Global vision

By Ian Fraser

Scottish Banker

December 2007/January 2008

In the light of RBS’s success in the acquisition of ABN Amro, Ian Fraser takes the long view of Scotland’s big banks’ approach to international expansion

IN an increasingly globalised world, both the Royal Bank of Scotland and its older rival the Bank of Scotland long ago recognised that to remain resolutely Scottish – or even to limit themselves to the UK market – would have been a recipe for stagnation and probably decline.

Both banks recognised they would rather be predator than prey, and that the best way to raise the bar to potential aggressors was to expand themselves. However, even though they shared the same starting point of seeking international growth, their approaches have been very different.

There are parallels with Aesop’s fable “The tortoise and the hare”. Whereas RBS has, like the hare, made a number of big leaps and bounds, HBOS has emulated the tortoise through its preference for steady organic growth. However unlike the fable, in the struggle between the two banks to internationalise their businesses, the victor’s identity is far from certain.

RBS — whose £21bn acquisition of NatWest propelled into it Europe’s banking premier league — has in recent years made a number of blockbuster acquisitions including the $10.5 billion acquisition of US bank Charter One in 2004 and the more recent €71 billion (£49bn) three-way takeover Amsterdam-based ABN Amro. However such deals have been interspersed by periods of calm, and insistence from the bank’s chief executive Sir Fred Goodwin that it wanted to prioritise consolidation and organic growth. HBOS, by contrast, has been pursuing a strategy of seeking to organically grow start-up operations and one or two relatively small infill acquisitions in selected markets.

Both banks began to internationalise their businesses in mid-Victorian times. The Bank of Scotland opened in London in 1865, ten years ahead of its fierce rival. In the 20th century RBS bolted-on various English banks including Drummonds and William & Glyn’s. However nearly a century elapsed before either bank opened its first overseas branch. The delay was partly due to strictures laid down by the Bank of England – which was not keen on domestic clearing banks also operating internationally.

The starting gun in the present day race was fired more than three decades ago. RBS had a slight head start, opening its doors in New York in 1960. Bank of Scotland took a slightly different route, opening a branch in Houston in 1975. The latter sought to target business from American oil and gas companies – the bank thought it would be able to make good use of skills had gleaned in the early days of the North Sea oil boom.

But the race did not begin in earnest until 1988. George Mathewson, who had arrived as RBS’s strategy director the previous year, took a more aggressive view of international growth than some of his predecessors on the bank’s board.

In 1981 the board had been perfectly willing to accept a £334 million takeover offer from the Asia-focused bank Standard Chartered. The deal was not stopped because of anything the bank did but because the Monopolies & Mergers Commission, egged on by the “Scottish mafia”, blocked the deal. Although Mathewson was not involved with RBS at the time, such a supine approach would have been inconceivable under his leadership.

Instead he believed RBS should itself go out on the takeover trail. In 1988, the bank did two things that would be critical to its future credibility on the international stage. The first was to enter into a strategic alliance with Madrid-based Banco Santander. Through this arrangement, RBS gained exposure and understanding of the European and Latin American banking markets, without any real risk.

Directors of each bank sat on each other’s board and the deal was reinforced by cross-shareholdings between the two banks.

However the Hispano-Scottish marriage went beyond the merely financial. For example, even after the formal elements of the deal had to be unwound after Santander acquired the Abbey National in 2004 (the UK Competition Commission would taken kindly to the idea that RBS would have had some influence in how Abbey was managed), the two banks remained on good terms.

The trust between the boards of the two banks was so profound that not only did Santander play a key role in supporting the acquisition of NatWest in 2000. It also meant Goodwin had a faithful ally to call on when he decided to seek a break-up bid for ABN Amro. Arguably, without having known each other for so long, RBS and Santander would never have been able to collaborate on that project as successfully as they did.

RBS’s other significant overseas foray came in 1988 when it splashed out £235m for the Rhode Island-based Citizens Financial. At the time RBS said it liked Citizens because of the US bank’s “strong and conservative management” and because it was “operating in areas that are familiar to us.” Again the strong cultural affinities between the two banks played a key role in the subsequent success of this acquisition.

In the ensuing 19 years, Citizens was used as the platform to create a much bigger banking business in the US. In a buy-and-build strategy the US bank’s chief executive Larry Fish made a further 26 acquisitions of banks and financial services companies, building Citizens/RBS into the US’s sixth largest bank by 2007. James Eden, analyst at Exane BNP Paribas, says: “RBS’s expansion in the US through Citizens was a glorious success story.”

Then came a stumbling block. Some commentators and analysts are convinced that RBS overpaid when it bought Cleveland, Ohio-based Charter One for $10.5bn in 2004. Eden is much more critical of this deal. He says: “The acquisition of Charter One, part-financed through the issue of RBS paper to new-to-group owners at a distressed price, did considerable damage to management’s standing with investors.”

Indeed they effectively forced Fred Goodwin to “do penance” and swear not to make any further chunky overseas deals. Instead he pledged he would focus exclusively on organic growth, a la Bank of Scotland, and return cash to shareholders through things like share buybacks. It was a tough period for Goodwin who nonetheless managed to get away with acquiring a 5% stake in the Bank of China because this was paid for by the proceeds of the sale of the Santander stake and was made in tandem with other investors including Merrill Lynch.

But in March 2007 everything changed again. The leading Dutch bank ABN Amro, which was hopelessly inefficient compared to RBS, was “in play” after it was targeted by hedge funds and agreed a low ball merger with Barclays.

Rumours started circulating that RBS was considering making a counter-bid to Barclays’ planned merger proposal with Dutch bank. The bank was attractive to Goodwin because, with offices in 53 countries, and a significant presence in the US, it was already a much more significant player in terms of geographical reach than either RBS or HBOS. In April, RBS confirmed it was intending to make a three-way bid for the Dutch bank alongside Banco Santander and Brussels-based Fortis.

At a packed press conference in the EICC, Goodwin said there was “compelling logic” to his proposed break-up bid and sought to downplay any suggestions that the old “megalomania” was reasserting itself. He said: “It doesn’t happen every day that something like this comes on the market. From an RBS perspective, we don’t need to do this transaction. But given that ABN finds itself in play, I think it would be negligent for us not to look.”

During the epic six month takeover battle that followed, sceptical investors wondered why RBS was proceeding with the takeover, particularly in the light of the credit crunch that marred many bankers’ summer. They were puzzled as to why Goodwin would want to overpay for a predominantly wholesale bank at a time when the liquidity squeeze was making wholesale banking decidedly unattractive. Some investors also fretted about the complexities and regulatory risk involved in dividing up an international banking giant.

Others argued that without the ability to take ownership of LaSalle – an American subsidiary of ABN Amro that always described as the most attractive part of the Dutch banking behemoth to RBS – the deal lacked any sense. As part of the Dutch bank’s “scorched earth” defense, LaSalle had been sold to Bank of America.

Then there was the risk that employees of the Dutch bank would be so disenchanted about the prospect of their national institution, which epitomized Holland’s softer-edged version of capitalism, being torn asunder by three rapacious foreign rivals they would become apathetic and the bank would lose momentum.

One indicator of the depth of investors’ fear about the deal is the movement of the RBS share price. This has fallen massively and is down from 705p on February 16th to 475.5p on November 2nd, a fall of 32.5%.

However Goodwin is adamant ABN Amro will turn out to be a good deal for RBS. Speaking to journalists on October 10, the Paisley-born chartered accountant said the businesses RBS is acquiring — predominantly the Dutch bank’s wholesale division in Europe, Asia and North America — are involved in commercial banking and are not “skewed towards the capital markets”.

He also said: “I think it is a very attractive financial case for our shareholders. We do transactions such as this based on the value we see coming from ABN Amro across the long-term, and our outlook on that has not changed.”

Over the next three years Goodwin and his team, notably the new ABN Amro chief executive Mark Fisher, have their work cut out. Analysts and investors will be watching them like hawks to check whether they are achieving their promised cost-cutting and revenue targets.

HBOS’s international expansion programme has been altogether more measured, and seemingly less risky, than that adopted by RBS. Since missing out in the battle for NatWest in 2000, HBOS seems to have eschewed swash-buckling acquisitions. Indeed, its former chief executive James Crosby won kudos in the City for walking away from opportunities to acquire NAB’s two Irish subsidiaries and Abbey National in 2004.

Instead the bank has been prioritising organic growth, tending to position itself as a “consumer champion” wherever it operates – for example by seeking to attract new retail customers from established players through well-publicised, highly competitive interest rates on current and savings accounts. Rather than seek to build a presence across half the world, HBOS has preferred to target selected English-speaking markets where it believes its model will catch on including Ireland and Australia.

Analyst James Eden is a big fan of the approach. He says: “Everything about the strategy is classic HBOS – building organically, establishing a sustainable cost advantage and attacking incumbents in economically attractive markets.”

In Australia, Bank of Scotland paid £434m for Bank of Western Australia (BankWest) in 1995. After some uncertainty over whether BoS wanted to retain Perth-based bank or not, HBOS made a firm commitment to the growing the bank about four years ago. First it bought out minority shareholders and then it consolidated its four Australian businesses – BankWest, St Andrews Insurance, financing arm Capital Finance, and structured finance division BOS International – into a single reporting structure. It then hired the New Zealander David Willis as chief executive of the newly created HBOS Australia. He has already parked his tanks on the lawn of the country’s “big four” banks – National Australia Bank, Commonwealth Bank of Australia, ANZ and Westpac.

Willis wants to attract some of their customers with eye-catching interest rates on savings accounts and has also embarked on an ambitious branch opening programme on the eastern seaboard where BankWest traditionally had no presence.

Willis said: “BankWest has already shaken up the status quo with the high interest deposit and innovative credit card products, attracting thousands of customers from across Australia. The [branch opening] initiative offers customers a real alternative to the Big Four and a better deal.” The approach appears to be working. HBOS’s Australian profits have grown by 66% from £189m in 2003 to £279m last year.

HBOS has adopted a similar approach to the Irish market. The Edinburgh-based clearer acquired Equity Bank in 1999 and ICC Bank in 2001 and then used both of these as the building blocks for a corporate and commercial bank in the Republic of Ireland which has already become that country’s second biggest business bank.

However one thing the bank lacked in the Irish market was a retail franchise. Rather than gain one through acquisition it opted to do it unconventionally, by buying a chain of former electricity showrooms. HBOS has been gradually converting these to bank branches, initially under the Bank of Scotland (Ireland) name but now under the more accessible Halifax banner.

James Eden says that well-established indignenous banks such as Bank of Ireland and Allied Irish are already beginning to feel the pain. He says: “Investors should reward CEO Andy Hornby for trying to do international the hard way, through organic growth. It is much easier and quicker to boost international earnings by making a series of value-destructive acquisitions.”

The bank is pursuing a similar slow-burn in continental Europe – where for example it is rolling out insurance products. Its Clerical Medical subsidiary entered the German market in 1995 and two years ago the bank strengthened it presence with the purchase of the German life insurer Heidelberger Leben. The combined unit is targeting a 12% share of Germany’s life and pensions market.

The Edinburgh bank also has patchwork of other retail operations in Europe including Banco Halifax Hispania – which sells mortgages to British expats in Spain – and BOSNL, a direct mortgage provider in Holland. Its corporate arm has a strong presence in lending sectors including oil & gas, real estate, gaming and infrastructure across both Europe and North America.

The two Scottish banks may have different approaches to international expansion but both have had setbacks and embarrassments along way. These included RBS’s thwarted attempts sell itself to Standard Chartered in 1981 and the Bank of Scotland’s abortive alliance with the homophobic preacher Pat Robertson in 1999.

So who is winning the race? Based on the numbers and sheer spread of its international operations, it would be easy to conclude that the hare (Royal Bank of Scotland) should already to be cracking open the champagne.

After all the Gogarburn-based bank’s international businesses generated operating profits of £3.9bn in 2006. That was 41% of its total operating profit of £9.4bn. By contrast, profits from HBOS’s international operations were £820m in 2006, or 14% of overall profits.

It certainly looks at this stage that RBS is in the lead. But no observer of this race should assume that it will emerge triumphant in the long term. After all, given the uncertainties over the credit crunch and the damaging questions over the logic of its ABN Amro acquisition, some investors are putting their money on the tortoise.

© Copyright Ian Fraser 2007

This article was first published in Scottish Banker, the magazine of the Chartered Instititute of Bankers in Scotland, Dec/Jan Issue 2008 (with minor edits). For information on how to subscribe to Scottish Banker, please click here .

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