Midlantic's Sour Loans Test Scheuring's Mettle

Gary Scheuring's skills at working out problem loans helped him win the top job at ailing Midlantic Corp. four months ago. But if he's not careful, those same skills may work him right out of the position.

Mr. Scheuring stunned the banking industry last week by dramatically boosting loan-loss reserves and putting a third of Midlantic's $21.5 billion of assets up for sale.

Although these decisive measures could allow Midlantic to at last climb out of its morass of bad loans, they also raise a question: After Mr. Scheuring's cleanup efforts, will Midlantic have transformed itself into a prime takeover candidate?

"That's the biggest danger to Garry Scheuring's job - if some big bank takes a run at it - and I think that's likely a couple of years down the road," said Jerome I. Baron, an analyst at Ryan, Beck & Co.

Among the most likely buyers: acquisitive Northeast institutions like First Fidelity Bancorp. of Lawrenceville, N.J.; CoreStates Financial Corp. of Philadelphia, and Bank of New York Corp., which already holds a block of Midlantic's preferred stock.

Assuming that Midlantic's condition steadily improves over the next year and its stock rises from its current level of about $6 a share to $10, Mr. Baron said, a big bank could offer twice that, or $20 a share, and still get a good deal.

Such a takeover price would be slightly below Midlantic's $21 book value and only five times Mr. Baron's estimates for the company's ultimate earnings power: $4 a share. Most mergers happen at 11 times projected earnings, he pointed out.

Potent Poison

For now, though, Midlantic has the ultimate poison pill: $1.88 billion in nonperforming assets, mostly bad loans and repossessed real estate. Potential acquirers will want to see those levels start coming down before they will think seriously about buying Midlantic.

For his part, Mr. Scheuring says he would rather keep the company independent, but he knows Midlantic's ultimate fate can't concern him now. His first concern must be to find ways to get the bank's pile of bad loans to generate income again. If he doesn't, the company's long-term prospects will be moot.

Mr. Scheuring, 52, is no stranger to the workout business. In fact, his experience with troubled loans was a major reason why Midlantic directors brought him in four months ago from Continental Bank in Chicago.

"He was clearly our top choice," said Arthur Kania, a Midlantic director and member of the search committee. "What impressed me most was that he was able to come in and put his arms around the existing problems."

Expert help doesn't come cheap. Mr. Scheuring's salary and guaranteed bonus will be $1 million a year.

A Skilled Negotiator

Mr. Scheuring had spent his entire career to date at Continental Bank, and made a name for himself in the late 1970s and early 1980s restructuring problem loans for such high-profile customers as International Harvester and Lockheed. Former associates say he displayed remarkable negotiating skill and financial creativity during the process, convincing hundreds of warring creditors to accept agreements all could live with.

He turned trouble to opportunity once again in 1984, when he took charge of restructuring $3.5 billion in bad loans stemming from Continental's failure and federal bailout.

For all the praise current and former associates heap, there is still one big unknown: He has never been a chief executive officer before. His last position at Continental was vice chairman in charge of corporate banking.

"The obvious challenges are to do those things he wasn't called on to do [at Continental] because he wasn't CEO," said William Ogden, former chairman and chief executive of Continental. He'll have to get used to having "different people reporting to him with different skills besides corporate banking."

In particular, he will have to adapt to the differences in running a bank with a huge retail business and branch network like Midlantic. Continental doesn't have either.

Already, some have suggested that Mr. Scheuring has not been forceful enough in cleaning house. Despite the aggressive stance on adding to loan-loss reserves for the second quarter, observers point out that the corporate suite has not been cleared of senior executives who presided over the bank's lending mistakes in the 1980s.

That's not to say Mr. Scheuring isn't bringing in his own team. He has appointed former Chemical banker Alfred Schiavetti Jr. to the new position of chief credit officer and is looking for a chief financial officer to replace Midlantic's former CFO, Frank Garnevicus, who retired in May.

Merrill Lynch to Advice

As for plotting strategy, Mr. Scheuring has hired Merrill Lynch & Co. to advise him and has made it a top priority to fully understand Midlantic's problem loans.

Geographically, Mr. Scheuring wants Midlantic to stick to its home territory, specifically New Jersey and the Philadelphia area. Thus, Midlantic banking operations in outlying areas of Pennsylvania are being sold, as are banks in upstate New York and Florida.

As for customers, the goal is to offset the decline in commercial real estate lending with consumer loans.

To set the tone of a kinder, gentler Midlantic, Mr. Scheuring has beefed up a program to reward employees for customer service. He has also made efforts to ensure that employees see him as friendly and approachable. For example, he occasionally dines in the company lunchroom, where he knows the cook and cashier by name.

This goes beyond public relations, Mr. Scheuring says. He believes that if employees are happy, they are more likely to provide good service than if they are unhappy. "People don't change banks that easily," he said. "If they are well served, they seldom change banks." Whether a bank can offer the lowest interest rate on a loan "is only part of the equation."

Change in Culture

This personal touch is a marked change from Mr. Scheuring's predecessor, Robert Van Buren, who was ousted in April. Mr. Van Buren was known for an almost military style of management. One former employee recalls that under the Van Buren regime workers of certain rank were required to wear jackets when not at their desks. Food or coffee were never allowed on desks after 10 a.m. Loafers and pink shirts weren't allowed either.

A relaxed style may help improve Midlantic's business, but clearly, the real work for Mr. Scheuring will be working his way out of sour loans. As Mr. Scheuring's hefty second-quarter provision for loan losses indicates, he is ready to start aggressively renegotiating loans so that Midlantic can get more funds coming in.

"Most banks ... worry about whether a loan is nonperforming or performing or whether they can collect the full principal or not," he said. "They may be better off collecting 70% of the principal but collecting it today than collecting 100% of the principal two or three years from now. That's the approach we have to take."

Unfortunately, much remains out of his control. Analysts say regulators will give him a chance to prove his mettle, but as they showed with their seizure of Bank of New England, they will not hesitate to move in if Midlantic's condition takes a turn for the worse.

Even Mr. Scheuring acknowledges that Midlantic can't take on too many more bad loans before it's in trouble. After the latest round of reserves, the company's equity stands at 3.8% of assets, which is better that several other sick banks of its size.

More Burdens This Year

But drains on Midlantic's resources will continue throughout the year. Mr. Scheuring indicated that he may have to add some $60 million to the loan-loss reserve later this year - but nothing like the $400 million addition just taken for the second quarter. The level on nonperforming loans should begin to fall next year, he said.

Whatever the outcome of Mr. Scheuring's efforts, experts say Midlantic will be a markedly different institution five years from now. After growing under Mr. Van Buren from $2 billion in assets to $24 billion, the fascination with size will likely end.

Under Mr. Van Buren, the philosophy was to aggressively build assets - "to seize opportunities wherever they lay," said one former employee. Mr. Scheuring's legacy, in contrast, is likely to be more measured.

Said Mr. Kania, "In banking as a whole, we're going from a very aggressive culture to a far more conservative culture. Garry falls more in the latter category."

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