Pitfalls Await Foreign Buyers of U.S. Banks

Foreign banks' interest in acquiring or investing in U.S. banks is heating up just as the long-predicted wave of consolidations here may finally be occurring.

But in the 1980s, foreign banks often found frustration and poor returns in the U.S. "mass market" - that is, the broad-based consumer and commercial banking businesses.

Several world-class banks have been confounded by the market peculiarities of the Northeast in particular and, to a lesser extent, California and Chicago. Many of these banks have recently changed their managements and narrowed the focus of their activities.

These banks did not necessarily make an error in deciding to enter the U.S. market. Rather, their problems occurred because of poor execution, which is typical in acquisitions.

Corporate lending, while not the only area of concern, has typically been most responsible for poor performance.

A number of the foreign banks, intentionally or by mischance, simply bought banks that needed improvement. Sometimes insufficient due diligence led to a misunderstanding of what was being bought. And some acquirers believed they could enhance the value of the purchased bank by managing it better

Due Diligence Is Crucial

No good excuse exists for failing to perform extremely detailed due diligence. It is crucial. It is a deadly formula to rely on due diligence teams lacking U.S. experience and on financial advisers with vested interests.

As for turnarounds, though they can be very successful, they require intensive management focus, substantial investment, and a fair bit of patience.

Lacking in-depth knowledge of the intricacies of the U.S. marketplace, many of the foreign banks appear to have fallen under the spell of the acquired bank, letting too many of the past policies remain in place.

Turnarounds require a very hands-on approach to achieve fundamental change. Investors must frankly examine themselves and their goals to determine if they want to go the turn-around route; for many, it is not to be recommended.

Looking for Quick Returns

The track record of foreign banks in the United States over the past decade shows that personnel screening and compensation policies often failed to support a strategy of high-quality loan growth.

A number of the foreign banks focused on hiring "gunslingers" who could generate assets quickly but were short-term (and bonus) oriented, not developers of relationships.

Ironically, generous compensation policies can lead to other types of problems. At least one foreign bank's troubles in the United States can be traced in part to its paying too much, too soon to its lenders. That bank, aiming to capture market share in a hurry, tied lender bonuses to loan growth. As a result, not surprisingly, some lenders were not rigorous enough in examining credit quality.

Jumping In Too Fast

In that same case, lenders ignored the time-tested concept of getting to know one's borrower by initially taking a small piece of a deal.

Instead, they overcommitted. For example, one bank underwrote $20 million of a new $30 million corporate loan, though prudence would have limited an initial loan to $5 million to $10 million, given the lender's U.S. equity position.

Incentive compensation need not lead to loan quality problems. However, loan growth should not be the key determinant for compensation. Furthermore, incentives must be crafted so that loan officers feel committed to the bank for a substantial period, work toward the bank's overall goals, and benefit from its long-term success.

A Success Formula

One U.S. bank that my company knows ties its incentive compensation to company stock and pays it out over a few years, beginning several years after the bonus is awarded. This serves two purposes: it creates "golden handcuffs" for excellent employees and links their economic interest directly to the bank.

Commission-type payouts will work only when there is a business development officer who is largely out of the credit approval loop.

Many of the foreign banks failed to institute an excellent This limited the sense of accountability.

In other cases, the bank was expanding and hired lenders from different banks, which had diverse training and approaches. Thus, no unifying approach to credit could develop.

Dangerous Combination

In retrospect, the recipe for writeoffs seems clear: incentive-driven lenders, a bank offering only one product (for example, credit), and an orientation toward near-term asset growth.

In a recent conversation, a lender called one foreign bank that has had significant credit problems a "bad competitor." This bank had driven down market pricing and weakened the structure of deals in its region in order to get orders.

Apparently, the two variables adjusted were pricing and structure, in one instance hurting loan profitability and in the other undermining loan quality.

Of course, problems related to hiring, compensation, credit, and strategy are not unique to foreign banks. And given the weakness in the U.S. banking system and the relative capital superiority of many foreign banks, foreign players remain particularly well positioned to build market share in mainstream retail and corporate businesses.

Guidelines for Investors

What should the approach be for foreign banks currently assessing a possible U.S. strategy?

* Agree on where you want to focus. Use detailed analysis of internal capabilities and preferences and an external market assessment to determine the types of business you want to pursue.

* Take an active approach to screening and due diligence. Banks that are available may not be the correct entry or expansion vehicles for your institution. Waiting for brokers or other interested parties to bring in deals may save time near-term but can lead to some significant risks.

The die is cast, in terms of a successful acquisition, in the due diligence process. In any acquisition, use the process to develop a detailed game plan for implementing change. This is especially important when the management team is an ocean away.

* Set both near-term and longterm goals.

Pushing to achieve increased profitability from Day One should be based on increased productivity, improved job definitions, reduced overhead costs, and such. Focusing on near-term risk asset goals can be suicidal. Longer-term goals should center on profitability and key products and markets, encouraging focus by relationship managers.

Opportunities abound for the investors, U.S. or foreign, with the will to plan a course of action and to focus staff on successful execution. But the economy has been unforgiving about mistakes, and the slower-growth environment of the 1990s requires more strategic and tactical planning to assure solid returns.

Mr. Wendel is a vice president of Strategic Planning Associates Inc., New York, a management consulting firm.

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