UK: NatWest's double act falls out of favour.

UK: NatWest's double act falls out of favour. - With failed merger talks, that £77-million hole and apparent U-turns, it is hardly surprising NatWest stands accused of weak management.

by Kirstie Hamilton.
Last Updated: 31 Aug 2010

With failed merger talks, that £77-million hole and apparent U-turns, it is hardly surprising NatWest stands accused of weak management.

Derek Wanless, chief executive of NatWest, strides across his office at the bank's Lothbury headquarters to extend a welcoming hand to all visitors - even, despite the hounding he has received over the last few months, to a journalist. The ready smile and quiet, unassuming manner give little hint of panic. Yet that is what his critics have accused him of. Confidence is, however, his trademark: when asked by one journalist if he was surprised to be appointed chief executive in 1992, at the age of 44 the youngest ever to hold the post, Wanless replied that he had had his sights on the job since he joined in the early '70s. But the confidence belies a series of failed merger negotiations, apparent U-turns and a disappointing share performance.

With Lord Alexander - the former silk who as chairman has steered NatWest through some of its toughest times, including the aftermath of the Blue Arrow scandal, the £155-million loan to Maxwell and a £2-billion bad debt provision in 1991 - Wanless stands accused of weak management. The relationship between the two has also come under severe strain, although both deny any split. Many believe that one or other of the two could be forced out within the next year; and some think that both should go.

Yet when Wanless first took on the job, a curiosity in the world of retail banking with his first-class honours degree in mathematics from Cambridge, he was seen as a breath of fresh air. Bright and popular with his colleagues - he was, he said, determined to analyse every component of the business.

'There is no place in the group for units that are subsidised or don't make the right sort of return on capital employed.'

So how did NatWest end up in its present state, where its share price lags its rivals', investors are calling for heads to roll and even insiders concede that panic is close to the surface? After all, NatWest reported half-year pre-tax profits of £775 million in August - hardly the mark of a bank in financial straits - and its retail arm remains one of the most visible on Britain's high streets. Next to Lloyds TSB, it has more branches than any of the other banks - around 1,800 at the end of August 1997, down from just under 2,700 in 1992 - and its 27% share of the small and medium-sized business market far outstrips all its competitors. NatWest shows little sign of going bust, and with bad debt provisions low and retail lending margins high, it would seem there could hardly be a better time to be in the banking business.

All that said, NatWest had shown signs of developing cracks in its facade for months. As happens with so many organisations, investors stayed silent about their concerns initially, only watching as the shares underperformed the rest of the sector. It was not until something occurred to shake them out of their reverie that the complaints began.

That event was the discovery in February this year of a pile of hidden losses clocked up by a hitherto obscure options trader at NatWest called Kyriacos Papouis. Papouis had moved on to work for Bear Stearns several months earlier, with his losses still undetected. It was only when a team of special investigators moved in as a prelude to a big shake-up in the fixed income division that his activities were uncovered.

Hidden trading losses at investment banks are a fact of life; compliance departments and managers spend their lives trying to prevent employees from slipping bad trades into a bottom drawer or excess profits into their back pockets, but inevitably the odd one slips through. Some are huge and devastating to a firm - on Wall Street, Joe Jett, the Kidder Peabody trader, effectively spelt the end of his firm's life as a GE Capital subsidiary with hidden losses, while Nick Leeson brought Barings to a dramatic and sticky end as an independent entity. For the few high-profile cases that emerge, though, there are countless smaller rogue traders, whose activities never make the press because the banks hush them up. It's not good to be seen as unable to control your traders, but every big bank will admit privately that such things can and do happen.

At NatWest, the effect of the discovery was not dramatic as far as profits were concerned - Wanless claims that the sum involved is less than two days' worth for the group as a whole - but it did have a dramatic effect on the bank's image. Almost overnight, it seemed the perception changed: NatWest Markets (NWM) ceased to be a major UK investment bank in the making and instead became an example of poor management on a grand scale.

Wanless says there were a series of reasons for the cataclysmic effects of discovering the losses: 'There are a number of layers to that,' he says. 'If you look at our overall results before that, we are in the process of transforming a large part of the group, which inevitably hits short-term profitability. Then there was the timing of the incident itself which, as it was revealed within such a short period of last year's results, in itself caused some worry. Then the loss was first of all one figure, then in a very short time it was higher - £77 million. Also, the trading had happened over such a long period. I think it would have been kept in proportion except that then came mention of the Abbey National/Prudential talks.'

Wanless believes the leaking of those early summer merger talks - first a rebuffed attempt to merge with Abbey National and then ongoing (but at this moment defunct) talks with the Prudential - caused some investors to believe that NatWest was being panicked into a complete U-turn in strategy.

Wanless fervently denies any switch, or even that the original strategy was flawed - a view which is widely held among many of his rivals. The truth, which emerged over the months following discovery of the options losses and the subsequent upheavals, is rather more worrying. NatWest seemed to have allowed itself to say one thing and do another. Its supposed strategy was to build up NWM while keeping a balance between the highly profitable and cash-generative retail side and the prestigious but cash-hungry investment bank. In reality, the investment bank was making all of the running.

Within six months, the options losses claimed their most high-profile victim so far when Martin Owen, chief executive of NWM, resigned. Owen was close to Wanless, and his determination and vision for NWM was enough to persuade the board to back him in a series of acquisitions which were intended to build up the investment bank. Over the course of two years, the bank spent £1 billion on acquisitions in fund management, bond trading and corporate finance.

Insiders say that although Owen was not a close personal friend of Wanless, he did have a remarkable ability to persuade his boss. Wanless was a key supporter in choosing Owen for the top job among three internal candidates, and remained loyal until the need for change was overwhelming. 'Owen had a hypnotic capacity; he had an almost mystical influence over the board,' says a senior NatWest executive.

When the losses were first discovered, Owen tried to take the heat out of the situation by announcing his intention of giving back £200,000 of his £500,000 bonus. Far from cooling the situation, it simply prompted more calls for his resignation. NatWest refused to move immediately, though.

It waited until the outcome of its investigation into the losses before bank officials made it clear Owen would have to hand in his resignation.

Another personnel change at the bank had already spelt danger for Owen.

That was the arrival of Richard Delbridge, the former finance director at HSBC Holdings, as group finance director in October last year. An archetypal, brusque finance director, 54-year-old Delbridge may not have the charisma and charm of a chief executive, but he has an iron grip on the facts.

Sir Brian Pearse, now chairman of Lucas Varity, found Delbridge in the finance director's chair when he moved in to become chief executive of Midland Bank. 'In the early days, if I had not had Richard about, I would have floundered,' he says. 'He has his finger on the pulse of anything that is going on - almost to a fault.'

The difference in style between Delbridge and Wanless is stark. Wanless will make broad-brush strategic proposals; Delbridge will ask exactly how this is to be achieved and paid for. Since taking over from the American Richard Goeltz - who, by comparison, was mannered and rather more careful of his chief executive's feelings - Delbridge had been horrified to discover both the extent to which NWM had begun to dominate the bank and the apparent laxity of controls within NWM. 'One of the reasons this thing erupted was because we had got to the point where 40% of our capital had ended up in investment banking,' says Delbridge. 'That is clearly not sustainable.

These things made it a very difficult time.'

Looking at the business with fresh eyes, Delbridge knew a change was necessary. But for a management whose commitment to building up NWM was a crucial and very vocal part of its strategy, the prospect of a change was painful and potentially embarrassing.

One way of fudging such a fundamental change within the bank would be if it was in the midst of an even bigger upheaval. It may have been with this thought in mind that Wanless casually mentioned to Peter Birch, his opposite number at Abbey National, that perhaps they should look at the prospect of merging the two banks. The two chief executives, plus their respective chairmen, duly held a polite meeting at the Waldorf hotel in the Aldwych to explore the prospects further, but discussions did not proceed much beyond that. Lord Tugendhat, Abbey's chairman and a former deputy chairman of NatWest, was never enthusiastic, and an Abbey board meeting voted unanimously against proceeding with the talks. The two lords agreed this was the last that would be said, publicly or privately, about the matter. Abbey National executives were horrified, then, to see it plastered over the newspapers.

If the leak was intended to encourage Abbey into talking, it achieved exactly the opposite effect. Abbey was adamant, and suddenly it was NatWest that was being perceived as vulnerable to a takeover.

Still reeling from this series of misfortunes, Nat-West's executives were in a particularly exposed position when Peter Davis, chairman of the Prudential, made his approach. Talks with the Pru advanced much further, and much more quickly, than the tentative Abbey discussions. Teams were despatched from both organisations to examine the other's books. But NatWest felt it was being railroaded into a deal that gave the Prudential all the power.

The Pru planned to offer Alexander the chairman's seat, but beyond that hardly any other NatWesters got a look in. The Pru intended putting in its own Derek Higgs as chairman of the combined fund management business, despite the fact that NatWest's Paul Myners has far more experience in the field. Delbridge, a highly experienced clearing bank finance director, was also to lose out to his counterpart at the Pru.

Wanless is reluctant to go into detail on why the deal fell down. 'It could not be the concept because banc-assurance is a concept we do believe in,' he says. 'Therefore it had to be some combination of what the merged organisation would try to be in the future and what its priorities would be.' Delbridge adds the financial dimension: 'The tricky thing about any merger is timing, because you have to get the respective values right, and if one side is fundamentally undervalued against the other, then it will not work.'

On that basis, unless NatWest can find another financial institution with a bombed-out share price, it will never find a suitable merger partner.

At the time of its talks with Abbey National, the two banks had almost the same market value, even though NatWest is a much bigger bank in balance sheet and market presence than Abbey. Only when speculation about a bidder started to enhance the share price did a gap open up between the two organisations.

After two disastrous sets of merger talks, NatWest cannot afford another mistake.Wanless says the focus now will be on getting the basic business of NatWest into the best possible form. NWM, with its slimmed-down capital base, is clearly separated from the rest of the group and will sink or swim on its own efforts. Chip Kruger, a 44-year-old American who was one of the founding leaders of Greenwich Capital, the bond trading offshoot which NWM bought last year, is now in charge of the business. It has been made extremely clear to all concerned that NWM cannot expect any further help from its parent.

John Aitken, banking analyst at UBS, welcomes the move which he sees as a means of bringing transparency to the investment banking operation - but is doubtful about whether it can ever make a good level of return.

He believes it may have to consider pulling out altogether. 'The question is, do they see it as a support function to the existing customer base or a stand-alone profit centre? If they see it as the latter, it's an enormously competitive area to be in.'

For some in the City and within NatWest Markets itself, NWM is a mere distraction from the real problem - the underperformance of NatWest's core retail banking operation. Wanless has been criticised in the past for not acting decisively enough in taking the axe to NatWest's branch network, a charge he has consistently rejected. Indeed, since 1994 NatWest has shut more than a quarter of its branch network - just over 600 branches.

It was down to 1,794 by August this year and plans to shut another 74.

And in its new retail bank strategy announced in December 1996, the retail bank forecast a fall of 10,000 jobs over the next four to five years, emphasising at the same time that there would be no new compulsory redundancies.

Overall staff numbers fell by 400 to 71,000 from the first half of '96 to the first half of '97, although for NatWest UK the headcount was reduced by 2,700 during that period.

In the meantime, analysts fret that the retail bank is still lagging behind its competitors in terms of cost efficiency. 'It has been closing branches but not quite as rapidly as some of its competitors,' says Aitken.

Overall operating expenses for NatWest UK are rising faster than income - core operating expenses for the first half of 1997 were £1,134 million, up 5% on the first half of 1996, compared with a 3% increase in operating income to £1,734 million. Hence the attraction of a deal with Abbey National, complete with its prospect of gaining market share while taking out overlapping costs.

Yet, compared with most of the rest of NatWest's operations, the UK retail and commercial business is performing well.

Both NatWest UK and Ulster Bank currently deliver returns on equity in excess of 25%, compared with 2.4% for NWM, and 10.8% for NatWest Wealth Management, which under rising star Myners is seen as a crucial part of any fight-back plan.

The 49-year-old joined NatWest in 1996 when Gartmore, the fund management group of which he was chairman, was sold to the bank by Indosuez. As unlike a NatWest lifer as it is possible to be, Myners is in no need of the income the bank provides: he made his fortune as he and his Gartmore colleagues cashed in their share options when British & Commonwealth sold the business to Indosuez for £138 million in 1990. But the former journalist's ambitions are not yet sated. He became head of a newly formed Wealth Management Division within NatWest a few months back. It operated outside what was then Owen's domain at NWM, and aside from Gartmore and NatWest's fund management operations it comprises the private bank Coutts, the venture capital firm NatWest Ventures, and NatWest Life. In the latest reshuffle, which was announced along with the half-year results, Myners joined the main board of NatWest. As a man with an in-depth knowledge of institutional investors and their behaviour, he has suddenly taken on an importance out of all proportion to his knowledge of banking or NatWest.

Before the thunderbolt of the options losses struck the bank down, NatWest had been keenly pursuing one last takeover - this time a life assurance company. Its own attempt at creating a life assurer, NatWest Life, began in a burst of enthusiasm just before the pensions mis-selling scandal hit the industry. In the grim new world that followed, NatWest Life's forecasts proved hopelessly optimistic.

Wanless appears to have given up on the last big acquisition. 'Paul Myners does not yet have a brand name that would develop the independent financial advisers' channel for assurance,' he says. 'But the likelihood is that in the short term he won't have because we cannot justify the prices being paid.' Myners backs him up: 'If you look at what the acquisitions bring in this area, it tends to be technology and infrastructure. But the key to making NatWest Life work is the ability to identify the assurance and investment needs of our existing clients. We have six million customers, a high percentage of whom will have an interest in buying assurance or investment policies or plans. My own view is that the advantages of life assurance acquisitions are over-stated.'

One crucial factor in NatWest's fight-back will be the strength of the bank's management team, which many of its shareholders believe is too thin to deal with its difficulties. One recent recruit is Lord Blackwell who was head of the 10 Downing Street policy unit when John Major was prime minister. In August, Blackwell, a former McKinsey consultant, became director of group corporate development - an area where the bank has been seen to be particularly weak.

The influence of newcomers like Myners and Delbridge will be crucial in deciding whether NatWest's current management gets a second crack at repairing the company. The bank is still, insiders say, imbued with an almost civil service-style lethargy, where decisions are made by committee and there is a committee for every occasion. The words of UBS's Aitken are far from comforting. 'The NatWest management, of all the banks I look at, are the most collegiate in nature. In many ways they are the most insular and inward-looking. Most of them have come through the ranks together, they know each other and support each other ... I don't think the management set-up at NatWest is comfortable with radical change.'

Strangely enough, the person most at risk from the current upheavals is someone who has tried hard to assert his own individuality at NatWest - Alexander. Even the heads of rival banks are in little doubt that the chairman should offer himself as a sacrifice. 'If Bob were to go, the share price would jump and the bank would be worth a billion or so more immediately,' suggests the chief executive of another bank. Will he do so? That probably depends on whether NatWest can survive the next six months without slipping on another banana skin. Any further mistakes could prove very costly indeed.

Kirstie Hamilton is City editor of the Sunday Times.


Operating Pre-tax

income (£m) profit (£m)

NatWest UK 1,734 453

Lombard 463 110**

Ulster Bank Group 181 70

NatWest Wealth 270 67


Coutts (now 225 51

part of Wealth


NatWest Markets 670 58**

Total 3,543 809

**excludes write downs.

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