Fleet's Fleeting Dreams

Bad loans and Argentine debt are hurting the once-rich bank

When New England's two largest banks announced in March, 1999, that they would merge, the deal was billed as a winner. FleetBoston Financial (FBF ), a combination of Fleet Financial Group and BankBoston, had $180 billion in assets--nine times more than its next-biggest regional rival, Citizens Bank (CZBN ). Executives trumpeted the merged bank as a mighty profit machine and a springboard to global growth. "Together we will build a new company with a new culture for a new century," declared Charles K. Gifford, then Bank of Boston chairman.

In January, Gifford became Fleet's CEO. But instead of taking over a sleek dynamo, he's stuck with a clunker that needs major repairs. Fleet is deep in the red, with more bad news to come. In the fourth quarter of 2001, the bank lost $507 million, due in part to the economic crisis in Argentina, where it is one of the largest foreign banks. Even more worrisome, it piled up bad loans faster than many of its peers. Nearly all of the bank's major business lines saw profit declines last year, and its stock is 24% below its premerger price.

Investors are fed up. "We're at the maximum point of pessimism on Fleet," says James Ellman, manager of Merrill Lynch Global Financial Services Fund, which owns some 1 million shares.

As a result, Fleet's future hangs in the balance. Despite its size, the bank has not been able to produce big profits. Its return on assets fell from 2.2% to 0.44% in 2001, vs. an industry average of 1.02%. Executives have acknowledged that Fleet may quit Argentina, where it has done business for over 80 years. Outsiders say Fleet may consider selling its investment bank, Robertson Stephens Inc., because it isn't happy with the volatile earnings the business brings in.

Some market players are betting that Fleet could wind up being swallowed by another bank hungry to consolidate. It has long been rumored to be a prime acquisition candidate for Citigroup (C ), largely because Fleet would give Citi instant entrée into New England's high-net-worth retail-banking market. Merrill's Ellman believes a deal could happen later this year, after Citi generates extra cash from spinning off its insurance unit. In fact, he's buying Fleet stock on the dips because of it. Ellman thinks investors will look favorably on the deal, enabling Citi to pay a modest premium of 5% to 10% to win shareholder approval. Neither Citi nor Gifford would comment.

Clearly, Fleet is scrambling for answers. CFO Eugene McQuade recently told shareholders that "we obviously made investments in the last few years we wished we hadn't." He added that volatility in earnings "is causing us to rethink what the right business model is." Gifford has pledged to return to the bank's roots. On Jan. 30, he told shareholders at an investment conference that he will emphasize core businesses such as consumer and corporate banking.

Pulling off a quick turnaround will be tough. Fleet has focused on improving its poor customer service in retail banking. And its 2002 growth strategy includes a big push in the New York City area. Competition there is stiff: Washington Mutual Inc. (WM ) and Commerce Bancorp Inc. (CBH ), both with reputations for excellent customer service, are moving in. Already, Fleet has lost customers to Commerce in some parts of New Jersey. Deposits at Commerce branches increased more than 60% when Fleet took over Summit Bancorp, as Commerce wooed away unhappy customers. "In New Jersey, Fleet has become a wounded dinosaur," says Commerce Bancorp CEO Vernon W. Hill II.

While many big banks are being pinched by bad loans, Fleet is feeling the pain more than most. In the fourth quarter, the bank moved $175 million in Enron (ENE ) debt and $100 million in Kmart (KM ) debt to nonperforming status. Salomon Smith Barney estimates that bad loans increased industrywide by 17% in the quarter--but by 25% at Fleet.

Undaunted, Gifford is predicting a sharp profit rebound this year, to about $3.2 billion. Anything short of that will only turn up the heat from investors looking for a breakup or sale. Fleet is certainly a new bank, but old problems may cost its independence in the new century.

By Geoffrey Smith in Boston and Heather Timmons in New York

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