in trading debt and equity alone - the bank is planning to expand.

Mandate to Acquire

Among the most recently hired: Leslie Hannafey, senior banker in charge of East Coast financial, who joined Natwest Markets from Commonwealth Associates. Her task is to grow the British bank's U.S. financial institution mergers and acquisitions business.

Meanwhile, Natwest in May announced a joint venture in Hong Kong with Wheelock and Co. Ltd. to develop equity stock brokerage, corporate finance, and investment management business.

"The very scale of transactions handled today forces major players to globalize," Mr. Owen observes. "No single market has the ability to instantly abosorb a $1.8 billion issue, and presence in markets is what gives you placing power."

Analysts generally give Natwest good marks for its reorganization. But they also note the bank remains heavily dependent on the U.K. market.

"The United States is the most important geographic market being developed outside its home U.K. base," said Ricardo Kleinbaum, a senior vice president and international bank analyst with Fitch Investors Service in New York

"They will continue to mirror the ups and downs of the British economy and their big challenge is whether they can derive incremental income from their domestic customer base."

Inconsistencies Seen

But analysts also question what they view as inconsistencies in the bank's international strategy. In particular, they say they have doubts about the logic of the U.S. organization's acquisition of Citizens First for $500 million - or 2.47 times book value.

Analysts have also raised eyebrows over the U.S. holding company's acquisitions and plans to set up a Delaware bank after losing hundreds of millions of dollars in the U.S. market over the past several years.

"They paid a pretty price for Citizens," said Phil Pickard, a specialist in U.K. equity sales at James Capel in London. "It makes them look like they're doing a U-turn by going back into the U.S. just as the market has peaked."

Adds Morgan Stanley's Mr. Collier: "The rationale for going into the United States in the 1970s was to get a dollar funding base. But they could just as easily get funding on the capital markets.

"There does not seem to be a coherent pattern into other portfolio business outside the U.K. market."

John Tugwell, chairman and chief executive of National Westminister Bancorp, flatly rejects the criticisms. "The strategy is not inconsistent at all," says Mr. Tugwell. "We've got a good-sized operation, making a hefty return on capital."

Net earnings at the U.S. holding company reached $300 million last year, or slightly less than 20% return on equity. Earnings will top that figure this year, Mr. Tugwell predicted.

Natwest has invested a total of $2.6 billion in the United States since 1979, including acquisitions and capital injections. Mr. Tugwell said the bank's U.S. franchise has now been independently evaluated at $2.4 billion and is expected to rise still further.

"It would have been illogical to have sold off the operation three years ago when it was valued at $500 million," he said.

The executive added that there was no comparison between the much smaller scale, money losing retail operations Natwest has disposed of elsewhere. U.S. operations, he also said, offered a healthy diversification from overreliance on the U.K. domestic market, while earnings in U.S. dollars would also become increasingly attractive if the British pound continued to depreciate.

U.S. analysts, too, display no reservations about the bank's U.S. strategy and predict the acquisition of Citizens First will soon pay off.

"The price is expensive but in line with other recent U.S. transactions," Salomon Brothers Inc. analyst John D. Leonard said in a recent report.

"We expect Natwest to recover the initial dilution by 1995 in its U.K. accounts and by 1996 on a U.S. GAAP basis."

Executives acknowledge the transition to a more integrated financial and international structure has not been easy. "Banking has had to change at its heart," says Mr. Owen. "This has meant having to learn new skills."

Natwest executives add that one of the most difficult tasks has been weighing their desire to preserve long standing relationships against the need to become a more transaction oriented bank.

"We've tried to develop a balanced operation," says Mr. Owen. "Bankers sometimes are so deal-oriented they forget about relationships or are so relationship-oriented they forget how to make money."

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