Merging on the ridiculous
Royal Bank of Scotland (RBS) recently announced that it is dramatically downsizing its investment banking business. This largely marks the end of its ill-fated acquisition of ABN Amro (ABN). The unwinding show the tough time commercial banks have when they try to break into investment banking through an expensive acquisition.
There are a few reasons why RBS' acquisition came to grief. First, there is no doubt that the bank overpaid for this asset. In 2007, ABN was the subject of an intense bidding war between Barclays and a consortium comprising RBS, Fortis and Banco Santander. The RBS consortium won and RBS took over the investment banking business and Asian network. Fortis and Banco Santander took over the Dutch and Brazilian retail operations.
The former chairman of ABN, Rijkman Groenink, was accused of obstructing the RBS-led deal. But he did a magnificent job of playing one bidder against the other, although he was only paid a few million euros to retire for his effort.
His strategy resulted in the consortium agreeing to pay US$98 billion for the bank at the peak of the market, at a huge premium over the bank's book value. It did not help that the 2008 credit crisis - a catastrophe for the banking business - hit just as the deal closed.
But ABN was not the right bank for RBS to fulfil its investment banking dreams. It was mainly a commercial bank with a relatively small investment banking business - as was RBS. ABN's investment banking business was built largely on using its commercial bank's balance sheet to give cheap loans to clients to win mandates.
Before the acquisition in 2006, despite its investment banking revenues being boosted by the buoyant markets, operating expenses and loan losses were ballooning. Its trading books were also filled with high-risk assets.
As such, a vicious cycle started when markets collapsed with the financial crisis. Demand for investment banking services plummeted, assets turned bad and their write-downs eroded RBS' capital base, which made it difficult to continue to lend cheaply to win investment banking mandates.
According to a report by the Financial Services Authority in Britain, which probed the acquisition, RBS proceeded with the bid despite being provided with very little information for due diligence. ABN provided only two folders and one CD-ROM of information. RBS was confident in its ability to wring synergies out of the acquisition.
The massive write-off of the goodwill and asset impairment charges from the acquisition wiped out RBS' capital base. The British government was compelled to nationalise the bank to prevent a banking crisis. The government ended up with more than an 80 per cent shareholding.
RBS, which has been downsizing its investment banking operations since 2008, was finally forced to exit that business after George Osborne, the British Chancellor of the Exchequer, said that the bank should focus on its business in Britain, and that investment banking should be supporting its corporate lending business.
Inflated pricing, poor strategic fit and shoddy due diligence are not the only reasons why acquisitions could fail. Cultural differences can also destroy much value down the road if the new owners fail to stem talent outflow or integrate operations. This is particularly true when commercial banks attempt to buy out investment banks.
For example, ING acquired Barings in 1995 for a nominal GBP1 (while assuming its liabilities), after Barings was brought to its knees by Nick Leeson's unauthorised GBP800 million (HK$9.6 billion) trading losses. ING bought Barings to 'increase its brand recognition and strengthen its wholesale banking presence in the emerging markets'.
The conservative, cost-conscious and hierarchical culture of ING - an insurance and commercial banking outfit - was a marked contrast with the volatility, egos and relatively high pay associated with an investment bank like Barings. ING suffered an exodus of talent when the retention bonuses were paid.
In 1995 and 1996, Barings was the top merger and acquisition adviser in Britain. A couple years later, it had fallen in the league tables. Because ING was unused to investment banking pay packages, it was unable to attract the talent required to generate the revenue needed to cover its high fixed costs.
In addition, as it was unable to stomach the losses when investment banking revenues declined during market downturns, Barings suffered a death of a thousand cuts as ING exited parts of the business after every crisis. In 1998, at the onset of the Asian financial crisis, it pulled out of its equities business in Latin America (where Barings was highly rated) and India. An increase in investment banking in 1999 ceased when fees dried up after the internet bubble burst in 2001. ING sold its investment banking operations in the US to ABN that year.
In 2002, ING dropped the Barings name altogether, marking an end to its investment banking aspirations. In March 2004 after the Sars outbreak, ING sold its Asian equities business to Macquarie, which then proceeded to build a successful investment banking business around it. It also sold Baring Asset Management. All that remains of Barings within ING is a shrunken presence in Britain and parts of Europe. So much for acquiring Barings for its brand name and presence in the emerging markets.
ING's much vaunted conservatism took a hit when the Dutch government had to rescue it with an Euro10 billion (HK$101 billion) loan in 2008, after suffering huge losses in its insurance investment portfolio. It has since been busy selling assets to repay the loan.
Investment banks continue to be attractive acquisition targets for many commercial banks despite the potential pitfalls. They offer opportunities to generate fee income to enhance returns.
Bank of America bought Merrill Lynch for about US$50 billion in 2008. Barclays paid about US$1.75 billion for some of Lehman Brothers' US operations, while Nomura took Lehman's Asian and European businesses for about US$225 million. Standard Chartered acquired Casenove Asia for an undisclosed amount.
Some of these acquisitions are already losing money, and steps are being taken to restructure. Recently, Jesse Bhattal, the head of Nomura's wholesale banking, stepped down and Bank of America Merrill Lynch fired 15 out of its 75 managing directors in Asia. Do such mergers work? The recent evidence is no.