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AmericasJune 1 2004

America for sale

European banks are rushing to buy American banks, but will they make money? Or will it all end in tears, as it did the last time they tried in the 1980s.
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From afar, America looks like the land of opportunity – and for no one more so than European banks. With its large population, a banking sector fragmented into thousands upon thousands of institutions, and fee-friendly consumers who think nothing of paying $30 for a new set of cheque books, it seems to offer everything Europe doesn’t: high margins and room for growth. Never mind that its lure has proved fatal in the past. “Historically the US has been a graveyard for foreign bank capital,” says Chris Ellerton, an analyst at UBS. “In the 1980s, the UK banks all bought US banks and generally sold them again at a loss.”

But now European banks are back and, helped by the weakness of the dollar, are participating in the frenzy of US bank consolidation with aplomb. Retail banking is in – and the Europeans are determined to be a part of it.

Royal Bank of Scotland’s $10.4bn acquisition of Charter One, a thrift based in Cleveland Ohio that is converting to a bank, is the year’s second biggest deal, and catapults the British bank firmly into America’s top 15 commercial banks. It also moves Royal Bank of Scotland (RBS), which runs its US operations through Rhode Island-based Citizen’s Financial, beyond a purely East coast focus and into America’s heartland.

“This deal with Charter One really opened a lot of people’s eyes,” says Michael Plodwick, an analyst at Blaylock & Partners. “It was a bigger deal out of Europe than we’ve seen in some time.”

But RBS isn’t the only one. BNP Paribas, which has focused its US presence on California (plus Hawaii, where it has a 40% market share) announced in March that it was paying $1.2bn for North Dakota-based Community First Bankshares, expanding its presence far inland to states such as Wyoming and Colorado. In April the cash-rich French bank was back, announcing a $245m deal for Union Safe Deposit Bank in California.

In the mid-west, ABN AMRO is the big player and owns LaSalle Bank, the second largest bank in Chicago. The bank sees a regional focus as key (it sold its stake in New York-based European American Bank to Citibank in 2001) – and analysts say chances are high it will make another acquisition in the region before the year is out.

HSBC, which last year paid a staggering $14.2bn for consumer lender Household Financial, is the 10th biggest bank in the country. With 400 branches, HSBC Bank USA boasts the biggest ATM network in New York State – and it is not over yet. “We are positioning ourselves for further growth,” said president and CEO Martin Glynn in March, as the bank tellingly applied to regulators for a national banking charter.

European banks, it seems, now have something they did not have in the past: scale. They’re still not much of a threat to America’s top three – who dwarf other banks in size (see table). But as the US market consolidates, analysts agree that HSBC and RBS have the muscle to be in the country’s top 10 by assets, if they want to be. ABN AMRO already is (see table). “With another couple of $15bn in acquisitions, HSBC could become a serious player,” says Mr Ellerton.

Cross-border barriers

The Americans, however, conditioned by history, remain unimpressed. “When will they ever learn?” asks Ray Soifer, chairman of Soifer Consulting, of the new European fervour for US bank assets. Handicapped by overseas listings that make it tough to pay for purchases with shares, there is little threat of the Europeans playing a dominant role in US bank consolidation, he argues. He adds that US investors face a tax disadvantage in cash deals, further hampering the attractiveness of European offers. “The buyer who can use shares is at a considerable advantage,” he points out.

Such scepticism is widespread among US analysts. “There are so many examples of European banks not understanding how to function in the US market that I’m hard pressed to figure out why they keep doing it,” says Dick Bove, a banking analyst at Hoefer and Arnett. “And if you were to ask me to point to the best merger made by a foreign bank in the US, which you could use as a model to show how well it could be done, I’d say it doesn’t exist.”

Uphill battle

There are headline-grabbing examples, such as Allied Irish, forced to sell Allfirst Financial to M&T Bank in 2002 after a rogue trader lost nearly $700m. (The Irish bank retains a 22% stake in M&T). But even HSBC, which has done well here, has found it difficult. “It was a real challenge for them. Now finally HSBC is settled in this country, but it was only after a real hard struggle,” says Mr Bove, of the bank’s acquisitions of Marine Midland in 1987 and Republic National Bank of New York in 1999.

Recent acquisitions do not seem to have entirely erased the reputation of Europeans as the big, dumb foreigners, always coming in at the wrong time and willing to pay over the odds for local targets. Indeed, RBS’s purchase of Charter One gave some a sense of déjà vu. “God bless them [Charter One management] if they got that price!” says Mr Plodwick, reporting the response of some of the American banks who also bid on the deal.

“I think they did overpay,” says Mr Bove of the Charter One deal. “I think Charter One’s earnings stream is peaking and I think it’s the wrong time to get into retail banking with a thrift in the US.” To give a sense of the soaring competition in retail banking, Mr Bove says that according to his calculations every three-and-a-half hours for the next two years someone is going to build a new branch in the US.

He says, “these guys [RBS] have jumped in, bought a company in an industry where capacity is being expanded at a time when the demand for the product is being reduced and the cost of the product is being increased – and they’re paying a big premium to do that.”

With saturated home markets and few acquisition opportunities in Europe, there is a sense that the Europeans are here because they are desperate. Mr Soifer, for example, argues the European banks are prepared to accept much lower returns on equity in the US than their American counterparts, but points out that for European banks, it is still a better idea than investing in France or Germany. “That’s the question I hear most often [from European bank executives] – ‘Where can we go?’”

European edge

And yet, it could be argued, that their experience of operating in a tough environment is precisely what can give European banks an edge in an increasingly competitive US market. Take for example the current holy grail of US banks: cross-selling. With few new customers to win over, European banks have always been forced to be good at it. American banks, with some exceptions, are not.

Pierre Mariani, head of international retail banking and financial services at BNP Paribas points out that in France, his bank on average sells between seven and eight products per customer. The equivalent average among mid-sized US banks is only around two or three. Among BNP Paribas’ US possessions, First Hawaiian Bank has managed to get that average up to five, and in California, it is approximately four, and the bank is working on raising that number.

“In Europe, in most places cross-sell ratios are much higher,” confirms Dale Simonson, a senior manager at Cap Gemini Ernst & Young, and one of the authors of the 2004 World Retail Banking Report, which compares banks across 11 countries.

Joining fee

Fortune favours the brave, but there’s a harsh logic to the bad timing of Europeans banks’ buying of US assets. As Mr Bove puts it: “People don’t sell if they’re in a phenomenally strong position. Obviously, if you really want to be in US banking you’ve got to buy at the wrong time, otherwise you can’t get there, you can’t get what you’re looking for. You want to get into a market, you have to pay up, you’ve got to be a sucker. If you’re not willing to do that, you don’t get in.” It’s worth adding that this is no less true for American acquirers.

And while it doesn’t make much sense for new European players to come into the market, economies of scale mean there’s every reason for the four major banks that are already here to continue on the acquisition trail – possibly ad infinitum. “Every subsequent acquisition one makes in the same market in the same line of business becomes even cheaper and cheaper,” says Ray Soudah, founder of independent advisory firm Millenium Associates. “It’s almost a financial imperative to make further acquisitions. The banks who are doing it are smart, the ones who are not doing it should do it – and there’s more [deals] to come.”

There’s also a sense of optimism about a new and improved European approach to US banking, which seems to consist largely of pretending not to be foreign. RBS in the US calls itself Citizen’s Bank – a good US patriot name – and sponsors baseball games. As Mr Bove points out, 99% of the banks clients probably don’t know that RBS is behind it.

This is vital in retail banking which is viewed in the US as a local, community business. Mr Plodwick notes with amusement the idea of the stereotypical Charter One client, Joe Six-Pack (essentially a blue collar worker) being owned by Royal Bank of Scotland. “He’s probably xenophobic and doesn’t necessarily want to know that when he deposits his paycheck it might end up in Edinburgh,” he says.

Customer perception

ABN AMRO retained the LaSalle name, and a straw poll at the 8th Avenue branch in Manhattan of HSBC, showed approximately half of customers in ignorance of its foreign provenance.

At BNP Paribas, Mr Mariani confirms the change in approach. “What’s true for Citizen’s for RBS and also BancWest for us, is that they are not European banks, they are American banks – pure local banks managed by Americans with the support of a global bank. That’s the big difference. When in Rome, do like the Romans do. When you are banking in the US, bank as the US bankers do.”

In response to US scepticism about how Europeans have done in the US market, Mr Mariani points to a recent CSFB report, naming the European banks in the US among the top 20% of most profitable institutions in the country. He notes that BancWest has delivered average asset growth of 20% a year and cash earnings growth of 32% a year for the past 15 years. “I don’t know if it’s a bad result for our competitors, but I wouldn’t have thought the average growth for the industry is that high,” he says.

Model for success 

BNP Paribas perhaps suggests a model for a new European success story in the US: a significant local, community presence on the retail side, combined with national status in certain niche activities – in BNP’s case, marine financing.

“The community banking is a way to strengthen the network and get access to relatively cheap retail deposits – and then use them to grow the asset side on a national basis,” Mr Mariani says. It is an approach that also seems to have worked for ABN AMRO, which while focusing on the mid-west, has the number five spot in the country overall in mortgage lending, partly through a highly successful website www.mortgage.com.

While other banks continued to charge customers for the dozens of confusing fees, which goes with getting a mortgage in the US, ABN AMRO came up with the vastly popular strategy of charging just one flat fee.

“Our approach in the mid-west is ‘think local – act global,’” says Norman R Bobins, president and CEO of LaSalle Corporation, which runs ABN AMRO’s US operations. “We are local because LaSalle Bank Corporation is a strong regional brand. We are relationship-oriented and very active in the communities in which we do business, [but] we can differentiate ourselves, especially among companies that have international needs, because of the global reach of ABN AMRO. This allows us to provide our customers the best in global products and services while operating as an established local player.”

The fact is that, in spite of all the talk of US banking consolidation, US consumers like hometown banks. James McCormick, president of First Manhattan Consulting Group, points out this one key trend, going on in the midst of all the mega-mergers: “A lot of smaller banks have been formed – and the smaller banks are generally as a group winning market share on the street corner.”

Local flavour

And as Citigroup and the other US banking behemoths take over the country, it may ironically be the Europeans who are more successful in the long-term, by retaining the local flavour of banking institutions.

“People are very happy with community banks,” says Mr Mariani. “Because the level of service they get from the big institutions has been disruptive in terms of quality of service – and lots of clients and customers have left these banks to go to more local banks.”

According to Mr Mariani: “In some places we have benefited from this because we have the capacity to be very local, but also to have a broader product offering than the pure local banks.”

Indeed it may well also end up being the fancy Europeans who win by being less snobby about the US market. If RBS catering to Joe Six-Pack through Charter One is one example, HSBC’s acquisition of Household Finance – which specialises in ‘sub-prime’ lending (a euphemism for dodgier customers) – is also worth noting. As UBS’s Mr Ellerton notes: “I think a lot of the US banks would dismiss that acquisition saying that they wouldn’t have been interested. But I think that’s wrong. HSBC took it from under their noses. HSBC had the nerve to do it – and a domestic bank wouldn’t have. HSBC would admit it’s the riskiest thing that the bank has ever done, but the economics of it were pretty compelling.”

Long-term view

The view that European banks are more gutsy is perhaps epitomised by Arkadi Kuhlmann, CEO of ING Direct, which opened in the US in 2000 and in three years has managed to snaffle some $26bn in bank deposits and 1.8 million customers from US banks by offering a no-nonsense internet savings account.

He argues: “Americans tend to be extremely tied to short-term earnings and pleasing the analyst community. Europeans are more intellectually independent. And in some ways more long-term focused, which means they’re willing to take some strategic bets that domestic banks are not willing to take.”

In a market where banks supposedly can only grow by acquisition, ING Direct has turned itself into the fourth largest thrift in the country, measured by deposits. “We’re now on the radar screen and people are wondering how was that possible?” Mr Kuhlmann says.

The strategy has been simple. As Mr Kuhlmann points out: “The US marketplace is so contaminated with fees and service charges and rates that the average customer can’t find his or her way through it.” ING tries to make it simple and straightforward: “We can’t have an argument about fees, because there are no fees.”

 

No frills banking

He adds: “We’re talking abut becoming a Southwest Airlines [a US no frills carrier] in the retail industry by high volume, low margin commodity products – not much different from Ikea. And don’t forget Ikea is a European success story here. So I think we’re seeing this in this category. And I think we should not be totally surprised that it has European roots,” he says.

True, some analysts question the sustainability of the European bank approach. At least part of ING Direct’s success has been to simply offer a higher savings rate (2%) than most US banks and let people know about it by advertising a lot.

RBS’s Citizen’s Bank, too, has been growing market share at least partly by using its deep pockets to offer better rates and advertise heavily. As Mr Bove puts it: “If they [European banks] want to pay up for loans – ie, offer lower rates on loans and higher rates on deposits – they’ll get money and make loans. Whether that is a valid long-term strategy of not, that is the question.”

And yet, if the gamble pays off, the new customers may well stay with the newcomers.

Dangers of complacency

Certainly, US banks don’t have time to rest on their laurels. At Cap Gemini Ernst & Young, Mr Simonson compares the US banking system in 2004 to the state of the US automotive industry in the 1980s. The US ruled in terms of market share, and was complacent about competition from Japan – at that point still viewed as technologically backward. Then the Japanese beat them at their own game.

He points to a number of areas where Europeans banks are already ahead of the US. “Clearly, in the electronification of transaction processing Europe excels,” he notes. But though things are changing, “the US market is traditionally stuck on paper cheques”, he points out.

A lot of the global competition in financial services has simply passed the US by, according to Mr Simonson: “It’s very insular because it hasn’t had to look outward. It’s hard to find an industry [in the US] that hasn’t already come under global pressures. Financial services is one where they have been slower to take effect but it’s inevitable. And it’s a question of how the US industry responds to it,” he says.

European banks may have failed in the past, lulling the American banks into a false sense of complacency. But this time around, things may be different. American banks watch out – the Europeans are coming.

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