Banking on a future

By Ian Fraser

Sunday Herald

October 3rd, 1999

This week the Bank of Scotland will let investors know the details of its NatWest bid. Ian Fraser examines the fine print

A DIRTY war has broken out for the heart and soul of British banking following the Bank of Scotland’s £21 billion dawn raid on National Westminster Bank. The Bank of Scotland, whose top executives claimed last night to have received a “solid response” following a tour of NatWest’s London-based institutional shareholders last week, has kicked off a process of consolidation which analysts believe will change the face of British banking forever.

Once the ‘rough wooing’ is over, there may be as few as three bank brands in the UK market. The grandiose Victorian and Edwardian banking halls that once graced high streets up and down the land may be a distant memory.

If the Bank of Scotland gets its prey, many bank branches will be shrunk and transformed into what it terms “banks in a box” — scaled down outlets that could nestle in the ground floor of a large office building or among the chain stores in an out-of-town shopping mall.

“These outlets will include automatic teller machines (ATMs) that offer more functionality. There will also be room for one or two members of staff,” said Gavin Masterton, chief operating officer of Bank of Scotland. “We expect to be piloting one of these in Scotland within the next week or two.”

He believes these outlets, which will be cheaper to run than traditional bank branches, will enable BoS to increase the number of branches operated by NatWest, should its contested takeover attempt succeed.

The Bank of Scotland’s bid, which depends on shareholders accepting that its management can do a better job of running NatWest than the incumbent team, values NatWest at £21 billion and now stands at a 10% discount to the market value of its prey. This means a counter-bidder is almost certain to emerge. “This is a once in a lifetime opportunity,” said Robert Mackenzie, banking analyst at WestLB Panmure.

So high street banks were last week weighing up their options, while City pundits took delight in speculating on who would make the next move. “After Friday’s bombshell it has become a waiting game,” said one City source.

As the claim and counter-claim grew wilder and wilder, only one thing was certain. Within a matter of months, both NatWest and Legal & General — whose own merger with NatWest has been scuppered by Bank of Scotland chief executive Peter Burt’s stinging attack on ‘bancassurance’ last week — will almost certainly have new owners.

The traditional high street banks have steadily lost market share since the 1980s, notably to the building societies, but they will see their position eroded even faster in the digital era. New entrants can offer attractive products — such as cheaper mortgages and deposit accounts with higher interest rates — through the use of cheap delivery channels like the internet.

If traditional banks can’t find ways of cutting their costs, their products will become increasingly unsaleable. However, the banks have an ace up their sleeves: consumer inertia. British current account holders are more likely swap their spouse than shift their bank accounts — which explains why the Bank of Scotland is prepared to stump up over £21 billion to get its hands on NatWest’s six million personal customers (16% of the UK market) and its one-quarter share of the corporate market.

David Erskine, investment director at Standard Life, said: “If they succeed at this price it would be very good news for Bank of Scotland.” It seems any residual differences between Standard Life and the Bank, which arose after the mutual life insurer’s surprise decision to off-load its 32.2% stake in BoS in 1996, have now been erased. “We have no hard feelings and still have a 1.9% stake in BoS. If their deal stacks up we will certainly support it,” remarked Erskine.

Erskine confirmed Bank of Scotland’s senior executives will be presenting their full proposals in a “one-to-one” meeting with Standard Life early this week. The BoS roadshow will also visit a string of other Scottish based institutional shareholders that own shares in NatWest. Peter Burt earlier said he was delighted that Standard Life is lending its support to his bank’s bid for NatWest. “That gives me particular pleasure,” he said.

The joker in the pack is the Bank of Scotland’s Edinburgh neighbour, Royal Bank of Scotland. But analysts are beginning to question whether RBS has the stomach to launch a counter bid. Despite the drama of Sir George Mathewson’s abrupt return from the United States last Friday and the appointment of Goldman Sachs and Merrill Lynch as its advisers, the Royal Bank decided to closely examine its armoury before throwing its hat in the ring. The US merchant bank Goldman Sachs had been eager for an early move, but Sir George returned to Edinburgh to watch the South Africans play Scotland at Murrayfield today.

It also appears Sir George’s attempts to persuade the NatWest board that the Royal Bank is a suitable ‘white knight’ have fallen on deaf ears. The board has indicated it would prefer to mount a standalone defence.

The important question facing Sir George is whether his management team can put a tighter squeeze on costs through merging with NatWest than the boys on the Mound. Some analysts believe it is possible, owing to a greater overlap between Royal Bank’s branch ‘footprint’ and NatWest’s. While the Royal Bank has 300 branches south of the Border, NatWest has 1700 and the Bank of Scotland has only two or three. The downside however is the St Andrew Square team would be more likely to face a gruelling Competition Commission inquiry.

A takeover by the Royal Bank of Scotland also inspires greater trepidation among NatWest staff. The combined financial services union, Unifi, has warned that there will be “carnage on the high street” if Royal Bank makes a successful counter-bid — with perhaps 30,000 bank staff losing their jobs.

If Sir George does proceed with a bid, it will be supported the Spanish banking giant BSCH, which has a 9.89% stake in the Royal Bank. On condition of anonymity, a source at BSCH said: “RBS is one of our strategic partners and anything that its management proposes will have our full support.”

There is some doubt, however, whether Sir George will mount a counter bid after all. Fund managers were unaware of the Royal Bank having sounded out the investment community’s interest in a rival bid, though it has made its interest sufficiently apparent for the Takeover Panel to formally add its name to the list of potential bidders for NatWest. “They are likely to be involved at some stage of the consolidation, whether as a predator or a prey,” said one fund manager.

But David Erskine, investment director of Standard Life, said: “It is probable that they will (counter bid). It depends what they believe they can extract in synergies and cost savings.” He does not accept, however, that a fully-fledged bidding war between the two Scottish banks would be damaging to either.

“NatWest knows the game is up,” said Robert Mackenzie, a banking analyst at WestLB Panmure. “They’d do anything to save their backs.”

AT the very least, it is expected that the Royal Bank and any other UK-based bidders — which could include Abbey National, Halifax, Lloyds TSB and HSBC — will await the Bank of Scotland’s formal offer document. According to takeover rules, this must be issued to NatWest shareholders within 28 days of the initial offer. Like an incumbent prime minister who can choose the date of a general election, Peter Burt has the element of surprise on his side. He could produce the document any time between tomorrow morning and Friday October 22.

It is only once this document is in the public domain that the takeover clock starts to tick. Once they’ve received the formal offer, NatWest shareholders have 60 days to decide whether to accept – which means the battle for control of the one-time doyen of British financial services could be drawn out until late January.

Foreign bidders, which could include Banque Nationale de Paris, Societe Generale and Citibank, are in a position to step in before the document is released, however. This is because they are likely to offer NatWest shareholders cash — instead of a lengthy treatise on how they would run the English bank better than its current chief executive, Derek Wanless, a man described as the John Major of British banking.

City sources believe the Bank of Scotland’s interim results, which were presented by the trio of Burt, Masterton and Gordon McQueen last Wednesday, have increased its chances of getting its hands on NatWest. Investors, analysts and City scribblers who attended were generally impressed by a 12% jump in pre-tax profits and 22% annualised growth in lending. However the situation turned nasty later that day, when NatWest’s Sir David Rowland said that the Bank of Scotland’s results “demonstrate some worrying underlying trends”. The NatWest chairman accused the bank of “buying market share” and “storing problems for the future”. Gavin Masterton retorted: “You can’t grow without incurring additional costs. They have not been growing their business.”

Whoever emerges victorious, there will be many more such verbal spats in the weeks ahead. But the mud is more likely to stick to banks that are inefficient than those that are lean and mean financial machines.

RIVAL SUITORS FOR NATWEST

ROYAL BANK OF SCOTLAND

DESPITE the acquisition of Williams & Glyn’s, which gave it hundreds of branches south of the border, the Royal Bank of Scotland is eager to boost its presence in the lucrative English market. But its proposed reverse takeover of Barclays earlier this year came to nothing. Founded in 1727, the Royal Bank has around 650 branches in the UK. Its strategic alliance with Spanish bank BSCH has spawned a number of ideas that have boosted both banks’ operations. The first was Interbank On-line Systems (IBOS) which permits the customers of member banks to make instantaneous money transfers. The Royal Bank also owns Direct Line insurance and in 1997 announced the creation of Tesco Personal Finance, a joint venture with Tesco. It also owns Citizens Financial Group in New England and recently opened branches in Paris and Frankfurt, mainly to serve the burgeoning private equity market in Europe. In 1981 the bank was spared the ignominy of a takeover by either Standard Chartered or HSBC when the Scottish business establishment rallied to its defence. The takeover was blocked by a compliant Monopolies and Mergers Commission.

HSBC

WITH a market capitalisation of some £59 billion, the Hong Kong & Shanghai Banking Corporation dwarfs all the other UK banks and, were it not for competition considerations, could swallow NatWest in a couple of gulps. HSBC was established in 1865 to finance the growing trade between China and Europe. Its founder was Thomas Sutherland, a Scot who spotted the demand for local banking facilities in Hong Kong and the China coast. In the late 19th and early 20th centuries, HSBC established a network of branches in China and South East Asia. In the 1950s, the bank diversified its sectoral and geographical spread via acquisitions, buying both the British Bank of the Middle East and the Mercantile Bank in the 1950s. By the 1970s a policy of expansion by acquisition was well-established. During the 1980s, HSBC moved into markets where it was not yet fully represented, with acquisitions in North America and Australasia. In 1992, HSBC acquired the UK’s Midland Bank — founded in 1836 but relabelled earlier this year as HSBC as part of a global branding policy. Midland’s subsidiary, Samuel Montagu, has been integrated into HSBC Investment Bank

HALIFAX

FOUNDED in West Yorkshire in 1852, Halifax Building Society converted to a plc two years ago. In recent years, this leading player in the UK mortgage market has gone on a major acquisitions binge, merging with Leeds Permanennt in 1995 and acquiring Clerical Medical in 1996. Last year, Halifax snatched Birmingham Midshires from the sights of Royal Bank of Scotland in a £780 million deal, further fuelling the Scottish bank’s desire for a deal south of the Border. When Halifax became a bank in 1997, it was valued at £18 billion, but today its market capitalisation has fallen back to £16.5 billion. On conversion Halifax comprehensively reviewed its branch infrastructure, introducing a modern, unintimidating style. Halifax described a pilot scheme, introduced last year, to open around of its 200 branches of its branches on Sundays as a “retaliatory strike”. Should the Halifax proceed with a counter-bid for NatWest, it will have to put earlier plans to acquire Norwich Union on ice. The mortgage bank, which derives 77% of its profits from home loans and deposit-taking is keen to boost profits from ‘non-traditional’ activities.

ABBEY NATIONAL

FORMED in 1944 through the merger of the Abbey Road Building Society and the National Building Society, in 1988 the Abbey National was the first building society to offer its members an interest-bearing cheque account. The following year, Abbey National became the first major building society to convert to a bank. Overnight, the number of shareholders in the UK increased from six million to 9.5 million. Its initial market capitalisation was £2 billion. Today the ‘mortgage bank’ is worth some £15.4 billion. The change of status has enabled it to embark on a rapid diversification programme. The 1992 acquisition of Scottish Mutual enabled Abbey National to expand into the life insurance market with the launch of Abbey National Life while a 1996 merger with National and Provincial brought the mortgage bank an additional three million customers. Today, half of Abbey National’s business comes from ‘non- traditional’ sectors including consumer credit, life assurance and treasury. However, the bank has said it will never abandon its mortgage and savings heartland. Any attempted takeover of NatWest could lead to a Competition Commission inquiry.

CATCH UP
Last week’s unexpected bid by Bank of Scotland for NatWest has focused British bankers’ minds on the need for consolidation. Following BoS’s £21bn share-and-loan-note offer for NatWest, analysts predict that several other banks — including Royal Bank of Scotland — could seek to trump its offer with a higher bid. Meanwhile a bunker mentality has developed at NatWest, which has been likened to the “Department of Social Security, circa 1960”

Copyright SMG Sunday Newspapers Ltd 1999

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