BOTCHING UP A GREAT BANK Under Tom Clausen, BankAmerica shoveled money out so fast it couldn't keep track. When the loans finally went sour, his successor, Sam Armacost, kept saying everything was fine. Even worse, the board of directors believed him.
By Gary Hector Excerpted from Breaking the Bank: The Decline of BankAmerica, (c) 1988 by Gary Hector, to be published by Little Brown & Co.

(FORTUNE Magazine) – AMADEO PETER GIANNINI, the San Francisco fruit merchant who founded BankAmerica, believed that the best customer a bank could have was the ''little fellow.'' Not that Giannini had modest ambitions: He dreamed that his bank would expand throughout the U.S., making loans, selling insurance, and offering investment banking services. Though the government thwarted his idea for a national financial chain in the 1930s, the bank continued to innovate, becoming the first to make loans for automobiles and appliances. By the time A. P. Giannini died in 1949, his was the largest commercial bank in the U.S. Giannini's faith in the little fellow and distrust of big corporations did not live long after him. Between 1950 and 1970, his successors wooed major corporate clients and expanded overseas. A. W. ''Tom'' Clausen, the first chief executive not trained by either A. P. Giannini or his son Mario, managed BankAmerica in the Seventies. Though neither an innovator nor a visionary, he produced more profits during his ten years than any banker in history. Clausen's strategy was to increase loans 10% each year. A loan officer's salary and promotions depended on the size of his portfolio and the number of people in his unit. To boost profits, Clausen delayed investing in computers, scrimped on bank control systems, failed to modernize the branches, and kept salaries low. But by the spring of 1980 Clausen's earnings record was in jeopardy. The bank's cost of money was soaring, while its income from old loans stayed low. Clausen turned to Samuel Armacost, hotshot loan officer turned head cashier, to solve the problem. Armacost reduced the bank's coverage for problem loans. Through this and other fiddles with the numbers, he generated $87 million in profit, the difference between an up year and a down year for Clausen. As Gary Hector explains in his forthcoming book, Breaking the Bank: the Decline of BankAmerica, which is excerpted here, none of the financial maneuverings were illegal. But they helped overstate BankAmerica's strength, which was waning fast. Over the past three years BankAmerica has reported losses of almost $2 billion, including $995 million in 1987 (see the Service 500), though the past three quarters have been modestly profitable. We pick up the tale after Clausen announced he would step down to become president of the World Bank. His successor was Armacost.

In August 1981, just four months after Sam Armacost became president of BankAmerica, Jim Nelson, a group vice president, prepared an analysis of ''Account Officer Problems'' for his bosses at the World Banking Division. The report spent 35 pages arguing that Bank of America's lending officers -- the ones making those huge loans to governments and corporations all over the world -- didn't stack up to their competitors. Nelson relied on interviews with corporate treasurers from an annual survey by Greenwich Research Associates, a highly respected market research firm. What Nelson found was startling. Corporate treasurers thought BankAmerica's lenders were the worst among their peers at the nation's five largest commercial banks. From 1976 to 1980, the bank's rating had been sliding at an alarming pace. The push to increase loans by at least 10% a year was burning out some bankers. Low pay sent good lenders to other jobs. Less competent officers tended to stay, especially since BankAmerica rarely fired anyone. A senior credit examiner transferred to London in the early 1980s to clean up a problem found that, under pressure to build the loan portfolio, bank officers had begun disbursing money before all the financial analysis and documentation was complete -- a violation of good practice. The credit officer also found inexperienced lenders, sloppy documentation, and a raft of loans that should never have been made. The bank's domestic lending was so swollen that its top credit men were drowning in paperwork. Each night they would leave the bank carrying stacks of new loans to review for a meeting the next day. ''There was no way they could evaluate all of that material,'' says a former BankAmerica lender. The systems needed to monitor the bank's bad loans were outmoded. No central system existed to collect information on problem loans; those data were kept at the branches. In the late 1970s national bank examiners sharply criticized the bank for tardy reporting. The rebuke sparked BankAmerica's staff to compile information on problem loans quarterly. No greater speed was possible because paper and pencil did not give way to computers until late 1986 at the earliest. BankAmerica's loan losses increased from $345 million in 1981 to over $1 billion in 1984. Internal studies that year found that the bulk of the loans that went bad had been made in a surge of lending between 1978 and the end of 1980 -- Clausen's last years and a hysterical period in the energy and real estate markets. Top management responded to the deterioration with disbelief. ''They saw these numbers and they simply could not believe this was happening to BankAmerica,'' says a former executive vice president. Adds a former government bank examiner: ''They thought that if things got this bad, warning bells would flash and sirens would go off.'' Instead, management got a sickening string of reports, each with numbers worse than the last. Management lacked the steel to take on the problem. Pete Talbott, a Citicorp veteran who joined the retail bank in 1983, remembers attending one of his first meetings with other top executives in the division. They heard a 15-minute presentation on the agricultural loan portfolio, where loan problems totaled over $1 billion. ''Nobody said a word, no questions, nothing,'' he says. ''They started to move on to the next subject. I raised my hand meekly and said, 'Don't those numbers just scare you to death? I've never seen anything like that in my life.' They said, 'No, the loans are classified as problems. That's not good, but we have a handle on them.' '' BankAmerica's problems were widespread. At other banks that faced serious trouble, the losses came in one or two industries: oil, real estate, or agriculture. At BankAmerica, disaster hit throughout the bank. For example, in 1984 BankAmerica rolled out a new program for consumers, a large personal line of credit backed by nothing but the borrower's signature. Though that would seem to attract plenty of takers, the bank did more: It offered bonuses to officers who wrote the new loans. New business came pouring in. Each borrower was reviewed, analyzed, and given a standard credit score, but no one at the branches seemed to pay attention to the resulting credit rating. Writing loans was more important than collecting them. Says Pete Talbott, who headed the effort: ''The branches were making $10,000 to $25,000 loans to almost anybody who walked in the door.'' The scheme cost the bank millions in loan losses. A bank branch in Inglewood, a suburb of Los Angeles, found itself in a different kind of embarrassment. The branch had taken it upon itself to place BankAmerica's name as trustee and escrow agent behind more than $133 million of mortgage-backed securities. In October 1984, Seamen's Bank for Savings of New York had trouble collecting interest on $19.5 million of the securities and called on BankAmerica to speed the process. When BankAmerica investigated, it found virtually no collateral to back up the securities that it had indirectly guaranteed. For instance, a 310-unit apartment building in Houston was so run-down it was uninhabitable; its Olympic-size swimming pool was filled with mud. This kind of bad news attracted the attention of the U.S. Comptroller of the Currency, whose office had begun a full review in the spring of 1984. By midyear the preliminary results had been sent to management, and it was, according to a former board member, a ''scathing report.'' Most directors bore * the criticism in silence, but Robert McNamara, the former Secretary of Defense, complained that he didn't like learning about the condition of the bank from examiners. Armacost took the Comptroller's report as a personal affront. He challenged the examiners on almost every point. Still, in November 1984 he signed a letter of agreement with the Comptroller's office. Under the terms of the agreement, the bank would study the adequacy of its loan-loss reserve, improve the management of its problem loans, and strengthen its balance sheet by raising its primary capital from 5.85% of assets to 6%. The directors on the audit and examining committee knew how bad the news was. Every quarter the bank wrote off millions of dollars of loans, thus dumping some of its troubles overboard. But every quarter the bank found more problems. In 1984 BankAmerica jettisoned more than $900 million of nonperforming loans, yet wound up the year with only $200 million less in bad debt than a year earlier. That meant the bank had discovered $700 million of new problem loans. ARMACOST TOLD THE DIRECTORS that the worst was over, that in 1985 the bad loans would start to decline. So instead of increasing the loan-loss reserve, the board allowed it to drop. With less money going into reserves, the bank could show higher profits. For 1984 the bank announced its first increase in net income since 1981. The euphoria lasted only until the bank did the final calculations of the Inglewood branch's mortgage-backed securities fiasco. A $95 million reserve for those losses wiped out the profit increase. In March 1985 the Comptroller of the Currency began a new audit. The agency flew in a team of examiners from the East Coast headed by Michael LaRusso, an experienced examiner with a reputation for being tough and thorough. This review would be more critical than the last. Instead of accepting management's good intentions, the examiners were looking for evidence that steps had been taken to improve the bank's financial position. In particular, LaRusso and company wanted to be sure that BankAmerica was attending to the adequacy of its loan-loss reserve, as it had promised in the November agreement. After collecting reports from various BankAmerica branches, LaRusso met with management. When the question came up of how much to set aside as loan-loss reserves, LaRusso bounced it back. ''It's management's responsibility to run the bank,'' he told Armacost. ''If I were you, I would err on the conservative side.'' That meant, given the figures LaRusso was working with, a reserve increase of at least $500 million, a jump of more than 50%. Armacost brought up the examiner's report at the July board meeting. Since the bank had already written off over $400 million of loans in the quarter, it would need to add $900 million to reserves to hit LaRusso's $500 million target. Some board members considered the Comptroller's request excessive. Armacost argued that the bank probably could get by with much less. The only strong voice for prudence came from Dick Cooley. A retired chief of Wells Fargo, Cooley had tried to save Seattle's Seafirst bank holding company, which had had the misfortune of being one of the biggest lenders to Penn Square Bank. When that little Oklahoma bank collapsed in 1982, it nearly took Seafirst with it. The best Cooley could do was to sell Seafirst to BankAmerica. Like LaRusso, Cooley urged caution. He encouraged Armacost to add $800 million, maybe even $1 billion, to the reserve -- which would have increased the loss for the quarter to between $600 million and $800 million. The board ignored him. It added $500 million to the reserve, the minimum requested by the examiners, producing a loss of $338 million for the second quarter of 1985. Robert McNamara had gradually become the leader of a small, vocal group of dissidents, a minority that included Cooley and Charles Schwab. A smart, good- looking self-made millionaire, Schwab had sold his discount brokerage, the largest in the U.S., to BankAmerica in 1981. The dissidents didn't win battles, but they challenged Armacost at inopportune moments. At the August board meeting in 1985 they led a fight to at least cut and preferably eliminate BankAmerica's dividend. In its report the year before, the Comptroller's office had pointed out that the common stock dividend of $250 million a year and the preferred stock dividend of $60 million equaled a whopping 85% of BankAmerica's profits. At the board meeting the Comptroller's men were back, expressing concern for the bank's low level of capital and making a compelling case for stopping all dividend payments. Armacost first contended there was no need to eliminate the dividend; then, bowing to pressure from dissident directors, he agreed to cut it in half. Before 1985 ended, the Comptroller and McNamara's group gained an ally: the Federal Reserve. The two government agencies issued a joint policy statement, . saying they would frown on any banking company that used the cash from a sale of assets to pay a dividend. Dividends, they argued, should come from a bank's basic businesses, not from the slow liquidation of the company. Since BankAmerica had sold its San Francisco headquarters building and put its consumer finance subsidiary, FinanceAmerica Corp., on the block, the ruling became known as ''the BankAmerica decision.'' In December, H. Joe Selby, acting Comptroller of the Currency, flew to San Francisco for BankAmerica's monthly board meeting. It was not a friendly visit. Despite warnings, tough examination reports, even the letter of agreement, the board had refused to significantly strengthen the financial underpinnings of the bank. Now BankAmerica was about to sell FinanceAmerica to Chrysler, and it appeared that the proceeds would go to pay the dividend -- a direct violation of the policy just announced by the Comptroller and the Fed. As hard as the Comptroller pushed for realistic, conservative change, the board championed the status quo and Armacost. AFTER THE DECEMBER board meeting, the Comptroller's senior staff met privately with the outside directors in a rare executive session. The examiners told the outside directors that over the past year they had reached an inescapable conclusion. ''The sum total of the disasters was only a symptom of a bigger problem,'' one of the bank's former examiners says. ''The bank needed a management that would give it direction.'' The regulators were suggesting Armacost's removal; the directors were not listening. When they met in January 1986, however, the directors finally swallowed hard and eliminated the dividend.

As BankAmerica continued to flounder, two enterprising businessmen saw opportunity. Joseph J. Pinola, once Clausen's deputy at BankAmerica, wanted to merge his First Interstate Corp., a Los Angeles bank holding company, with BankAmerica. Sanford Weill, who had sold his firm, now called Shearson Lehman Hutton, to American Express, offered to turn BankAmerica around as its new chief executive. His proposal -- scorned as a ''job application'' by Armacost -- came along with a pledge of $1 billion in badly needed capital from Shearson's president, Peter Cohen. To defend himself against the Weill offer, Armacost promised the board a new strategy: slimming down to become a narrowly focused West Coast bank. More important, he promised profits -- $415 million for 1986, over $1 billion by 1990. The board liked Armacost's message and spurned Weill's offer. Armacost never mentioned the talks with First Interstate to the board, apparently figuring that he would introduce Pinola as a white knight against Weill only as a last resort. After Armacost's reassurances, the board was not pleased when BankAmerica reported a surprise $600 million loss in the second quarter. At the September meeting, Lee Prussia, chairman of BankAmerica's board, challenged Armacost's rosy assumptions for the future. Salomon Brothers, the investment bank hired to review BankAmerica's financial situation, presented a 46-page report that showed the company could make a comeback. But the Salomon team also said the bank was sorely in need of capital. Though the firm had told the board in April that it could raise $1 billion in the open market, the startling second- quarter loss had damped investors' enthusiasm for the stock. The only way to raise capital, other than a merger, was to sell more assets. But there weren't many left to sell. After the meeting the bank's outside directors took an informal poll on whether to remove Armacost. He survived by a single vote, mainly because the directors had no candidate to propose as his successor.

Soon after, some directors discreetly asked close friends to suggest a new BankAmerica chief. Rumors spread in Japan, Europe, and the U.S. that BankAmerica was in danger of failing, that senior executives were talking with the Federal Reserve about a bailout. In California consumers began pulling their accounts. Armacost quickly went on the radio, telling depositors the bank was healthy. The one-minute spots helped ease the nervousness. But a slow loss of deposits continued, finally costing the bank at least $2 billion. The rumors and the run helped turn more board members against Armacost. What's more, a potential successor presented himself. Tom Clausen, who had not been asked back for a second term at the World Bank, let board members know, through intermediaries, that he was ready to help. He had already told the Los Angeles Times that he was following the company's travails very closely. ''I bleed a little with each story,'' he said. Joe Pinola decided it was time to make his move. He knew the board was ready to dump Armacost; he figured no insider was a logical choice to succeed him, and he thought an outside candidate from another bank would take too long to tackle BankAmerica's problems. First Interstate was the logical alternative. $ Pinola had spent 23 years at BankAmerica and had recruited more than a dozen young executives from his alma mater. On Friday, October 3, Pinola sent a three-page letter to Armacost offering to acquire BankAmerica for securities worth $18 a share, well over its $10 selling price. Three days later the board met to consider the offer. After more than five hours of discussion, Philip Hawley, head of the retailer Carter Hawley Hale and chairman of BankAmerica's executive compensation committee, moved the outside directors into a closed-door session. FINALLY the directors felt a sense of urgency. The loss of deposits had unnerved them, and the Interstate bid seemed frighteningly real. The board was ready for new management but wanted someone who understood the bank and could restore stability. Hawley proposed Tom Clausen, knowing that he was prepared to come back. No other name received serious consideration. At 4:30 P.M. Hawley and a small group of outside directors telephoned Clausen and asked him to return. He immediately said yes. The next morning they told Armacost of their decision. Though he had been expecting a call for his resignation for years, Armacost continued to believe that he could turn BankAmerica around. As he was cleaning out his office, Armacost told a longtime BankAmerica adviser that the board had made a mistake. He said: ''It was like pulling a pitcher in the ninth inning, when the team is behind, but just before they are about to win the game.'' Clausen took charge quickly. In a series of meetings with top executives, he began to assess where the bank stood -- and executives began to assess him. They weren't impressed. Clausen had no idea how bad conditions were at the bank, or how much authority the board had vested in Tom Cooper, the president since March. As key managers began to discuss the issues, Clausen offered solutions that were unworkable and out of touch with the new world of banking. He had lost his feel for the market, for domestic and international competitors, for the demands of regulators. One former executive quipped that Clausen was 20 years out of date, though he had been away for only five. One thing Clausen made clear: He would do everything he could to stop a merger with First Interstate. He was careful to stop short of outright rejection, but at one point he said: ''I didn't come back to rearrange the deck chairs on the Titanic.'' Throughout November, December, and January, BankAmerica and First Interstate sparred. Pinola prepared to buy BankAmerica's stock even if Clausen rebuffed him. BankAmerica charged that First Interstate had withheld information from the public, understating its own problem loans. Both chief executives flew around the state talking with the press. Clausen held pep rallies at the branches, handing out T-shirts, lollipops, and white buttons emblazoned with the letters B of A. In the war of words, the First Interstate bid and the potential benefit to shareholders seemed largely irrelevant. BankAmerica never presented the offer to shareholders. In January 1987 the board voted unanimously to reject First Interstate's offer. The directors said that the merged companies would be undercapitalized. They also took a slap at Pinola, arguing that First Interstate lacked ''experience in managing an institution as large and complex as the combined company would be.'' BankAmerica did not attempt to argue that the price First Interstate offered was unfair to shareholders. It represented a substantial premium over the market price -- a benchmark of fairness. Even Salomon Brothers could not contend that the price was too low. In its tepid opinion of the First Interstate offer, the investment firm said that if BankAmerica's analysis and forecast of the future were right -- they included an earnings projection that showed a profitable BankAmerica by the end of 1987 -- then the board was safe in spurning the offer. After the meeting Clausen phoned Pinola, asking him to drop his bid. Pinola said no. A FEW DAYS LATER BankAmerica announced that it had agreed to sell Charles Schwab & Co. back to a management group headed by Chuck Schwab. The price: $280 million -- $175 million in cash and $105 million in BankAmerica loans at below-market rates. BankAmerica also canceled a $50 million loan to the discount broker, which reduced the total to $230 million. The sale of Schwab at a bargain price helped end Joe Pinola's pursuit of BankAmerica. What was left of the company? The bank had already sold FinanceAmerica, its profitable Italian subsidiary, other overseas operations, and its headquarters buildings in San Francisco and Los Angeles. On February 9, First Interstate issued a press release announcing the decision to withdraw its bid for BankAmerica. ''Every word in that press release has a meaning,'' Joe Pinola said later. ''I drafted it myself.'' ''The current dismemberment of this institution no longer justifies our current offered price,'' Pinola wrote. ''As profitable and strategic BankAmerica Corp. assets are sold, the remaining Latin American and other debt, together with other substantial nonperforming assets, becomes an increasingly larger part of the smaller banking company. Further, the capital raised through sale of these assets is required to support the balance sheet and thus not available for asset growth. The BankAmerica shareholder has been denied the right to vote for or against our proposal.'' That evening, in the corner office on the 40th floor of the BankAmerica world headquarters, Tom Clausen asked President Tom Cooper and an executive assistant to join him in his office. Clausen had a bottle of champagne on ice. In the stillness of late evening, he proposed a victory toast. Cooper suggested that perhaps they should send the news out to the branches. Clausen responded: ''No, we deserve this.'' In May, at the first annual meeting of his second term, Tom Clausen faced 2,000 agitated shareholders and employees. They wanted an accounting of the turbulence of the past year, the losses, the front-page stories, the fight with First Interstate, and the firing of Sam Armacost. Clausen told shareholders the company would return to profitability that year and would restore the common stock dividend as soon as possible. He laid out two corporate objectives: to be the dominant bank in the West and to be a preeminent wholesale bank throughout the world. In presenting his vision of the future, he sounded the themes of Sam Armacost: ''Our conscious goal is to be a smaller company, a much more focused company, and most important, to become once again a very profitable company.'' CLAUSEN AVOIDED CRITICIZING prior management, but one comment was obviously aimed at Armacost. ''I want you to know that we are well aware that one of the chief casualties of recent years has been the credibility of the corporation with many of our constituencies. Excessive optimism that creates unrealistic expectations in the short term only leads to shattered confidence when performance does not match the promise.'' Eleven days after the meeting, Tom Clausen announced that BankAmerica would lose $1 billion in the second quarter -- the largest loss in the company's history.

CHART: NOT AVAILABLE CREDIT: NO CREDIT CAPTION: The Rise and Fall of BankAmerica Assets DESCRIPTION: BankAmerica assets, 1904-1987.