Foreign Banks Are Losing Interest In The American Market

Tim Geithner

As the world’s largest economy, the U.S. has always been an attractive market for foreign banks looking to expand their international presence.

But in the wake of the housing and financial crisis, some foreign banks are figuring it’s time to pack up their things and head to greener, and more profitable, pastures.

After eleven straight quarterly losses, Royal Bank of Canada exited the retail banking business in the U.S. earlier this month, selling its operations to PNC Financial Services for $3.45 billon.

HSBC, wounded by its acquisition of Household International in 2003 that gave it exposure to the subprime mortgages, is in the process of winding down its consumer loan business. It has also placed its $33 billion credit card portfolio under “review”, as it looks to refocus its efforts in emerging markets.

Capital One Financial is reportedly emerging as a bidder for HSBC’s card portfolio, having just completed an acquisition of Dutch bank ING Groep’s online banking unit ING Direct USA for $9 billion.

In ING’s case, the bank was forced by the European Commission to sell its U.S. retail banking business by 2013 as part of a wider restructuring plan following its bailout in 2008.

The banks haven’t abandoned the U.S. altogether. ING will get a nearly 10% stake in Capital One as part of the deal, making it the largest shareholder.

Both Royal Bank of Canada (RBC) and HSBC expect to build on their presence in some markets. RBC, for instance, is looking to grow its investment banking and wealth management units, while HSBC is hoping to expand its commercial banking business and capitalise on its global network.

But it does appear that the U.S. consumer banking market has become decidedly less attractive for foreign banks.

On one level, foreign banks have realised that U.S. banking is more competitive than they thought. “We can’t compete on a domestic agenda in the US against the four big American banks that have got much bigger,” HSBC group CEO Stuart Gulliver said in a presentation to investors in May, suggesting that the bank’s strengths lied in its ability to leverage its international network in commercial banking business.

RBC also cited heightened competition in the retail banking business as one reason for its exit. “A large capital investment would be required to achieve the necessary scale to succeed in the highly competitive U.S. retail market,” the management said in a presentation following the sale of its U.S. unit.

Tom Mitchell, analyst at Miller Tabak, says the U.S. retail banking market is fragmented, which makes it fairly easy for international banks to enter the market by acquiring smaller banks.

“There are other markets where the largest bank has a much higher concentration. It is still relatively easy to start a bank and compete. But it is very competitive and you can’t reach oligopolistic size(where a few players dominate the market). Even Bank of America isn’t oligopolistic size.”

Without the critical mass, it is harder for foreign banks to get a high, constant return from consumer banking, says Tabak. And past acquisition failures have made banks wary of investing further capital in the business.

HSBC has for instance come to regret its acquisition of Household Finance in 2003. “When HSBC acquired Household in 2002, it trumpeted the firm’s risk-modelling systems, which it anticipated would enable it to judge the riskiness of loans more accurately than competitors could.

As it turned out, HSBC placed too much faith in its newly acquired expertise and failed to adequately supervise its U.S. managers,” Erin Davis, who covers international banks at Morningstar said in a note.

Chip MacDonald at Jones Day says acquisitions remain the easiest way for foreign banks to gain entry and scale, but is always a risky strategy. “There is an art to it. Some people are successful, others unsuccessful, others just unlucky sometimes. Sometimes you have to be unlucky just once.”

MacDonald noted that Toronto Dominion, Bank of Montreal and Spanish bank Banco Santander continue to expand their presence through acquisitions even as their rivals withdraw.

Still, competing in the consumer banking business is difficult because it is largely commoditized, notes Davis. “In Merchant Banking it is possible to build strong relationships and earn higher margins.”

Ultimately for foreign banks, it boils down to a call on growth of the the U.S. consumer banking market, according to analysts.

“There is a prolonged period of slow growth ahead. U.S. banks don’t have a choice but foreign banks like HSBC have more opportunities,” says Davis.

While JPMorgan Chase and Citibank may be targeting international markets, regional banks don’t have the ability to diversify. “A large portion of consumer banking is served by regional banks. If they opened a branch in Brazil, it would be a disaster,” she said.

Mitchell says that for HSBC, operating in the consumer banking space is more appealing in a market like Hong Kong, where the middle class is still booming. “The whole idea of the empowerment of the middle-class? That’s come and gone in the U.S. The market is certainly well-established, but there is no growth wave,” he said. “Incomes have gone nowhere in 30 years. Yet the market is competitive. You don’t really get the benefits of consolidation.”

For HSBC, the decision to exit consumer banking also comes from a realisation that it can’t live up to its slogan of being the world’s local bank in the current environment.

“We can’t be all things to all people in all countries,” CEO Stuart Gulliver told investors in May. The bank is looking to exit retail banking in 39 markets.

“HSBC is going through a personality transition,” says Tabak’s Mitchell. “It is fine to be all things to all people when you are growing at 18% year-on-year. But when you run into adversity, not knowing who you are is a big problem. They are working hard now to define whose banker they want to be.”

Indeed all foreign banks might consider focusing their U.S. strategy more clearly, says Davis.

“Foreign banks may choose to have more businesses that are of a larger size and spin off or sell smaller businesses. They need size because it brings cost advantages but the businesses also need to be focused enough that it gets sufficient management attention.” 

This post originally appeared at The Street.

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