Bullish Spanish fight it out
A month after Adolfo Lagos Espinosa was brought in as the new chief executive of Grupo Financiero Serfin, Mexico's third-largest and most troubled financial institution, he had a surprise call from the bank's chairman, Adrian Sada Gonzalez. Recalls Lagos: "He said somebody from HSBC had come to visit him and would I talk to them about a possible investment."
The highly regarded Mexican banker wasn't keen. Though only in his job for a few weeks, he had already put together the makings of an ambitious recapitalization by drawing on his associations with finance minister Guillermo Ortiz, a former college classmate, and JP Morgan's M&A chief, Roberto Mendoza. Mendoza knew him well from the 1992 privatization of Mexico's Grupo Financiero Bancomer, where Lagos's reputation was built.
Having convinced the government to take on an unprecedented $2.7 billion of Serfin's bad loans - one-third of its portfolio - and after persuading JP Morgan to make a $290 million bridge loan for immediate capital needs, Lagos decided to postpone finding a foreign partner until the bank's turnround was more assured.
As for HSBC Holdings, the London-based financial group whose major emerging market activity is in Asia, "I didn't even know who these guys were," he says. Lagos has since done his homework. He now proudly points to the fact that HSBC is the most profitable financial group in the world and the fifth most profitable corporation. That was heady company for Serfin. Although run by one of Mexico's most powerful families, the Sadas, the bank, which has assets of $20 billion, had been saddled with dodgy mortgage loans, high funding costs and weak management even before Mexico's peso crisis of 1994 threatened its survival.
Somewhat reluctantly, Lagos agreed to a meeting with two HSBC executives - George Cardona, Midland Bank's general manager in charge of international, and Michael Geoghegan, then Midland Bank general manager and head of international in Latin America. The Mexican banker quickly tried to take control of the negotiations. "One of the first things I told them was that if they were in Mexico searching for an opportunity related to the banking crisis, if that's what they were looking for in Serfin, they were in the wrong place because we weren't willing to sell the bank for a dime.
"But if they were willing to speak of an alliance similar to that of Bank of Montreal and Bancomer," he suggested, referring to a minority investment in the better-positioned number two bank, "we could continue talking." Lagos laid out his position further: "I told them I already had my recapitalization needs. I already had my bridge capital, and I had 18 months of time to find this partner. I was under no pressure."
HSBC, which wanted to diversify away from Hong Kong risk and - as Lagos recognized - saw troubled banks in Latin America as fitting into its buy-low acquisition strategy, bided its time. It's a strategy that has proved profitable not only for HSBC but for other foreign banks in Mexico, where the most recent deals have been judged the most advantageous for the foreigners.
After half a dozen meetings between Lagos and various HSBC executives in London, New York and Mexico City, HSBC got what it wanted. Serfin announced in March the sale of a 19.9% stake to HSBC Holdings - the largest the law allows - for the amount of JP Morgan's bridge loan, $290 million. The deal is not yet finalized as it is pending a further $350 million to be raised in the capital markets and the finalized sale of part of the financial group's insurance operations for $85 million. But when it does go through later this year it will complete one of the most significant, and certainly the most complex, of an onslaught of foreign bank investments in, and acquisitions of, Latin American banks, most of them announced over the past year.
The precise terms of the HSBC/Serfin deal have not been made public, no doubt because they are politically sensitive. As in many foreign bank investments in Latin America, HSBC is paying for its stake largely with Brady bonds, sold to the government at par, though worth far less in the secondary market. At the same time, the Mexican government has taken on a mountain of other debts: $43 billion in bad loans and other assets.
According to sources close to the deal, HSBC has managed to wrest additional concessions from the government. For starters, the government will take on an additional $1.3 billion of Serfin's bad mortgage loans. And although under Mexican law foreigners cannot have majority control of the top three banks, HSBC will have several seats on the board and what is called consent rights. In other words, few big financial decisions - whether for loans or trading positions - can be made without HSBC's approval. In addition, says Daniel Abut, Latin American banking analyst at Goldman Sachs, HSBC most likely made its investment on condition that at some point it could gain majority control, one of its standard demands. "From a financial standpoint, it's extremely attractive for HSBC," says an individual close to the deal. "It has enormous upside, but limited downside if the thing tanks."
And, although the Sada family brought HSBC to the bargaining table, they aren't going to be the winners in the final deal. The family agreed to put in about $500 million in new capital, but their stake is bound to be diluted further by the additional capital that still has to be raised in the international markets. It's what one European bank executive calls the typical accordion play: offload bad loans to the government, and squeeze the existing shareholders to make room for the new. Adrian Sada, whose reputation was tarnished last year after revelations that he had given the former Mexican president's brother, Raul Salinas, $15 million for what he claims was an investment that never materialized, will retain the chairmanship he has held since Serfin's privatization in 1992. But he is largely a figurehead.