In October 2007 the Royal Bank of Scotland Group (RBS) led a consortium in acquiring Dutch bank ABN Amro in a deal worth £50bn. However, a year later the company had endured a £5.9bn write-down of its asset book value, a £12bn rights issue to raise necessary capital and eventually had to be supported by HM Treasury in a well-publicised bail out of UK banks. The question is; what went wrong?
First of all the motivations for the acquisition have to be seriously called into question. The £50bn deal represented a hefty chunk of capital but this seems even pricier when you consider that RBS paid a whopping 70% premium over the actual value of ABN Amros’ shares. This was evidently a boom time in the banking industry and sacrifices have to be made, many argued. During mergers and acquisitions companies usually expect to pay a 20-30% premium on the value of the target companies shares but looking back, boom or no boom, this price seems ridiculous. In addition there was growing uncertainty in capital markets and it was being questioned whether growth could be sustained in the banking sector.
Nevertheless the acquisition promised to provide RBS with €1.8bn synergy gains and would enhance the group’s international capabilities. What part did management play in the failures of this takeover?
RBS’ acquisition of ABN Amro was a hostile break up bid and it was virtually unprecedented to break up a company which operated on such a worldwide stage, in particular a bank. Since 2000 ABN Amro had experienced rapid expansion into the foreign markets of Europe, South America and the USA. At one point it had been seen as a potential rival to some of the banking sector’s leading world players. However the company had experienced recent poor performance leading to deterioration in the share price and calls from its own shareholders for the company to be broken up. Considering the growing concerns over the viability of the banking sector surely RBS would have been best served by refining and improving the existing services of the bank. ABN Amro quite obviously had the ability to be successful, they just needed the guidance of RBS to realise this once again.
However RBS were fully intent on a major overhaul of the business involving extensive staff cutting and cost saving measures. This was represented early on by the dismissal of ABN Amro’s current CEO Rijkman Groenink for a costly final severance package of just over €30m. This, and other strategic decisions, was questionable, however RBS quite clearly wanted to firmly plant their own stamp on affairs. Commentators at the time drew distinct similarities with RBS’ extremely successful takeover and implementation of the National Westminster (Natwest) bank in 2000. RBS were quite fairly attempting to follow a similar process. But what went wrong this time around?
Firstly, and most importantly, post deal there was a serious decline in credit market conditions and a quickly worsening economic outlook in what has since been coined the ‘financial crisis’. For RBS this meant the capital required to fund the ABN Amro deal was placing a huge strain on the company’s assets. This, coupled with the exposure to the housing market crash, led to the write down of £5.9bn of the company’s assets and a £12bn rights issue in April 2008 to help shore up the company’s finances. At the time this represented the largest rights issue in UK corporate history and the deal allowed shareholders to purchase shares at an incredible 46% discounted price of only 200p per share (the actual share price at the time was 372.5p!). The turmoil was quite clear to see and the capital straining ABN Amro deal was being pinpointed as the root of the problems.
The situation did not ease and the UK government famously intervened in October 2008 to help recapitalise UK banks. RBS was one of the main beneficiaries of an initial £37bn bailout aimed at stabilising the situation; providing short term liquidity and facilitating future lending. What I cannot understand is if there was uncertainty surrounding the UK economy, and in particular the banking sector, then why participate in such a daring, capital intensive takeover of ABN Amro. Perhaps the motives of a certain individual could help explain this?
The acquisition of ABN Amro represents the world’s biggest ever bank takeover and the then CEO, Fred Goodwin, would have taken immense personal pride in being at the centre of such a prestigious deal. John Varley, CEO of rival bidder Barclays, commented at the time that Goodwin was willing to pay any price for ABN Amro - to win at any cost! Goodwin appeared to take the attitude that he had done it before with Natwest, why couldn’t he do it all over again. His overriding desire was to enhance the bank’s worldwide power as opposed to protecting the welfare of the company and, in particular, the shareholders. In the year from the takeover to the government bailout RBS shareholders lost an astonishing 440.5p (86%) off the value of their shares - and the situation is still no better:
The ABN Amro acquisition was an immense failure, but it could be argued this was largely due to it being a victim of circumstances. The credit crisis put too large a strain on RBS resources and ultimately the ABN Amro deal went down with it. But the cost of the deal reached dizzy heights at a time of uncertainty and I would describe it as a silly deal at the end of a simmering debt-fuelled boom in the UK economy. A bank like RBS, the epitome of safety to many, should have known better and Goodwin not only should but probably did know better.
You clearly believe the acquisition of ABN Amro played a major role in the downfall of RBS. Do you think RBS would still have had to be bailed out by the UK government if the deal had not taken place?
ReplyDeleteThis is a difficult question and one which could be discussed and discussed; however put simply I think that RBS would still have had to be bailed out even without the ABN Amro deal. Firstly, the total consortium deal to purchase ABN Amro was worth £49bn however the RBS stake was in fact only £10bn. Under normal circumstances this outlay could have been easily managed, however the purchase depleted capital reserves, a problem which was heightened with the onset of the credit crunch the following year.
ReplyDeleteThe main reason I believe RBS would still have had to be bailed out is because the company was already well exposed to the bad debts even before the takeover of ABN Amro. In 2006 the Financial Times recognised RBS as being one of the top three underwriters of CDO’s; the debt with the steepest writedowns and most exposed to the subsequent housing market crash. The original bailout package for RBS was worth £37bn, looking at this from a basic level it should be recognised that this far outreaches the original £10bn stake made to purchase ABN Amro.
Furthermore I feel that most of the losses were not realised with ABN Amro until after the government bailout. In January 2009, three months after the bailout, RBS were forced to writedown £20bn of goodwills, £16.9bn of which was estimated to be relating to the overpayment for ABN Amro. When you look back with hindsight this overpayment becomes glaringly obvious. The closest rival bid from Barclays, which was eventually withdrawn due to accurate concerns about worsening economic conditions, was worth €61bn. The RBS consortium eventually paid €71bn, €10bn over the rival offer even though it was withdrawn.
All said I am not downplaying the significance of the ABN Amro as it was certainly a major factor in RBS’s failure; over 50% of the market losses experienced by RBS, largely associated with subprime debts, could be originated back to ABN Amro portfolios. In conclusion I feel the bailout package would still have been required, albeit to a lesser value.
You only comment briefly on the role of Fred Goodwin in the case of RBS. Can you expand more on his actions which have contributed to the failure of the ABN Amro takeover and moreover the failure of RBS generally?
ReplyDeleteFred Goodwin was the CEO of RBS from 2001 to 2008. Despite what has subsequently happened to RBS this was largely regarded as a successful period for the company, especially for shareholders where for the large part the share price rose healthily reaching a peak of nearly 700p a share in 2007. The achievements of Goodwin personally were recognised in 2004 when he was awarded a knighthood for services to banking (this has subsequently been taken away).
ReplyDeleteHowever some key criticisms have been levelled at Goodwin both during and following his tenure with RBS. Firstly he was a lavish spender using vast amounts of shareholder funds on resources that added little value to the company. For example over half a billion pounds was spent on overly luxurious headquarters firstly in Scotland in 2005 and in Connecticut (USA) the following year. Similarly it was reported the company owned a private jet to ferry around the already vastly paid directors. This cost the company around £18m and a further £7,700 per hour (!) it was operational. This shows a complete lack of frugality which should have been displayed in abundance by the leader of such a huge bank to display to shareholders and the general public.
Fred Goodwin was at the heart of RBS’s rapid expansion strategy in which the company purchased numerous companies in the millennium. These included Natwest, Churchill, Direct Line, Charter One Financial and, as focussed on in the blog, ABN Amro. The problem with these deals was that Goodwin regularly overpaid for companies that were often failing or debt-ridden. It is argued that the purpose of this strategy was simply to increase the size, prestige and assets of RBS and to allow Goodwin to achieve the extensive financial bonuses that came with this. The final deal in this expansion strategy was ABN Amro, the worlds biggest ever bank takeover, but this was to be a deal too far.
Most infuriating about the case of Fred Goodwin is that he actively deceived the board of directors and more importantly the shareholders. Goodwin regularly stated that RBS “don’t do sub-prime” and even stated in the 2006 annual report that the company had performed well due to a “long-standing aversion to sub-prime lending”. However following the banking crisis it has emerged that in 2007, under Goodwin’s supervision, RBS had amassed a whopping £34bn of sub-prime assets. This was at a time when even US banks were offloading these debts as it was quite clear how dangerous they were. A large amount of the exposure to the sub-prime crisis was inherited in the ABN Amro deal.
It cannot be presumed that Goodwin knew exactly what trading was occurring regarding sub-prime assets but ultimately he was the boss so the buck stops with him. His continued pursuit of an endless expansion strategy coupled with a desire for personal prestige certainly led the bank astray.