Why would Bermuda?s largest financial institution ? the Bank of Bermuda ? allow itself to be sold, especially with 114 years of success under its belt?

The bank?s pending sale ? it is still subject to shareholder and regulatory approval ? was announced last month, with it going to the world?s second largest bank, HSBC for a $1.3 billion price tag.

Speaking with this week, bank CEO Henry Smith said the bank had been struggling in recent years as interest rates plummeted and competition increased. It also was concerned that it would not be able to compete against a foreign bank on Bermuda soil, something Government had indicated was imminent. On Wednesday, Mr. Smith said: ?I and the management team are charged with delivering success to shareholders. But we also need to look our for the success of the Island. We have to do what is right for Bermuda as much as possible, as well as for our staff and clients.? And Mr. Smith said the HSBC deal was seen, by management, as achieving both of those ends.

Although conceding that it was a difficult decision to make, perhaps made more difficult by his being Bermudian and understanding the bank?s place in the Island?s history, but one that he is now 100 percent behind.

Mr. Smith said: ?We have been under fairly intense pressure in this (low) interest rate environment. Unlike most banks, we are very much a cash organisation. We do not have a huge loan portfolio. It may look like a big portfolio here in Bermuda, but in terms of our balance sheet it is not a huge loan portfolio. We do not have a great return on assets and we have been hit hard in the last few years with the declining interest rate environment. We were also struggling for a while on the fee side of revenue as part of our fees are based on the value of clients ? whether individual or investment funds ? since most stock markets ment funds ? since most stock markets have been under pressure, our fees were therefore under pressure.

?We were having a pretty tough time and we found ourselves, as all organisations, facing continuous change in the regulatory (whole layers of regulation that we did not have a few years ago, from different bodies) and political environment.

?What it has added up to, there is much more reporting required ? compliance, know your customer and more. We have seen a huge increase in the cost of running the business following all of these rules at a time when our revenues were under significant pressure.?

Mr. Smith said ultimately it became difficult to compete with bigger banks who were streamlining their operations with greater and greater emphasis on technology, and the funds to do that. As a comparison, Mr. Smith said the bank spent $30 million a year compared to the $2.5 billion that HSBC budgets for technology each year.

He added that management and the board were forced to ask themselves how they could manage through this (time) and what was the best course to chart for the bank?s future.

?The next thing we heard, and this was about a year ago, was that the Bermuda Government was intent on building the financial services industry in Bermuda and that they were open to, and would be looking for, applications from major global institutions to set up here. That was partly alluded to when we listed, as when they gave us exemption from 60/40, that was not just for the Bank of Bermuda it was in the context that we are opening up the market.

?That made us think pretty hard as we now potentially had a situation where we were competing globally against big players, and were concerned about doing that. But then all of a sudden, at home in Bermuda, which is a very important market for us, we possibly could be competing against the biggest and best banks in the world on our own turf.

Mr. Smith continued: ?This really made us sit up and pay attention. I want to say, up front, that I do not blame the Government at all. I think this was the right thing to do, and that it was inevitable to open up (the market).

Mr. Smith added that, it was his view, that if it was ?done right?, opening the sector could create another industry for Bermuda that would rival the Island?s insurance sector.

?When we heard that news we started discussions with Government on how do you do that. About 30 percent of our revenue is derived from Bermuda. And we knew that if, say Citibank, suddenly appeared in Bermuda setting up a bank from scratch, several things could happen and they were all bad.

?To start from scratch, they would bring in their own management. There would be more non-Bermudians coming in,? which he said would compound already existing pressures on Bermuda?s infrastructure.

In addition, Mr. Smith said although management might be imported, a new bank would also need to hire some staff locally which could mean the bank?s best people being headhunted.

He said: ?They would be getting them from me, and the Bank of Butterfield. Do I want my best people to be targeted in my home jurisdiction? No, that would be very difficult for us. And with their scale they are huge, and their influence and balance sheet, they are going to be able to pretty quickly out compete us on our own turf.

?There was a real threat that the value we had slowly built up over 114 years could disappear. Our shareholders could have possibly found that the share price went down (if that happened), not up,? he said.

In looking at these challenges, Mr. Smith said the bank?s management and board ?realised that competition might be right on our doorstep. And we began talking with Government offline. We said to Government, and speaking as a Bermudian, should someone be allowed to start from scratch. Or would the better approach, from Bermuda?s perspective, be to join with a bank that is already here using Bermudian staff and management already in place.

?It was pretty obvious, that from Bermuda?s perspective, and without blowing ourselves up, the best way was to be open to the possibility of a foreign banking buying a Bermuda institution. That was a very quiet discussion with Government over a long period of time. and it was realised that based on the bank?s small size compared to the banking giants, it was going to be tough going.?

?Then HSBC, who had intimated an interest in the bank some years before but without that coming to anything, then, once again, made its interest in the bank known in February, and this time they were serious.

?Obviously they (HSBC) had been looking at the market and seen we were struggling. They had apparently always been interested in Bermuda, especially from a private client perspective. They saw it as a good place to manage their trust business from, which is also big business for us.?

A meeting was set up, one that Mr. Smith could not make but chief financial officer Ed Gomez, already in New York, met with HSBC.

Mr. Smith said the bank?s negotiations were against a backdrop of the sector being opened up by Government.

?It was clear right from the beginning that the Bermuda Government would let them (HSBC) in some way, because they are high quality. It was also clear that they had the tools that we did not, technology, products and services and global coverage among other things. We started to look a little more carefully at it, and realised that the fit between the two organisations was very, very compelling.?

But first there were many hurdles: ?We had two issues to deal with. The first was we were talking about selling a Bermuda company to a foreign institution. It had never been done and the question was how do we do it. We then got into discussions with Government about the transaction. We let them know pretty early on ? February or March ? that we were in discussions with HSBC and then we keep the Finance Ministry and the MBA as well, informed of progress.

?Government was very, very careful. They asked lots of questions over a long period of time. We had a couple of interview with Cabinet, and let me say they did their due diligence and they did it heavily. On a personal level I found that frustrating as the longer it went on, the longer I was having to keep it a secret and not being able to move ahead on other fronts but on a professional basis, I understood it and applaud them not making a snap decision.

?On the other hand we were talking with HSBC about price. No one will pay more than they think they have to. We got into pretty heavy price negotiations. We did not start at $45, we worked our way up.

Mr. Smith concluded: ?The discussions for me, marked an incredibly difficult time, on a personal basis. And that is not just me, that was the case for the bank?s senior people. But we knew the HSBC (transaction) could be truly transformational, and for Bermuda, as it would have the beginnings of a truly important banking industry but all of a sudden Bermuda, which has virtually no influence in the world, would have a pretty serious vested interest in the well-being of this Island. You are not going to make a $1.3 billion investment, without paying attention to it.?