Hubris: How HBOS Wrecked the Best Bank in Britain (13 page)

No turning back at Derby

In November 1745 a Scots army led by Bonnie Prince Charlie crossed the border and headed for London. They had been victorious in their native land, defeating an English army at
the battle of Prestonpans. They easily captured Carlisle and pressed on southwards, so that by 4 December they had reached the bridge over the River Trent at Swarkestone, near Derby. There
self-doubt began to overtake them. Rumours had been building of a massive English force waiting for them and after a day of arguing with his council of advisers, the Prince reluctantly led the
retreat back to Scotland.

In fact there was no English army. London was in panic at the imminent arrival of the feared Scots and King George II’s courtiers were loading his possessions onto a ship ready to flee.
What might have been had Charles Edward Stuart not turned back at Derby is one of the great ‘what ifs’ of Scottish history. As it was, although he captured Stirling and achieved one
more victory at Falkirk Muir, his retreat gave the Government time to regroup. His army was destroyed at the battle of Culloden and he spent the rest of his life in embittered alcoholic exile.

More than 250 years on, the bankers on The Mound were determined not to turn back before London. What was preoccupying Peter Burt and Gavin Masterton after the Pat Robertson debacle was
something much more important and dramatic than an American telephone banking venture – they began to contemplate a move which had the potential to double the size of the Bank at a
stroke.

Having failed to find a partner among the building societies, Bank of Scotland had also tried to forge a friendly alliance with one of the London Big Four. Two approaches to NatWest had been
rebuffed and talks between Peter Burt and Peter Middleton, Chairman of Barclays, had come to nothing.

A dramatic way out of the impasse was suggested by Will Samuel,
who, as head of corporate finance with the long-established and revered London merchant bank Schroders, was
an adviser to Bank of Scotland. He also had a personal link; his sister Lesley Knox was a non-executive on the Bank board. If NatWest could not be interested in a friendly merger, suggested Samuel,
why not launch a hostile bid?

This was a radical suggestion. Hostile bids were never easy in any industry, but especially not in banking. The Bank of England, which had overall responsibility for the banking sector, was
known not to look kindly on such moves and the last openly hostile full bid – by HSBC for Royal Bank of Scotland 18 years before – had been blocked by the Government. There was also the
difference in scale. Bank of Scotland was less than half the size of NatWest. There was no way it could raise the resources for a cash bid, so it would have to persuade NatWest’s
institutional shareholders – the professionals who managed investments on behalf of pension funds and insurance companies – to accept Bank of Scotland shares in payment. In effect Burt
and Masterton would be asking the City of London to trust them to make a much better job of managing NatWest’s assets than it could itself. They had proved they could do it in Scotland, but
would the City accept that they could operate at three times the scale in the less familiar English market?

Samuel argued that NatWest’s management record had been so awful for so long that shareholders would be ready to take the risk. The London bank had lurched from crisis to disaster with
amazing regularity. After nearly going bust in the secondary banking crisis of the 1970s, during the following decade it had become embroiled in a financial scandal which resulted in an
investigation by the Department of Trade and the resignation of several board members, including the chairman. Ill-judged acquisitions in Canada and the US had not worked and been sold at a loss,
and the domestic banking business in the UK was slow and inefficient. In an astonishingly arrogant move, the bank had built the NatWest Tower, an ostentatious headquarters in the City of London,
which until the development of Canary Wharf was the tallest building in Britain. The building had a footprint in the shape of the bank’s logo and an art gallery at the bottom which housed its
extensive picture collection. (It was only occupied for a few years before Irish terrorists severely damaged it with a bomb.) The latest disaster, losses uncovered in the investment banking
business, had again led to calls for top resignations.

By 1999 NatWest had a new chairman in Sir David Rowland, who had made his name leading the Lloyds of London insurance market, but also a long-serving chief executive,
Derek Wanless. He was regarded by the City as undoubtedly clever – he had studied maths at Cambridge and was a qualified statistician as well as a banker – but far too nice. He lacked
the ruthlessness to deal with the bank’s inflated costs.

Peter Burt was convinced not only that Bank of Scotland’s management could run NatWest, but also that he had a sporting chance of convincing the City to back him. But the London bank would
be a huge mouthful to swallow. Samuel suggested a plan which he thought would halve the risk and double the chances of success, so in August 1999 Burt walked down The Mound from the Bank’s
headquarters in the Old Town, crossed Princes Street into the New Town and called on his main rival, the chief executive of the Royal Bank of Scotland – now Sir George Mathewson, after his
knightood in the New Year’s Honours List. Burt’s proposal was that they should co-operate in a joint attack.

On paper the plan looked watertight. Both Scottish banks were much smaller than NatWest, with the Royal Bank being slightly larger than Bank of Scotland, but together they were roughly equal to
the London bank. Bank of Scotland had a 20-year record of management competence and superior financial performance behind it and, since the Mathewson revolution, the Royal could easily match it. By
contrast NatWest was a serial under-performer. The plan was essentially to capture and dismember NatWest, injecting a double dose of strong Scottish management to drive down costs and boost
sales.

Mathewson had transformed the performance of the Royal Bank, but faced the same problem as Burt: how to a make step change and secure a bigger share of the English market against the entrenched
hegemony of the Big Four – LloydsTSB, Midland (now owned by the international group HSBC), Barclays and NatWest. He too had held talks with Barclays’ chairman Peter Middleton, but had
come away with the same answer as Burt. Mathewson believed Barclays and NatWest were in the same position that the Royal Bank had been in a decade previously, with the difference that they did not
want to take the steps necessary to pull themselves out of it.

He was sufficiently interested in Burt’s joint bid idea to want to explore it further and small groups of top executives from both banks
started meeting in secret to
plan the attack and the division of the spoils.

At the same time, each bank individually began to work out how it would manage its share of the acquisition. Gavin Masterton, for the Bank, was already planning his moves and for the Royal
Mathewson’s new recruit, Fred Goodwin, was doing the same. Masterton had worked his way up through the Bank in the time-honoured fashion. He had joined the old British Linen Bank straight
from school, taken a correspondence course to get his certificate from the Scottish Banking Institute and been moved around by the bank to gain experience. He had joined Bank of Scotland when it
acquired British Linen and progressed quickly up the management chain. Recognising his potential, the Bank had put him through Harvard University’s Advanced Management Programme.

Goodwin, by contrast, was one of the new breed of late entrants to banking from other professions. He had read law at Glasgow University and then trained as an accountant, rising quickly to
become a partner in the international firm Touche Ross. His sharp forensic mind had made him the ideal candidate to lead the liquidation of the Bank of Credit and Commerce International (BCCI), a
vast sprawling multinational which had collapsed after a complex fraud. His skilled handling of that job had convinced National Australia Bank to hire him to head their two UK banking operations,
Clydesdale and Yorkshire Bank, where his cost-cutting had earned him the nickname ‘Fred the Shred’. He was being lined up to move to Australia and the top post in NAB when Mathewson
lured him to the Royal Bank as his number two.

Both Scottish banks were ambitious to continue their expansion, but to do that they needed access to the English market, which was ten times the size of Scotland. In particular they coveted the
vast deposit base which NatWest had garnered through its 1,700 branches. The Royal Bank had 200 English branches, but the Bank had only 25. Dividing the NatWest total between them would enable each
of them to leap decades of organic growth.

The talks continued for a few weeks but as they began to work out the detail it became clear to both sides that the joint bid idea had a fundamental flaw – they both wanted the same parts
of NatWest and neither was willing to allow the other to take the largest share or the best bits. However united they might be during the bid battle,
afterwards they had to
become competitors again. The talks ended in failure. Mathewson wanted Burt to agree not to bid alone; Burt was unwilling to do so, but he still faced the problem of convincing his own
non-executive directors to go ahead with a lone bid.

In a board meeting Burt told his colleagues that the Bank was too small to survive on its own. It lacked the scale necessary to invest enough in technology, marketing or management to be able to
compete and would sooner or later be swallowed up by a larger predator. ‘Whatever we thought of Peter’s analysis, we had to admit that it was well researched and the board accepted
it,’ recalls one director. ‘But we still had questions over a bid for NatWest. Did we want it? If we did, could we get it, given that it was over twice our size? On that we were very
much in the hands of our advisers. If we went for it and failed to get it would we be in play ourselves? If we got it, could we manage it?’

On the last question, Gavin Masterton, whom Burt had proposed to run the combined bank, told the board he had already identified 100 key managers from within Bank of Scotland and his first
priority would be to do the same in NatWest. They would form the core team to lead the integration of NatWest into the enlarged group and the transformation of its performance.

Board opinion was moving in Burt’s direction – ‘We were thinking, “if we don’t do this now we will never do anything” ’ – when NatWest made the
decision for them. At the beginning of September 1999 the London bank announced an agreed takeover of the insurance giant Legal & General at the high price of £10.7 billion. This was a
now-or-never moment for Bank of Scotland. NatWest at twice the size was already a big pill to swallow; if it were to succeed in acquiring the insurance company it would become more than three times
Bank of Scotland’s size and well out of reach. But the announcement also created an opportunity. Institutional investors did not like the NatWest proposal and began to criticise it openly:
the London bank was paying too much, previous acquisitions had not been well-managed and had destroyed value rather than creating it, and NatWest’s management should be concentrating on
getting their existing business right before taking on new ones. They showed their displeasure by selling NatWest shares and over the next two weeks the value of the bank on the stock market fell
by more than a quarter, making it more digestible for the Bank.

If they were going to move, the Bank team did not have much time. NatWest had called a special shareholders’ meeting for early October to approve the Legal &
General deal. To persuade NatWest’s investors to reject it, Bank of Scotland had to be ready to make a public announcement of a credible and detailed alternative proposal. The Bank’s
internal team had done some work, but there had been little thought about the technical aspects of an offer. What was the right price? It would have to be high enough to convince shareholders to
back the Bank, but low enough to be affordable without compromising future performance. How was the bid to be funded? Mostly it would have to be a share-for-share offer: investors would be asked to
swap their NatWest shares for Bank of Scotland shares, but it would not be a straight swap and the question of how many new shares investors would get for their old shares would determine the
balance in the new enlarged group. NatWest shareholders would inevitably end up with the majority of the shares, but would it be 60, 65 or 70 per cent? If they got too much, the Bank’s
existing shareholders might feel cheated and not support the deal.

The answers to these questions would come partly through doing the arithmetic, but the rest had to be ‘gut feel’. This was where the Bank’s investment banking and stockbroking
advisers were expected to earn their large fees. Their knowledge, contacts and experience would help judge the mood of the market and pitch the price at the right level, but the Bank would not have
Will Samuel on its side. Schroders was acting for Legal & General and so was compromised.

A bid would not be attractive without some cash in it and the amount was another issue needing fine judgement, but whatever the level it would be a whopping sum for the Bank to raise. To do so
it would have to issue loan notes – a way of borrowing from the stock market. Shareholders would want to know that the Bank could do this before accepting any offer, so the issue would have
to be underwritten. A group of investment banks would be persuaded – for a fee – to guarantee to buy the loan notes and provide the cash if, for some reason, the Bank could not sell
them in the market.

In addition to these high-level decisions there was a huge amount of routine work to be done in the preparation of documents, the fulfilment of regulatory, legal and accounting requirements,
preparation for making the announcement, presentations to be made to investors and stockbrokers, public relations strategies and so on. The
clock was already ticking. Peter
Burt virtually moved into the Canary Wharf offices of Credit Suisse First Boston, the international investment bank which was to be one of the lead advisers.