Hubris: How HBOS Wrecked the Best Bank in Britain (16 page)

The bid would now also run through the end of the millennium, which was supposed to be a time for celebration but was overshadowed by the ‘millennium bug’ or Y2K – possible
flaws in computer programmes which it was feared could cause everything from the controls on nuclear power stations to aircraft guidance systems to crash. The problem was taken seriously enough for
the United Nations to establish a taskforce and individual governments around the world to formulate action plans. The Scottish banks had redesigned their computer systems relatively recently and
were well
advanced in checking millions of lines of code for parts of programmes which had to be rewritten, but there was always the chance that some other part of the
financial system would fail, bringing down the whole network. In the event there were no serious difficulties and opinion was divided between those who said the expensive remedial work had averted
catastrophe and those who said the whole issue was just hype to bring work to IT consultants.

Meanwhile the confrontation ground on. NatWest responded to the Bank’s improved offer (‘still inadequate, shareholders will not be hoodwinked by an illusion’) and were answered
in kind (‘painfully lame, repeating the same weary rhetoric, NatWest management has thrown in the towel’). For the first time Burt had to acknowledge publicly the possibility of defeat
when he was asked whether failure would lay the Bank itself open to takeover. He dismissed the question, adding that if the price of NatWest rose too high, Bank of Scotland would walk away
‘without a backward glance’.

But the tension was obviously getting to him and, against the advice of his public relations managers, he succumbed to the temptation to attack the Royal Bank’s management, recalling Fred
Goodwin’s nicknames of ‘Fred the Shred’, and ‘Fred the Impaler’ and drawing attention to the fact that many of the Royal’s top executives had been brought in
from outside, without much banking experience. ‘I’m struggling to think of an executive of RBS who came up through the ranks. If Fred Goodwin falls under a bus, who is going to run the
bank?’ George Mathewson briefly replied in the same negative style, drawing attention to the age of Burt’s number two, Gavin Masterton (58, less than two years from normal bank
retirement age) and Fred Goodwin’s 41. It was left to Goodwin to bring the temperature down. ‘We think logic and fact will win this. It needs to be done on a more professional footing,
rather than slagging each other off.’

The long drawn-out fight was also producing tensions within the Bank of Scotland board as some directors began to question the wisdom of having made the bid in the first place and spoke among
themselves of having been railroaded into it by the executives. Counter to this was the feeling among the executives that they had not had strong enough leadership from the board. Was Sir Jack
Shaw, who had been propelled into the post by the illness of Sir Alistair Grant, the right man for the job? He was able and committed but he lacked the guile of a practised City operator or the
personal
connections which might have swayed investors. The man who should have filled Sir Alistair’s shoes, some argued, was Sir Robert Smith, who as chairman of
Deutsche Bank Asset Management, was well-known and respected in the Square Mile and as a former corporate financier was a veteran of bids and deals, but he had only been on the board a short
time.

As the contest ran its course, both bidders added refinements to their offers in the hope of making them more attractive to shareholders, and NatWest announced that it had poached Gordon Pell, a
senior executive at LloydsTSB, to join them. This went part way to answering the criticism that, however able Rowland and Sandler might be, they lacked banking experience. Pell had it in
spades.

Rowland’s defence tactics, which had previously looked piecemeal and borrowed from his tormentors, now began to look plausible. By adopting virtually the same programmes as the Bank and
the Royal – sell peripheral businesses, concentrate on core banking and reduce costs – he had removed strategy as a basis for deciding the bid. If all three banks – the Royal,
Bank of Scotland and NatWest – had the same strategy and were roughly offering to return the same value to shareholders, it was a question of which management team could best deliver. His
argument was that the incumbents had the best chance, since they knew the business best.

As the bid moved into its final days in mid-February opinion swung between the three possible outcomes. One or two analysts now suggested that NatWest might – or indeed should –
remain independent and it began to look possible that both bidders might fail. There was a fillip for Bank of Scotland as the influential
Financial Times
Lex column recommended that
shareholders accept its bid, but slowly large institutional shareholders began to declare themselves for the Royal Bank. Now the peculiar logic of the stock market began to show itself. As the
Royal Bank began to look the likely winner, its share price fell, whereas the price of Bank of Scotland shares rose on the prospect of it being the loser. By the Thursday of the last week the Royal
Bank’s shares had fallen 18 per cent from the level at which it had made the offer, meaning that its bid was now worth less than the Bank’s bid and less than the value at which NatWest
shares were trading on the stock market.

At lunchtime on Friday there was enough good news to convince Peter Burt that he had won, but the afternoon was still taken up with a
hectic round of investor meetings. In
the evening the Bank’s team, Burt, Masterton and George Mitchell, head of corporate banking, were invited for champagne by Richard Lambert, editor of the
Financial Times
, which had
been a consistent supporter. As they filed into his office Burt asked Lambert what was it to be: congratulations, or commiserations? The latter, replied Lambert, enough institutional shareholders
had now declared for the Royal Bank to guarantee it at least 51 per cent of NatWest shares. The three men drained their glasses, cancelled their remaining scheduled meetings with investors and
caught the last flight to Scotland. Burt put on a brave face: ‘We saw NatWest as an opportunity, pure and simple. Someone was on the other side of the street holding up a £100 note, we
crossed over and offered them £90 for it, but someone else made a better offer.’

In the following week NatWest gave up the fight and the Royal Bank mopped up the remaining shares. George Mathewson felt strangely deflated after his stunning victory. A decade before, his bank
had been on the edge of falling into loss, now he had tripled its size and made it a major force in UK banking. He had fought a short, but extremely hard campaign, tirelessly presenting to
investors, not only in London and Scotland, but flying to New York to woo NatWest’s American shareholders. He’d taken the supersonic service on Concorde to save time, but had to spend
frustrating hours at Heathrow Airport when the flight was delayed. After months of lack of sleep and living on adrenalin, fatigue and depression overcame him. ‘It took me weeks to
recover,’ he told friends, ‘and I won!’

The loser succumbed to ’flu and had to take a week off work – an almost unheard-of event for Burt – but he knew he could not afford to give way to exhaustion. A week after
conceding defeat, and after numerous post-mortems, he admitted to being bitterly disappointed, but determined to carry on. ‘We must do something. We don’t necessarily have to acquire
something, but we must drive the business forward because if we don’t we will not only be seen to be vulnerable, we will be vulnerable and deservedly so.’ It was a sentiment widely
shared. Despite the Bank continuing to report sparkling profits growth, in the harsh judgement of the City Burt was now seen as having had two failures in a row, the Pat Robertson affair and
NatWest. ‘The next thing he does has got to work, otherwise he’s toast,’ one unnamed banker told the
Financial Times
.
¹

The feeling of despondency in the Bank extended from the boardroom to the branches. Six months’ work had crumbled in 24 hours and there was no alternative to
swallowing hard and carrying on, but the concern that the Bank could now become a victim persisted. Takeover speculation swirled around for the following six months, with newspapers vying with each
other to produce more names of banks said to be running their avaricious eyes over Bank of Scotland. The rumours had been enough to keep its share price at a premium level but they were baseless
and when Burt reported a 14 per cent rise in profits for the half-year he commented that despite the stories, there had been a ‘distinct lack of bids’. Slowly the speculation died down
and the share price subsided.

The old problem, however, would not go away. Bank of Scotland’s growth was being propelled by its success at lending, which was growing at 20 per cent a year, but it was only generating
new capital at 13 per cent a year.
²
To fill the gap it was increasingly being thrown back on the wholesale funding market. It badly needed
access to a larger deposit base. Burt had received a tentative approach from National Australia Bank and had spent some weeks talking to them but the discussions had come to nothing.

Another opportunity was not long in coming. A call came from Abbey National, a former building society which had demutualised and turned itself into a bank. The fit looked reasonable. In
contrast to Bank of Scotland, Abbey had deep roots in the north and south of England, with only a small branch presence north of the border. It was predominantly a deposit taker and a mortgage
lender, with only a modest corporate or small-business lending book, although it had moved into pensions and life assurance. Abbey was headed by another Scot, Ian Harley, whose insistence that he
be the chief executive had scuppered previous deals, according to press reports. He was not an easy man to talk to – even Abbey’s own chairman, the former Tory politician Lord
Tugendhat, described him as ‘a bit dour’, before adding, ‘but he does deliver’. But Burt got on quite well with him and did not feel he was an obstacle to a merger.

Talks continued with Tugendhat enthusiastically urging them on: ‘Bank of Scotland has been extolling the virtues of this for some time – it is self-evidently a good deal.’ But
more than personalities were getting in the way. Peter Burt favoured a merger of equals – Abbey was bigger, but Bank of Scotland was better, a more comprehensive
organisation with a broader range of skills and superior performance. Abbey, however, was unimpressed and saw it as a straight takeover: ‘We will be acquiring and we will decide
how it goes forward,’ its spokesman told the press. Recognising that a takeover by an English company, of a bank which had been part of the Scottish firmament for 300 years, might not go down
too well north of the border, Abbey’s PR department tried to make some conciliatory noises, promising extra shareholder gatherings and board meetings in Scotland. There would also be Scottish
directors – ‘It will be a pretty tartan board.’

Despite this patronising tone, the negotiations progressed, with Tugendhat and his deputy Charles Villiers meeting Sir Jack Shaw and Sir Bob Reid for the Bank. Advisers also met, but in the way
of mercenary armies some had now switched sides. Morgan Stanley, which had been on the Bank’s side in the NatWest struggle, was now aiding Abbey National. A deal looked do-able. Bank of
Scotland thought it could generate £400 million more in profit from Abbey National’s branch network and estimated that £350 million could be taken out of costs. Abbey began to
talk enthusiastically about becoming a fifth force to challenge the hegemony of the Big Four London banks, but the Bank team began to have doubts. Abbey’s corporate lending book did not look
good but the Bank of Scotland team was not allowed to see the figures.

The Bank was on the verge of walking away when, almost on the anniversary of the date on which the Royal Bank had launched the bid which had snatched NatWest away, LloydsTSB announced an offer
for Abbey. The predator was now the prey and although there was a certain referral of the bid to the Competition Commission on monopolies grounds, meaning a six-month delay, investors put pressure
on the Abbey board to end its ambitions to tie up with Bank of Scotland and support the LloydsTSB bid. Lloyds’ branch network had considerable overlap with Abbey. If it could hold on to the
customers while closing branches it would be able to make massive cost savings. It was a trick it had pulled off twice before with its acquisition of TSB (the Trustee Savings Bank) and the former
building society Cheltenham & Gloucester.

In the spring of 2001 Gavin Masterton retired as group managing director and was succeeded by George Mitchell, who like Masterston was a Bank lifer, having joined straight from school. A quick
learner
and a safe pair of hands, he had led the Bank’s operations in Hong Kong and New York before being given a mess to sort out in the international treasury
department and then heading corporate banking. Life had to go on and the Bank pressed ahead with an acquisition in Ireland and a deal with insurance company Zurich to offer loans and credit cards
to its customers.

Peter Burt, tired after years of trying to solve the Bank’s strategic problem, had taken his family for a skiing holiday to Chamonix in the French Alps when he took a call from David
Mayhew, senior partner at Cazenove. The Old Etonian had been against the Bank in the NatWest battle, now he was asking whether Burt would be willing to meet James Crosby, chief executive of
Halifax.

The former building society had undergone a transformation since Bank of Scotland had last approached it to discuss a possible merger. Mike Blackburn had retired as chief executive to be
succeeded by the man he had brought in to run Halifax’s insurance business. Crosby was young (45 in 2001), energetic and fiercely intelligent. After reading mathematics at Oxford he had
trained as an actuary with life assurance company Scottish Amicable, before moving into fund management with Rothschild Assurance. He looked the archetypal egg-head and it was joked that he was
bald because his brain was so big it had pushed his hair out. In the six years since he had taken over the top job he had made a series of bold moves designed to transform Halifax from being a
one-product mortgage bank to a more rounded financial institution. He had spent £1 billion buying the life assurance business of Equitable Life to add to Halifax’s Clerical Medical
subsidiary; he had poached Scotsman Jim Spowart from Standard Life to set up a new telephone and internet bank named Intelligent Finance; he had bought into the wealth management business St
James’s Place Capital and he had gone into partnership with Peter Wood, the man who had set up Direct Line insurance.