Is This Europe's Best Bank?

Royal Bank of Scotland has turned into a top player

Some chief executives like to play the role of visionary. Fred Goodwin of Royal Bank of Scotland Group PLC doesn't bother. "We have a philosophy that you shouldn't try to predict the future, but rather spend your time preparing yourself for what the future might bring," he says.

In other words, the gangly, boyish-looking Goodwin and his aides are opportunists waiting to pounce on chances that come their way. Judging by the results of recent years, this approach serves RBS well. In two years, RBS has transformed itself from a Scotland-based regional player to one of the dominant financial institutions in Europe. It's the second- largest European bank by market capitalization, 10th by assets, and one of the most profitable. And it's building an increasingly strong presence in the U.S.

With a shakeout likely to occur in European financial services over the next decade, RBS has a good shot at being a leading protagonist. It is aggressive, innovative, and unstuffy, unlike some of its rivals in London and on the Continent. Above all, it is lean: By consolidating technology platforms and making myriad other cost-cutting moves, it is expected to post the lowest cost-to-income ratio of any major European bank this year. And if it goes hunting, it has a strong ally in Spain's Banco Santander Central Hispano. While Goodwin says cross-border combinations that make sense are probably years off, Santander is an excellent source of market intelligence. The Spanish return the compliment. "RBS is a real banker's bank," says Santander Chairman Emilio Botin. "They are solid, profit-oriented, efficient."

So far, RBS has struck its richest deal at home. In 2000, it bested Edinburgh rival Bank of Scotland in a $33 billion hostile takeover of inept but well-endowed National Westminster Bank PLC, an institution three times the size of RBS. Combining the two has been a brutal process involving 17,000 job cuts. Service is spotty--the lines at NatWest branches can be long--and, to customers, the two outfits still seem like separate operations. The pain, however, will translate into $3 billion a year in savings, the bank says.

Goodwin, who managed the integration, is more than a slash-and-burn artist. He says he values revenue-boosting over cost-cutting, saying, "If you can grow income, you can sort everything else out later." For instance, he ended a NatWest branch-closing program that he feared would cut deposits and business, and wound up keeping Greenwich Capital, a U.S. securities firm that RBS planned to sell. "I think the clever part of the NatWest deal was that RBS realized NatWest was struggling but not a basket case--they had a lot of strengths," says Mike Trippitt, bank analyst at Bear, Stearns & Co. in London. RBS has "injected a growth spirit." Certainly, NatWest is a big reason for RBS's strong earnings growth. For 2001, RBS reported a 28% increase in pretax profits, to $6.62 billion, on an 18% rise in revenues, to $22.6 billion. Commerzbank forecasts a 15% increase in profits for this year, to $7.65 billion.

A blunt but self-effacing Scot, Goodwin, 43, arrived at RBS in 1998 as deputy CEO to George Mathewson, who is now chairman. Before RBS, Goodwin was the chief executive of two midsize British banks after serving as a partner at accounting firm Touche Ross & Co., where he played a key role in managing the liquidation of rogue bank BCCI.

Sizing up his options, Goodwin says another major acquisition in Britain is not on the cards unless the regulators become more liberal about local giants gobbling up market share. So he's focusing on his existing businesses. He is enthusiastic about Coutts, the private bankers to the Queen and other luminaries, which came with NatWest. Coutts has gone into the red-hot hedge-fund business and has expanded its funds under management by 6%, to $53.7 billion, last year. Goodwin thinks Coutts will fare better than other asset managers if equity markets continue to plummet, since it also provides banking services. NatWest also gave RBS the balance-sheet size needed to play the risky but lucrative game of lending for buyouts deals. Among its recent deals: a $550 million high-yield bond for Allianz Capital Partners' purchase of industrial-gas producer Messer Griesheim from Aventis, and $865 million for the management buyout of Lafarge Specialty Materials.

For now, pushing business lines such as aircraft leasing and insurance--rather than buying banks--is Goodwin's plan on the Continent. In a crossborder takeover, it wouldn't be easy to combine functions such as personnel and payroll, and banks in different countries are usually too different to smoothly consolidate their technology. Financial products also vary too much from country to country to achieve big gains by marketing them across borders. Some day, he says, as employment practices and financial services converge, deals will become attractive. But Goodwin thinks that will take three years or more.

This state of affairs means there isn't a wide range of activities RBS can profitably share with its Continental partner, Santander. Nevertheless, the relationship, which dates to the 1980s, pays a lot of dividends, Goodwin says. Several members of the two management teams dine together monthly and share insights on the industry. Santander's Botin helped clinch the NatWest deal by coming up with $2.64 billion in cash on the basis of just a phone call. "There aren't many friends you can do that with," Goodwin says. RBS helped in a smaller way with Santander's purchase of Banespa, a Brazilian bank, in 2000. Santander owns about 8% of RBS, while RBS owns 2.7% of Santander.

Meanwhile, a more important hunting ground could be the U.S., where RBS is quietly becoming a force. RBS has proceeded cautiously, acquiring Citizens Financial Group Inc. back in the late 1980s, when it was just the seventh-largest bank in Rhode Island. It gradually took over other local banks and is now the second-largest bank in New England, behind FleetBoston Financial Corp. Running out of room there, Citizens recently turned to Pennsylvania, paying $2.1 billion last year for the retail and small and midsize corporate business of Mellon Financial Corp. People close to RBS say Goodwin now has the confidence to play a major role in the next phase of U.S. bank consolidation. Citizens, they say, has a shot at becoming the top bank in the Northeast and moving into the Midwest. Last year, Citizens kicked in $776 million in profits.

What could derail this express? The greatest danger is a sharp slowdown in Britain, where RBS still has about 80% of its loans. Provisions for problem loans more than doubled in 2001, to $766 million. Goodwin, however, says he is not overly concerned. Companies are better-managed than they were in the disastrous British recession of the early 1990s, and, he says, it is much easier to nurse a viable business through a crisis at today's 4% interest rates than at the 15% of a decade ago. Moreover, the British economy has held up better than most. Of course, the future is a foggy place these days. Then again, Goodwin never said he was in the business of prediction.

By Stanley Reed in Edinburgh

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