Hemmed In Down Under

After a disastrous U.S. foray, Nation- al Australia Bank’s Frank Cicutto is targeting the U.K.

As a teenage messenger for National Australia Bank Ltd., Italian-born Frank Cicutto attended night school and spent weekends trying to master cricket, the national sport of his adopted homeland.

The son of a concrete layer in Sydney’s working-class suburb of Bankstown, Cicutto got rewarded on both counts. After getting a bachelor of commerce degree from the University of New South Wales in 1971, promotions lifted him from National Australia’s mailroom and by 1999 landed him in the managing director’s suite at what had become the country’s biggest bank. In cricket, he progressed to opening batsman for Bankstown, a training ground for stars like Steve Waugh, who led Australia to a 1999 World Cup triumph and wins in a record 16 successive test matches, each played over five days.

Cicutto, 52, says his banking strategy is like the Australian team’s approach to sports. “They play a hard brand of cricket,” says the 6-foot CEO from his 35th-floor office that overlooks Melbourne Cricket Ground. Similarly, at National Australia, “all of our units compete vigorously,” Cicutto says. Investors say Cicutto isn’t competing hard enough to make National Australia an international power. Four national banks, 10 regional lenders and 37 foreign institutions serve Australia, a nation of 19 million. In 1981, the government decreed that none of the big four—National Australia, Commonwealth Bank of Australia, Westpac Banking Corp. and Australia & New Zealand Banking Group Ltd.—could acquire a major rival. The government has reiterated its so-called four pillars banking policy, thereby quashing hopes that National Australia could lift market share through a takeover on its home turf.

Forced to shop for growth overseas, National Australia has hit rough times. From 1987 through ’98, the bank paid US$6 billion to acquire seven foreign lenders in four countries: Ireland, New Zealand, the U.K. and the U.S. The U.S. effort soured in 2001. National Australia took a US$2.2 billion write-down on its US$1.23 billion purchase of No. 6 U.S. mortgage lender HomeSide Interna- tional Inc., which it had bought three years earlier.

National Australia’s shares tumbled 13 percent to 28.90 Australian dollars on Sept. 3, 2001, wiping out US$4 billion in market value in the stock’s biggest decline since the 1987 market crash.

While the shares climbed back to their A$33 preslump level by January 2002, the bank hasn’t regained the momen- tum of the 1990s, during which management delivered eight successive years of record profits. This year National Aus- tralia shares have edged up 4 percent to A$33.03 on June 6. By comparison, shares of ANZ have gained 8.8 percent to A$18.87 and Westpac has surged 18 percent to A$16.23.

Cicutto’s attempt to expand in Europe has faltered. After taking over as managing director in 1999, Cicutto sold both of its U.S. lenders: HomeSide and Michigan National Corp. Then he zeroed in on Britain and Ireland, where National Australia owns four regional banks: Clydesdale Bank in Scotland; National Irish Bank in the Irish Republic; Northern Bank, based in Belfast; and Yorkshire Bank in northern England.

So far, Cicutto has failed in his acquisition efforts. On Oct. 9, National Australia told the Australian Stock Exchange that it had approached Abbey National Plc with an offer to buy the No. 2 U.K. mortgage lender. In a 35-word statement, National Australia said no agreement had been reached and the talks had ended. “We gave it some thoughtful consideration,” says Abbey National spokesman Matt Young.

William Malcolm, an investment director at Standard Life Investments in Hong Kong, says time is running out for Ci- cutto to carve out a future in Europe. With 3.5 million Euro- pean customers and 2.5 percent of the U.K. market, National Australia’s units are dwarfed by five big British banks: Bar- clays Plc, HBOS Plc, HSBC Holdings Plc, Lloyds TSB Group Plc and Royal Bank of Scotland Group Plc.

To compete, Cicutto has reduced margins on bank loans and mortgages. On May 31, Clydesdale Bank cut its lowest mortgage rate by 0.2 percentage point to 3.79 percent for the first two years of a 25-year loan. The reduction came at a time when the Bank of England has kept its rates unchanged, at 3.75 percent. In the six months ended on March 31, Nation- al Australia’s interest margin in Europe fell to 2.57 percent from 2.99 percent a year earlier. “They can’t afford to stay as they are,” says Malcolm at Standard Life, which holds National Australia shares among its US$110 billion in assets. “To generate value for their shareholders, they are obliged to get bigger or get out.”

Cicutto says he doesn’t dispute Malcolm’s observation. “If we ever reach the day that we believe we can’t compete, then we have no right to be there,” he says.

Cicutto says that day hasn’t come. Even after quitting the U.S., National Australia has a market capitalization of US$32 billion. Its market value is 17th among the world’s banks. In early June, National Australia was more valuable than ABN Amro NV, Deutsche Bank AG and FleetBoston Financial Corp.

National Australia has assets of US$250 billion, 1,600 branches and 8 million customers—almost half of them in Europe. One in five Australians and one in four New Zealan- ders use its services. And it’s the only bank in the Asia-Pacif- ic region—and one of the few banks in the world—with a long-term AA credit rating from Standard & Poor’s. S&P rates Citigroup Inc. and HSBC AA–.

National Australia got 80 percent of its US$7.6 billion in revenue during the six months ended on March 31 from loans to individuals and businesses. It gets half of its revenue in Australia, a quarter in Britain, 10 percent in New Zealand and the rest from corporate and institutional banking and wealth management in the U.S. and Asia.

Cicutto moved into wealth management via his US$2.74 billion purchase of Sydney-based MLC Ltd. in June 2000. The unit, which manages US$42 billion, has 2.8 million customers and 5,000 employees.

Rather than running its own funds, MLC uses the man- ager of managers model, which Cicutto says lets it select the most-appropriate fund managers. It offers 20 of the major funds, such as those sold by Fidelity Investments and Vanguard Group.

The 26 percent drop in the Standard & Poor’s 500 Index for the 12 months ended on March 31 has hurt MLC. In May, National Australia took a US$135 million write-down be- cause fund management earnings for the most-recent six months had fallen 24 percent to US$100 million from a year earlier. At the same time, National Australia said MLC funds under management in Britain had increased 2 percent last year to US$1 billion compared with a 23 percent drop for the U.K. funds market.

Cicutto says Na- tional Australia can become more profitable by expanding in the south of England, where the wealthiest of Britain’s 60 million residents live. He plans to sell the products that have been most popular at home. Among them are so-called offset accounts that let mortgage borrowers lower their interest payments when they have a checking or savings account with the same bank. For example, the holder of a US$200,000 mortgage who has US$10,000 in checking and savings accounts would pay interest on US$190,000.

Cicutto also plans four banking centers for business customers. Three of them—in the Thames River valley city of Reading, the port of Southampton and the western hub of Bristol—are in southern England. The fourth is in the northwestern city of Liverpool. Among the bank’s offerings will be loans tailored to small and medium-size companies. National Australia has 28 percent of the Australian small and midsize business market, according to London-based mar- ket research firm Taylor Nelson Sofres Plc.

Cicutto aims to cut costs by melding the record-keeping and computer operations of its four regional banks. Credit card processing will be run from Leeds, where Yorkshire Bank is based. Technology will be managed from Glasgow, Scotland, home of Clydesdale.

Cicutto says he’s ready to try another U.K. takeover, should the right target emerge. “If we retreated to Australia, I’d scratch my head and wonder where the growth options will come from,” he says.

An acquisition may be getting closer after Cicutto’s March appointment of John Stewart, 54, to head Na- tional Australia’s European units. Stewart had been deputy chief executive of Barclays, Britain’s third-biggest lender. “Stewart is a serious heavy hitter in retail banking,” says Philip Middleton, a partner and retail banking head at Ernst & Young International in London. “I very much doubt he would have joined simply to mind the fire.” Stewart was on a sailing vacation before assuming his new duties in Au- gust and couldn’t be reached for comment.

Middleton says possible targets are Abbey National— again; Alliance & Leicester Plc, Britain’s No. 8 bank; mort- gage lender Bradford & Bingley Plc; and Ireland’s two biggest banks: Allied Irish Banks Plc and Bank of Ireland Plc.

Some analysts say an acquisition could cause another drop in National Australia’s shares. “NAB still has a major credibility issue following HomeSide,” says Brian Johnson, a Sydney- based analyst at J.P. Morgan Chase & Co. “What happened increases the execution risk of an acquisition next time.”

National Australia’s roots date to the gold rush of the 1850s. The fledgling bank set up shop as National Bank of Australasia in the then British colony of Victoria. Some of the branch managers worked in wooden huts on the out- back gold fields, where they stood guard with revolvers over boxes of sovereigns, says historian Geoffrey Blainey. In the following century, the National, as it was dubbed, made acquisitions and survived bank runs, depressions and a post–World War II government threat of nationalization. In 1981, it merged with Commercial Banking Co. of Sydney to form what became known three years later as National Australia Bank.

In 1987, led by then managing director Neil “Nobby” Clark, National Australia made its first foray overseas. It paid a total of 472.7 million pounds (US$777.7 million) to Britain’s Midland Bank Plc for the Clydesdale, National Irish and Northern banks. Three years later, it bought Yorkshire Bank for £893.5 million.

In 1992, it acquired Bank of New Zealand, that country’s third-largest lender, for 1.48 billion New Zealand dollars (US$800 million). In 1995, it paid US$1.56 billion for Michi- gan National, that state’s second-biggest bank.

When Cicutto’s predecessor, Managing Director Don Argus, bought Jacksonville, Florida–based HomeSide, he planned to turn National Australia into a global mortgage lender. Instead, HomeSide’s U.S. managers miscalculated interest rate assumptions for 2001 and overestimated the in- come they’d earn. The U.S. Federal Reserve cut interest rates eight times, and HomeSide lost customers to rivals that adjusted rates more quickly. In July 2001, National Australia wrote down US$450 million. In September, it wrote down another US$1.75 billion. That month, S&P said HomeSide had sullied the bank’s reputation and put its AA long-term rating on negative watch.

In October 2001, National Australia commissioned New York law firm Wachtell, Lipton, Rosen & Katz to review the in- cident. The report’s conclusions, which the bank released, said Cicutto and his National Australia team hadn’t been derelict in their duty. All the same, it would’ve been preferable to have had an on-site senior manager at HomeSide. Three HomeSide executives were fired after the losses were revealed.

Last year, National Australia completed the US$2.1 billion sale of HomeSide to Seattle-based Washington Mutual Inc., the biggest U.S. savings and loan association.

Cicutto says the HomeSide debacle was the worst moment of his career. “After the first write-down in July, I had sent a team in to make sure there were no more lurking problems,” he says. “Then I got a call on a Saturday morning to say we have an issue here. On the Monday morning, we made the announcement of the second write-down.”

The news from Europe is far from upbeat. For the six months ended on March 31, earnings at National Australia’s U.K. banks fell 6 percent to US$372 million. That compares with an average profit increase of 6 percent for comparable British and Irish banks, according to a May 16 research paper by Alastair Hunter, a London-based analyst at Australian stockbroker JBWere Ltd.

All told, National Australia’s first-half earnings fell 17 percent to US$1.21 billion. The results lagged the 9 percent profit increase to US$708 million for ANZ and the 3 percent increase to US$670 million for Westpac. “In the last two 6- month periods, we have not done as well as we wished,” says Cicutto of his European results.

Cicutto says National Australia’s profile in Britain will rise when Stewart comes on board in August. Even now, its influence is bigger than its collection of banks indicates. In a December address to the British Bankers’ Association, he said National Australia’s assets in Britain totaled £37 billion. U.K. profit for the year ended in September was £541 million—a quarter of the bank’s total earnings. “A valuation based on this latest profit and using market-based multiples would place our combined U.K. banks at number 41 in the FTSE 100” in terms of market value, he told the bankers.

Hunter says Cicutto’s calculations are fair. “They would certainly be inside the top 50 companies,” he says.

If Cicutto’s rivals are concerned, they aren’t saying so. Fred Goodwin, CEO of Royal Bank of Scotland and former chief executive of both Clydesdale and Yorkshire banks, declined to comment on Cicutto’s statement. Spokesmen for Abbey National, Barclays, HBOS, HSBC and Lloyds refused to discuss National Australia.

Investors remain skeptical about Cicutto’s prospects in the U.K. “They are underrepresented in the south of England, and it will be very difficult for them to grow organically,” says Neil Margolis, Sydney-based investment manager at Alliance Capital Management Ltd., who helps manage US$2.6 billion of Australian stocks. “If they have a competitive avantage, we need to know where it is.”

Some Britons in southern England say they’d do business with National Australia’s small banks. Trevor Millington, a 44-year-old lawyer with homes in London and the coastal re- sort of Brighton, says he’d consider changing his £135,000 mortgage to get a better deal. “I switched to Cheltenham & Gloucester [part of Lloyds] to get a preferential rate for new customers,” he says. “When that expires next year, I’ll look again. I know National Australia has worldwide clout. If these guys can offer a more favorable deal, I’ll certainly consider it.”

Millington says he probably won’t abandon his checking and savings accounts with HSBC. “I’ve heard a lot of horror stories about people who switch bank accounts,” he says. “It’s just too much trouble.”

With the HomeSide saga behind him, Cicutto says, there will be no such retreat from Britain. “Our franchises will compete more vigorously than they have ever done in the past,” he says.

As a cricketer, Cicutto realized early on he didn’t have the skills to make it onto the Australian team. “I played club crick- et, and I had to work very hard to maintain that level,” he says.

Reaching the top of National Australia Bank management, he says, was also beyond his wildest expectations. He’s yet to discover whether he’ll end up on a winning international team.

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