Native intelligence

In March of 2002, U.S. hedge fund giant Farallon Capital Management shocked veteran Asian financiers by leading an investment consortium that won control of Bank Central Asia, which had been Indonesia's biggest lender before the 1997 Asian financial crisis. Little known in the region, the secretive Farallon and its Mauritius-based FarIndo Investments group won BCA even though they underbid one of the most respected foreign players in Asia, Standard Chartered Bank, in the government-sponsored sale.

A month later FarIndo named New York City­born Eugene Keith Galbraith to run BCA, giving him the distinction of becoming the first American chairman of an Indonesian bank. At first blush, the selection of a U.S. citizen to head a giant local lender was nearly as surprising as FarIndo's winning bid, but Galbraith, who had spent years in the country -- including two studying at a Madura island Islamic madrasah -- spoke the national language, Bahasa Indonesia, had worked as a consultant to the Indonesian government and had helped start a foreign-owned investment banking operation in Jakarta a decade before.

Galbraith's unusual background, in fact, helps him carry out one of his tasks as chairman: keeping the bank's biggest shareholder, FarIndo, whose main co-investors include $8 billion-in-assets distressed-debt specialist Farallon and Indonesia's biggest cigarette maker, Jakarta-based Djarum, abreast of BCA's progress. Says Galbraith, 51, in a rare interview with Institutional Investor at his office in a modest building on Jakarta's bustling central thoroughfare, Jalan Jenderal Sudirman, "I translate for foreign shareholders some things about Indonesia that may appear opaque and for Indonesian shareholders other things that to them are equally opaque."

Today Galbraith is translating mostly good news. With BCA's share price more than doubled since FarIndo bought its controlling position, the firm's $541 million investment is worth about $1 billion, even though profits slipped last year. In just two years Galbraith has engineered a thorough revamping of BCA. He and president director Djohan Emir Setijoso have created a new lending culture at the bank, implementing Western risk management techniques, installing credit-scoring systems and drastically cutting loan-processing time. BCA's ratio of nonperforming loans to assets fell to 2.36 percent last year from 8.86 percent in 1999. At the same time, the new management has led a spirited push into Indonesia's consumer and small- and medium-size enterprise markets to further cut the $34 billion-in-assets bank's once-near-total dependence on big corporate loans. They have added new services, such as Internet and mobile phone banking, to an existing satellite-linked ATM network that is the most advanced in the country and gives BCA's 6 million customers instant access to their money from all over the vast archipelago. The low-priced service has helped make the BCA name the best-known banking brand in Indonesia, according to a 2003 ACNielsen survey.

"They clearly have done a good job in turning it around," says Irawan Heriyanto, head of research at UBS in Jakarta. Adds Ferry Yosia Hartoyo, research chief at DBS Vickers Securities (Indonesia): "They have had to change everything, including the way the people think. Now they've got their house in order; that's management's major achievement."

Galbraith knows he has a ways to go before he completes his mission. With improved systems and a cleaner balance sheet at his bank, he has begun to venture further into Indonesia's sometimes treacherous lending markets to diversify BCA's portfolio and its revenue base. Like most of its competitors, BCA still relies heavily for its income on bonds the government issued in 1998 as part of a recapitalization of local banks following the International Monetary Fund's $43 billion bailout of the country. These government bonds, totaling $6.2 billion, account for 29 percent of BCA's $760 million in net interest and other operational income and nearly 56 percent of its earning assets. A drop in local interest rates last year caused the bank's earnings to slide nearly 6 percent, to $281 million, in part because of lost bond income.

Galbraith says he's "acutely aware of the need to diversify our balance sheet into higher-yielding assets" such as mortgages, credit cards and auto financing, yet he's not about to expand recklessly. BCA's extremely conservative lending policies, in fact, have helped make its shares an investor favorite. "That's why it's trading at a price of 1.3 times book value, the highest among Indonesia banks," says researcher Hartoyo.

BCA nudged its loans-to-deposits ratio from 20.44 percent in 2002 to 24.6 percent last year -- well below the industry average of nearly 41 percent and rival Bank Danamon's 56.5 percent, but Galbraith isn't interested in making a huge bet on Indonesia's still-fragile economy. "I would be misspeaking if I said our loans-to-deposits ratio would go to somewhere around 50 percent in two years, because that implies a view of economic prospects that the facts don't warrant," he says. Such caution has served BCA well, says analyst Heriyanto, but "they should perhaps start to expand the loan book more aggressively." Galbraith must find the right mix of balance-sheet strength and growth if BCA is to compete effectively, say analysts.

WORKING IN A FINANCIAL INSTITUTION -- MUCH less running a big Indonesian bank for a U.S. hedge fund -- wasn't one of Galbraith's childhood dreams. Both his parents worked at banks, his mother as a customer relationship manager at a local bank in New Jersey and his father at Chase Manhattan Bank, where he ultimately spent 55 years, the latter portion as an assistant treasurer. The young Galbraith decided he wanted a career at "the farthest extreme from finance."

As an undergraduate at Baltimore's Johns Hopkins University, he majored in philosophy and tilted politically toward socialism. After graduation he pursued a Ph.D. in anthropology and a master's degree in economic history at Hopkins. Two years later he and his wife (they have since divorced) took off for Brazil, where, as part of his field study, he charted the development of a peasant community near Orobo and Pernambuco in the northeastern region of the country.

In 1981, having received his doctorate and his master's, Galbraith accompanied his wife to Indonesia for her Ph.D. field study on the practice of Islam on Madura island, just off Java's northeast coast. Galbraith studied Islam for two years at a local madrasah. At about this time, the young anthropologist began to question his own political and economic views. He read Friedrich von Hayek's The Road to Serfdom, the classic economic treatise championing free markets and open societies over centralized planning and state control; he considered its arguments persuasive. Listening to BBC and Voice of America radio broadcasts in 1981, he found himself rooting, from several thousand miles away, for then­U.S. president Ronald Reagan in his showdown with striking air traffic controllers.

By 1983 Galbraith had started to use his anthropological and economic development studies as an adviser to the local governor of West Timor in the provincial capital of Kupang. Working for local consulting firm Resource Management International, Galbraith designed and implemented rural credit programs, evaluated the delivery of everything from seeds to goats and cattle and provided planning support for the provincial government.

The advisory post hastened Galbraith's conversion to a market-oriented philosophy. He came to believe that even though the province's planning process was decentralized and sought out local input, it "had the effect of increasing [villagers'] dependence on the government and diminishing their self-reliance. The phrase 'You can't get there from here' ran through my mind repeatedly in that we were on the wrong path to a worthy goal."

Thanks to his five years of work in West Timor, Galbraith was able to land a job in Jakarta in 1988, advising Indonesia's Ministry of Finance on development. Two years later an affiliate of British brokerage Hoare Govett -- HG Asia, whose management team in Hong Kong had just bought their operations back from onetime U.S. banking giant Security Pacific Corp. -- hired Galbraith to start an equity research group tracking local companies. On the strength of Asia's early 1990s boom, HG's Indonesian business flourished, and it grew into a full-fledged brokerage and investment bank, headed by Galbraith.

At HG Asia, Galbraith got to know his future partners in BCA. Working as an equity analyst, he tracked Djarum and became acquainted with several of the cigarette maker's senior executives. He also established a working relationship with then­Goldman, Sachs & Co. banker Raymond Zage, who later became Farallon's Asian point man and brought Galbraith to FarIndo's attention. The two worked closely on Indonesian cement company Semen Gresik's acquisition of rivals Semen Tonasa and Semen Padang.

When Dutch banking giant ABN Amro bought HG Asia in 1996, Galbraith moved to Hong Kong, where he was charged with running ABN Amro Asia Securities, overseeing a staff of 200 as well as eight offices across Asia. Two years later Galbraith cashed in his shares from the HG Asia buyout and left ABN Amro; in 1999 he started a regional financial information Web site, Asiawise.com, which burned through its funding by 2001. By then, however, he was also serving on the board of Bank NISP, Indonesia's 12th-biggest bank.

PROFITABLE AND MUCH MORE DIVERSIFIED, BCA today bears little resemblance to its beleaguered predecessor. In 1998 a run on deposits forced Jakarta to nationalize the bank, then controlled by Lim Sioe Liong, a longtime friend and business partner of disgraced former president Suharto. Through cheap financing and lucrative contracts, the Suharto government helped Lim's family businesses obtain monopolies in such commodities as wheat and cement and a near-monopoly on the production of a local staple, instant noodles. At the time of BCA's collapse, an estimated 75 percent of its loans were to companies linked to Lim. In contrast, at the end of 2003, BCA's loan portfolio was 43 percent corporate, 46 percent small- and medium-size enterprise and 11 percent consumer. Galbraith's goal is to get the bank closer to an even division among these three main segments of its portfolio.

Galbraith and senior managers, who have worked closely with about 20 consulting bankers from FarIndo adviser Deutsche Bank during the past two years, initially focused on creating a Western-type approach to credit analysis. "We have a backdated scoring database now for our existing client base that gives us not just the confidence but the actual mechanisms to make informed decisions about sectors, regions and creditors," says Galbraith. The new system, he explains, allows BCA to "keep track in general of what's going on in the economy and where we should be giving more attention and, more important, where we should be scaling back." The technology has also reduced BCA's processing time by two thirds, to ten days.

With its credit analysis system in place, BCA has begun to boost its lending to virtually all segments of the Indonesian market. Its overall lending -- albeit from relatively low levels -- surged 36 percent last year, more than twice the growth rate of much bigger rival Bank Mandiri.

But to achieve more balance in its portfolio, BCA will have to increase its consumer lending, where the bank "needs to up its game," says Galbraith. At the same time, consumer finance is a new segment in Indonesia, and its rapid growth worries the BCA chief. "We're no shrinking violet," he says, but "we think we have our eyes slightly wider-open than some of our competitors." Mandiri last year increased its consumer lending by 147 percent, lifting its consumer portfolio to $415 million. For its part, BCA boosted its lending by a smaller but still significant 104 percent, giving it a $373 million portfolio.

Galbraith sees potential problems in almost every consumer lending category. The market for auto loans, he says, is crowded, while mortgage lending can be problematic because of Indonesia's weak legal protections and complicated ownership rules. And he's also wary of apartment loans because of boom-and-bust cycles in the local real estate market.

Of course, these risks are magnified in a country that faces so many economic and political challenges. The economy expanded by 4.1 percent last year and is anticipated to grow 4.5 percent this year but is only now returning to its precrisis size. Per-capita GDP, at $969 last year, remains below the $1,153 of 1996. And concerns about security abound in Indonesia, where terror groups allegedly affiliated with al-Qaeda have struck twice. Separatist movements, particularly in the northern provinces, have repeatedly challenged Jakarta's authority. Adding to the uncertainty, the first round of presidential elections begins this month. In late June President Megawati Sukarnoputri, credited with several economic policy successes, was lagging in the polls, raising the possibility of a change in government. (If no one gets 50 percent of the vote, a runoff between the top two vote-getters will take place in September.)

One more risk for BCA is the freewheeling competition to offer consumer loans, as the country's biggest banks try to offset anemic expansion in corporate lending. BCA lags behind major competitors Bank Rakyat Indonesia, which holds a 16 percent share of the consumer market; Bank Tabungan Negara, with 12 percent; Bank Danamon, with 8 percent; Bank Negara Indonesia, with 6 percent; and Citibank and Bank Mandiri, with about 5 percent each, according to private estimates. BCA's share is said to be just under 4 percent. And new rivals are emerging all the time, says Galbraith. "There are now very good international players from Singapore, Malaysia and the U.S," he notes.

Galbraith and his colleagues are trying to pare risk by developing new, fee-based sources of income. More than a decade ago, BCA inaugurated its state-of-the-art ATM and payment system, which links all of BCA's 780 branches and 2,540 ATMs via satellite to the bank's electronic payments hub in Jakarta. As a result, a customer on the island of Bali can deposit money that's immediately available to pay a bill back in Jakarta. So far no other bank in Indonesia can match that speed or efficiency.

The system is so popular with Indonesian customers that they use it despite BCA's generally less attractive deposit rates, which give the bank the lowest cost-of-funds rate of any Indonesian bank. DBS Vickers analyst Hartoyo reckons that "even if BCA reduced its interest rates by another 1 percent, most of the customers would stay, because they are not there for the interest rate, anyway."

On the back of this electronic platform, BCA in early 2003 introduced an Internet banking system, IB Bisnis, which, among other capabilities, allows small- and medium-size enterprises to make payments and transfer funds. This year BCA added payroll administration and foreign currency remittances to IB Bisnis' services. Mobile phone banking was linked to BCA's satellite transaction platform last August. These new features complement the country's biggest debit card network, with 10,000 participating merchants, and a personal Internet banking system called KlikBCA that is the most widely used in Indonesia, with 473,000 customers.

These initiatives helped BCA generate more than 8 percent of its $760 million in net interest and operational income last year from transaction banking fees rather than loans. The fee-based income also offset some of the bank's earnings decline from lower interest rates on its huge government bond portfolio. Coupled with a bankwide cost-containment program, the fees allowed BCA to report a 51 percent cost-efficiency ratio (overhead costs relative to net interest income) last year, one of the best in Indonesian banking.

Even though earnings fell, Galbraith was encouraged by BCA's progress. "Almost all our earnings in 2001 and 2002 came from tremendous income on floating-rate bonds in a high-interest-rate environment, but we didn't make money the old-fashioned way," he says. "We are now putting in place the system that will enable us to make money the old-fashioned way."

If that happens, Galbraith will have more good news to translate for his investors. The BCA chief -- who's never met Farallon head Thomas Steyer -- says the bank's biggest shareholders give him and senior managers free rein to make needed changes. Galbraith speaks every two weeks with the hedge fund's Singapore-based Asian representative, Zage, to inform him of "important developments." (Farallon's only other known Indonesian play is a $180 million investment in discounted bonds issued by a local coal-fired power station that got into difficulty during the financial crisis.) "I've never received a phone call from any shareholder to do anything," he says. "There has been absolutely no pressure or influence or interference by anybody" in managing the bank. Farallon, says Galbraith, is "quite pleased with the investment." Shareholders whose holdings have more than doubled in value in two years generally are.