A Raid On The Staid

Bank of Scotland's NatWest bid roils British banking

Rarely in recent memory has an event so excited the City of London as Bank of Scotland's $35 billion raid on National Westminster PLC on Sept. 24. The unwelcome assault on a major if somewhat tarnished London bank by a Scottish player less than half its size has stoked up hope among investors that the long-awaited shakeout in British banking has at last arrived. With other bids rumored, share prices of banks and insurers from Barclays to Abbey National have turned frothy.

There's a lot here to put the City in a tizzy. It's by far the biggest takeover ever attempted in Britain. And whether it succeeds or not, the Edinburgh-based bank's raid is likely to have sweeping consequences for the sleepy but profitable world of British banking. Everyone knew consolidation made sense. But since the mid-1990s, the pecking order in British banking has been virtually frozen as the four biggest institutions--NatWest, Barclays, HSBC, and Lloyds TSB--warily circled each other without pouncing. Hefty market capitalizations and concerns that regulators would block combinations of the big banks discouraged strategic moves.

Now, credit goes to Bank of Scotland, a smaller, more innovative player, for trying a new avenue of attack that could crack open the market. Credit goes especially to Peter A. Burt, Bank of Scotland's 55-year-old chairman and a former executive at Hewlett-Packard Co., for stalking big prey. Combining Bank of Scotland's focused management with NatWest's franchise could produce a winner, analysts say.

HUGE THREAT. NatWest is often dismissed as a weak sister compared with its stronger domestic competitors, but it still has 16% of the British retail market and a quarter of the corporate market. It made a return on equity of 19% last year. And NatWest had operating profits of $3.8 billion for the 12 months ended June 30, 1999. "If Bank of Scotland's team starts to run NatWest, it will be a huge threat to HSBC, Barclays, and Lloyds TSB," says Jonathan Gollins, bank analyst at Donaldson, Lufkin & Jenrette International in London.

But first, Burt has to bag his prey. Bank of Scotland originally considered making its bid in combination with Edinburgh-based Royal Bank of Scotland Group PLC. Now, Royal Bank is contemplating a rival offer that would have the support of Spain's Banco Santander Central Hispano, which owns a 10% stake in Royal Bank. Other potential bidders include British mortgage specialists Abbey National and Halifax. Outsiders, such as Deutsche Bank or even Citigroup, could be tempted to go for a huge piece of the British market.

NatWest put its own independence into grave jeopardy. The bank, headed by CEO Derek Wanless since 1992, repeatedly disappointed investors. It has been slow to cut costs and has made huge blunders. Its troubled foray into the U.S. in the late 1980s led to a $1.1 billion loss in 1996. And its failed move into investment banking resulted in $730 million in write-offs in 1997. The final straw was the bank's Sept. 3 announcement that it had agreed to buy insurer Legal & General for $17 billion. Investors thought the price was too high. They pounded NatWest's share price down 19%, exposing it to suitors.

The City finds the Bank of Scotland's Burt and his chief executive, 57-year-old Gavin G. Masterton, a welcome contrast to NatWest's brass. Burt and Masterton have juiced up Bank of Scotland's performance. In the fiscal year ended last February, it earned $1.6 billion pretax. It helped its bid by reporting pretax earnings up 12%, to $777 million, for the six months ended Aug. 31.

Bank of Scotland plans to dispose of NatWest's noncore assets, including marginally profitable U.S. bond boutique Greenwich NatWest Ltd. and its Gartmore fund management unit. Analysts reckon the disposals could bring $4.1 billion. Bank of Scotland would also cut $500 million in costs per year, largely by combining back-office operations.

Investors will now have to decide whether the Scots have the proper credentials to run one of Britain's biggest financial institutions. Bank of Scotland's bid may not be the winning move, but it has certainly changed the game.

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