OXFORD BROOKES

UNIVERSITY
RESEARCH AND
ANALYSIS PROJECT
AN ANALYSIS OF THE FINANCIAL AND
OPERATIONAL CONSEQUENCES OF A
MERGER BETWEEN TWO
ORGANISATIONS OR OF THE
ACQUISITION OF ONE ORGANISATION
BY ANOTHER.

A CASE STUDY ON THE ROYAL BANK OF

SCOTLAND (RBS)
BY BLESSING R UMOETTE
2011
 OXFORD BROOKES RESEARCH ANALYSIS PROJECT

AN ANALYSIS OF THE FINANCIAL AND OPERATIONAL

CONSEQUENCES OF THE ROYAL BANK OF SCOTLAND
ACQUISITION OF NATWEST BANK

1999-2003

BY: BLESSING REUBEN UMOETTE

ACCA NO. 1496234

Word count 6,500

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TABLE OF CONTENT

PART ONE: INTRODUCTION, RESEACH OBJECTIVES AND APPROACH .................................................... 4

1.1 Introduction ...................................................................................................................................... 4
1.2 Reasons for choosing Royal Bank of Scotland................................................................................. 5
1.4 Research Objectives and Research Question .................................................................................. 6
1.5 Research Approach ......................................................................................................................... 6
PART TWO: INFORMATION GATHERING................................................................................................ 8
2.1 Sources of information ..................................................................................................................... 8
2.2 Methods Used To Gather Information.............................................................................................. 9
2.3 Limitations of information gathered............................................................................................... 10
2.4 Ethical issues and resolutions ......................................................................................................... 10
2.5 Accounting and Business models used and their limitations ......................................................... 11
PART THREE: RESULTS AND ANALYSIS .................................................................................................. 13
3.1 Background of the Acquisition ....................................................................................................... 13
3.2 Financial Motive that lead to the Acquisition ................................................................................. 13
3.3 SWOT ANALYSIS OF THE ACQUISITION ....................................................................................... 14
3.4 Main Financial Ratios for Both Banks: ............................................................................................ 20
3.5 Operational consequences of the merger between Royal bank of Scotland and NatWest bank
.............................................................................................................................................................. 24
3.6 Financial consequences of the merger between the Royal bank of Scotland and NatWest bank . 29
3.7 Conclusion ....................................................................................................................................... 34
3.8 Recommendation ........................................................................................................................... 35

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TABLE OF FIGURES

Figure 1: SWOT Analysis of the RBS merge with NatWest ................................ 15

Figure 2: MARKET CAPITALIZATION ................................................................ 16
Figure 3:Market Capitalization ......................................................................... 17
Figure 4:RBS MARKET SHARE AND MARKET GROWTH RATIO .......................... 18
Figure 5:UK Business Cycle............................................................................... 19
Figure 6: RBS CAPITAL ASSET GROWTH RATIO ................................................ 20
Figure 7: RBS Cost: Income Ratios .................................................................... 21
Figure 8:Main financial ratios........................................................................... 21
Figure 9: Cost to income ratio of the Royal bank of Scotland group (1999-2003)
......................................................................................................................... 22
Figure 10: RBS Return on Equity ratios (1999-2003) ........................................ 23
Figure 11:RBS table of Staff reduction ............................................................. 27
Figure 12: RBS Staff reductions ........................................................................ 27
Figure 13: RBS Equity ratios ............................................................................. 30
Figure 14: RBS earnings per share ratio ........................................................... 30
Figure 15: RBS Share price(2000-2003) ............................................................ 31
Figure 16: Income ratios .................................................................................. 31
Figure 17:RBS Revenue (2000-2003) ................................................................ 32
Figure 18:Revenue and Cost benefits analysis ................................................. 33

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PART ONE: INTRODUCTION, RESEACH OBJECTIVES AND
APPROACH

1.1 Introduction
This study elaborates on the consequences of mergers and acquisitions in the UK
banking industry. Mergers and acquisition represent a fast-paced and highly complex
environment in which transactions provide unique opportunities with considerable
risk, mergers and acquisition are also a vital part of any healthy economy because
they force firms to use their resources efficiently and allow strong companies to grow
and weaker ones to be taken over (Baker 2011). Through mergers and acquisitions
a company can grow rapidly without having to create another business entity,
furthermore it enables firms to achieve their competitive advantage by anticipating
and adjusting to change (Johnson 2008).

It also enables companies to achieve its strategic objective and goals and
thereby increase shareholders wealth (Kaplan 2011). Mergers and acquisitions also
represent an important means of corporate restructuring (Gaughan 2011),
companies are keen to participate in it because by combining their assets with those
of another firm they can achieve operational and financial synergies such as
realizing economies of scale and scope, increased market power, increased
utilization of the management team, cheaper access to capital and a greater internal
capital market.

Jensen (1988) defines mergers and acquisitions as a market for corporate

control where management teams compete for the right to manage the assets
owned by shareholder. Trends in globalization, Technology and competition
continue to drive Mergers and acquisitions globally.

There has been a huge increase in the number of mergers and acquisitions during
the past few years in the UK banking sector, it has become a distinctive trend of the
UK economy, which is often driven by the anticipation of financial success due to
reduced competition, operational synergies and having a large market share,
Unfortunately not all mergers and acquisitions turn out to be a success as is normally
foreseen. It is on this note that I developed an interest towards the topic, because of
the uncertainty surrounding a merger and acquisition deal.

4
Lastly, studying for the ACCA examinations has given me an understanding of the
different strategic decisions a company makes, on how to compete, where to
compete and how it can utilize its resources to gain a competitive advantage and
maximize shareholders wealth.

1.2 Reasons for choosing Royal Bank of Scotland

According to BBC news online, Royal bank of Scotland is one of the banks that
began the merger wave in the UK banking industry, when it made a bold bid in 1999
to take over the NatWest bank. It became market leader in the UK banking industry,
after winning a hostile takeover battle for the NatWest bank on 11 February 2000,
which is said to be the largest takeover battle in UK corporate history, Royal bank of
Scotland has operations in the UK, Europe, the US and the Asia pacific region. How
a small Scottish retail bank was transformed in less than two decades into not just
one of Britains, but one of the worlds largest banks, and how it also went from a
position of global leadership to a failure at the height of the financial crisis that almost
brought down the entire UK financial system and the intervention by the UK
taxpayers.

Also its acquisition history which saw it forming a consortium with Fortis bank and
Santander to acquire ABN AMRO a Dutch bank, which is said to be the reason
behind the Royal Bank of Scotland downfall, these happenings at Royal Bank of
Scotland caught my Interest and motivated me to choose it.

RBS Group is the largest banking group in Scotland, and at its earlier peak was the
second largest in the UK and Europe (fifth in stock market value), and the fifth
largest in the world by market capitalisation. According to Forbes Global 2000, it was
the tenth largest company in the world.

The RBS Group operates a wide variety of banking brands offering personal and
business banking, private banking, insurance and corporate finance throughout its
operations located in Europe, North America and Asia. In the UK and Republic of

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Ireland, the main companies in the Banking division are: The Royal Bank of
Scotland; National Westminster Bank; Ulster Bank; Drummonds; and Coutts & Co.
Also, the RBS group owns Citizens Financial Group; the 8th largest bank in the
United States. From 2004 to 2009 it was the second largest shareholder in the Bank
of China and the world's fifth largest bank by market capitalisation in February 2008.

The Insurance division includes: Churchill Insurance, Direct Line, Privilege, and The
National Insurance and Guarantee Corporation (NIG).

1.4 Research Objectives and Research Question

The following are the research objectives:

This research is aimed at assessing the business and financial motives

behind the acquisition and mergers of Royal bank of Scotland and NatWest.
This research will also provide a critical analysis of the biggest acquisition
deal in the UK by looking at the financial and operational synergies the
company will achieve following the merger.
It will also provide an overview of the effect the merging exercise has on the
Royal bank of Scotland and the NatWest financial performance .
Research Question: Did Royal bank of Scotlands acquisition of NatWest
bank deliver its target results as promised?

1.5 Research Approach

A Swot analysis is carried out on the Royal bank of Scotland following its acquisition
of NatWest bank.

Also an analysis is carried out on Royal bank of Scotland to evaluate the operational
effect of the merger and acquisition of NatWest Bank. The following effects will be
evaluated for that purpose:

Business synergy
Systems compatibility

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 Change in Marketing strategy
Change in Product Mix
Redundancies or Recruitment

Also an analysis of the financial consequences of the merger is carried out by

evaluating the following effects:

Economies of scales
Revenue benefits and cost savings
Benefits to shareholders and Stakeholders

A ratio analysis is carried out to analyse some of these financial effects on the Royal
bank of Scotland. Financial statements of the Royal Bank of Scotland from 1999-
2003 is used for this analysis, the financial ratios of the Royal bank of Scotland
before the acquisition and post-acquisition are analysed to reach the conclusions.

7
 PART TWO: INFORMATION GATHERING

2.1 Sources of information

The research is carried out based on secondary data, which was taken from the
following sources:

On-line and electronic data bases

I had access to the on-line and electronic data base such Pro-quest, Data monitor,
Fame, Osiris also helped in analysing the financial data which contributed a lot to the
necessary information needed to carry out this research.

Technical Articles

I was able to gather data from e-journals mostly business journal and Academic
journals such as the journal of management review, Harvard business review ,
Journals of market research also provided useful insight, ideas on the topic I had
chosen.

Newspapers

Newspaper articles and reports on mergers and acquisitions were very helpful as it
provided a useful insight into these activities and why companies are eager to
acquire or merge with other companies, and also information on Royal bank of
Scotland Acquisition of NatWest, The financial times, The Guardian and Vanguard
also helped a lot.

Textbooks

Useful explanations, various theories was provided by these textbooks, text books
on corporate finance, exploring corporate strategies, The ACCA paper F9 text, P3
text, Financial management text and other textbooks on Mergers and Acquisitions
contributed a lot to these research Analysis project.

8
Companys websites

The company website helped in terms of the company's historical background,

activities and also annual reports and financial statements. I decided to use the
website since it would be the best place to get first-hand information concerning their
activities, background and investor related matters.

2.2 Methods Used To Gather Information

SECONDARY RESEARCH METHODS

This is also known as desk research, secondary research involves processing data
that has already been collected by another party. With this form, researchers will
consult previous studies and findings such as reports, press articles and previous
market research projects in order to come to a conclusion. The relatively low
expense in comparison to primary research is the main advantage of this research
as no new research needs to be commissioned. However, its main disadvantage is
that the data used in the analysis may be out-dated and therefore return inaccurate
results. Furthermore, previous studies may not have targeted the exact issue that the
current research requires.

INTERNET RESEARCH

Through the internet I was able to gather information about the company
background, its corporate strategy, activities and financial statements. This was done
by visiting the company website.

The internet also provided me access to journals and online articles, online
databases, newspapers and Technical articles.

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LIBRARY RESEARCH

The British library and the City Business library helped a lot in providing books and
journals relevant for this project. These libraries provided me with the knowledge on
how to carry out in-depth analysis of financial statements and tools for carrying out a
SWOT analysis. Quality books on the subject of mergers and acquisition, corporate
finance, Exploring Corporate strategies were readily available and also past
newspapers articles were also available for my use.

LIBRARY DATABASES

Library Databases such as one-source, Osiris, Fame, Data monitor were very good
sources of information. There especially helped a lot in the breakdown and financial
analysis of the companys ratios, the presentation of the financial statements of the
company for four years and also the trend analysis during those years.

2.3 Limitations of information gathered

The main limitation of the information gathering was my inability to gain access
primary data, which would have been very useful in this research, my inability was
mainly as a result of time constraint, which is because I am also writing the last three
ACCA papers, this left me with a little amount of time to carry out a primary research
which would have been quite helpful for this research, but all the same the
advantage of using secondary data was that I was able to gain access to a wider
range of sources which would not have been possible if I was using the primary data.
The 6500 word limit was also a limitation, because there was so much that I could
have written but because of the word limit I was restricted.

2.4 Ethical issues and resolutions

In carrying out this research, I came across the work of different researchers that
might have been helpful, but as a prospective qualified accountant I made sure I did
not plagiarise because it has been stated that as a requirement for this project,
copying of any sort or using the work of others must be referenced adequately.

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2.5 Accounting and Business models used and their
limitations

SWOT ANALYSIS

A SWOT analysis is a strategic model for evaluating a companys business

performance; it provides information which assists in evaluating the firm's
competences and resources and matching it with the competitive environment in
which it operates. SWOT analysis is also a strategic planning method used to
evaluate the Strengths, Weaknesses/Limitations, Opportunities, and Threats
involved in a project or in a business venture. It involves specifying the objective of
the business venture or project and identifying the internal and external factors that
are favourable and unfavourable to achieve that objective.

A SWOT analysis must start with defining a desired end state or objective. A SWOT
analysis may be incorporated into the strategic planning model.
Strengths: characteristics of the business, or project team that give it an advantage
over others
Weaknesses (or Limitations): are characteristics that place the team at a
disadvantage relative to others
Opportunities: external chances to improve performance (e.g. make greater profits)
in the environment
Threats: external elements in the environment that could cause trouble for the
business or project.

Limitation of a SWOT analysis

One major problem with the SWOT analysis is that while it emphasizes the
importance of the four elements associated with the organizational and
environmental analysis, it does not address how the company can identify the
elements for their own company. Many organizational executives may not be able to
determine what these elements are, and the SWOT framework provides no
guidance.

11
For instance, what if a strength identified by the company is not truly strength? While
a company might believe its customer service is strong, they may be unaware of
problems with employees or the capabilities of other companies to provide a higher
level of customer service. Weaknesses are often easier to determine, but typically
after it is too late to create a new strategy to offset them. A company may also have
difficulty identifying opportunities. Depending on the organization, what may seem
like an opportunity to some may appear to be a threat to others. Opportunities may
be easy to overlook or may be identified long after they can be exploited. Similarly, a
company may have difficulty anticipating possible threats in order to effectively avoid
them.

RATIO ANALYSIS
It can be defined as the calculation and comparison of ratios over time which is
derived from the data in a companys financial statement.
The level and historical trends of these ratios can be used to determine a companys
financial condition, operations and also why it could be attractive or not to investors.

Ratio analysis involves the use of historical information to determine present

situation of a company which is normally not the current situation of a company.
Ratios are subject to the limitations of the accounting methods, different accounting
choices may result in significantly different ratio values.
Also with ratio analysis precise comparison between similar banks might be difficult
as they often compete in different markets, have varying product features, customers
base, and different business and financial risk, as such it may be misleading as it is
difficult to compare like with like. Lastly, ratios do not exist in isolation they are often
interrelated, poor profitability ratio may affect liquidity and capital ratios, as such it
does not give a true performance of a company (Casu et al, 2006)

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PART THREE: RESULTS AND ANALYSIS

3.1 Background of the Acquisition

In March 2000, Royal Bank of Scotland acquired National Westminster Bank
following a long takeover battle with rival Bank of Scotland. The deal was worth
21bn which was considered as one of the largest of its kind in the British banking
industry and seven times the size of the previous biggest hostile takeover (Financial
Times, 2003). At the time of the acquisition, NatWest was vulnerable and acquisition
was widely expected due to the low performance from the giant bank. According to
Trapp (2001) at that time NatWest was considered to be the 58th largest bank in the
world and was ranked among the top 20, while RBS was 1/3 rd its size.

3.2 Financial Motive that lead to the Acquisition

Before the merger took place, NatWest was making effort to restructure its
operations and thus its cost to income ratios peaked to 70 while other banks at that
time were aiming for 50 (Business Insight, 2004). The restructuring involved job cuts
across different departments, branch closure across the UK and the selling of
NatWest groups Bancorp in the US. The private banking market at that time was
characterized by rapid growth and attractive economies of scale and scope, both of
which continued to draw new entrants into the industry.

The industry was highly competitive but remained fragmented at that time with
competition from a wider range of different financial service providers such as
traditional private banks, major international banks, investment and security houses,
high street and merchant banks. Thus, in the increasingly uncertain world of
traditional financial institutions, it was a little surprise that NatWest came up with the
idea of friendly deal with Legal & General (L&G), the pension and life assurance

13
specialist for 10.75bn (Birmingham Post, 1999). The deal was not supported by the
shareholders and the share prices fell by 26% due to this move by NatWest.

Thus the effects of restructuring showed poor performance coupled with the low
share prices and shareholders apprehension in the L&G deal, made NatWest a
target of takeover from the rival banks and the interesting parties were Lloyds TSB,
Bank of Scotland and Royal Bank of Scotland. The Bank of Scotland was the first to
bid for the bank but soon it was competing with the Royal Bank of Scotland for the
takeover of the 2nd largest retail bank in UK. Finally after a six month battle RBS
acquired NatWest and become the 2nd largest bank in UK and Europe (Evening Mail,
2000).

The acquisition took more than two years to integrate the operations of both the
banks. After the takeover RBS set to work immediately in identifying those sectors of
activity that could be merged with its own to get the synergy effect and cost savings.
According to RBS, the strategic direction of NatWest was orthodox and lacked
innovation. Therefore the process of change management during the integration
emphasized upon creativity and innovation.

The RBS Group Chief Executive before the merger took place was Sir George
Mathewson who stated that, NatWest was living in dark ages (Adams, 2000) as a
result of their strategy. This line of thought was based on the fact that NatWest was
not offering Tesco a full range of products because of the threat of competition that
this UK grocery giant might pose to the bank. However, after the acquisition RBS
handled the backend features of the financial services provided by Tesco and
assessed the grocery giant as one of the potential opportunities that the bank had,
thus showing the difference in culture between NatWest and Royal Bank of Scotland.

3.3 SWOT ANALYSIS OF THE ACQUISITION

In order to achieve the aims and objectives of this report, A strengths, weaknesses,
opportunities and threats (SWOT) analysis of the acquisition has been studied to
conclude the feasibility of the financial strategy adopted for this successful
acquisition.

14
In order to have a snapshot of the SWOT analysis presented below, the following
abridged SWOT diagram is presented.

Strengths
Synergy
Effect Restructuring
Fastest Capabilities
Growing Possible Cost
Bank Cutting

Growing Less Turbulent

Market Business Cycle

Expansion
Threats across UK

Same Business Opportunities

Model

Economic
Downturn
High Costs of
Takeover Integration of IT

Weaknesses

NatWest / RBS Merger Abridged SWOT Analysis

Figure 1: SWOT Analysis of the RBS merge with NatWest

Strengths

In 2003, the successful acquisition and integration of NatWest bank had a

positive impact on the Royal bank of Scotlands growth, which saw it rapidly
becoming one of the largest banks in the world (the fifth largest in terms of
market capitalization) its ability to integrate acquisitions with relatively lack of
disruption was a great advantage to the group.

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World Banks Market Capitalisation on the April 25, 2003

Bank Market Capitalization

(billions)
CITIGROUP 124.4
HSBC 69.9
BANK OF AMERICA 68.9
WELLS FARGO 50.1
RBS 46.8
UBS 37.2
JP MORGAN CHASE 35.1
WACHOVIA 31.9
BANK ONE 27.9
HBOS 27.5
Figure 2: MARKET CAPITALIZATION

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 Market capitalization(billions)

CITIGROUP
HSBC
BANK OF AMERICA
WELLS FARGO
RBS
UBS
JP MORGAN CHASE
WACHOVIA
BANK ONE
HBOS

Figure 3:Market Capitalization

Due to the overlapping business of the two banks and their functionalities,
the biggest strength arose for the cost savings by having a centralized
technology and processing activities. The elimination of duplication across a
wide range of areas includes technology, back office processing, central
functions and Treasury. It has been speculated that cost savings amounting
600 million per annum has been made after the integration of NatWest.

Combining NatWests scale and the RBSs innovation and growth culture,
the enlarged RBS Group had a leading position in the number of banking
markets, a range of strong brands and a leading distribution capability. Due
to the overlapping businesses, strength came in the form of synergies found
between the growing RBS and the ailing NatWest. It has been established
that NatWest Groups average rate of growth in income between 1993 and
1998 was 4% per annum (NatWest, 1999), against 16% per annum for the
RBS Group (RBS, 1999). Therefore the transfer of expertise and innovation
from RBS to NatWest proved beneficial across different segments in which
the banks operate. The difference between both, the banks earnings across

17
 different segments before the acquisition can be depicted from the results of
1998 (Goldman Sachs, 1999; NatWest, 1999; RBS, 1999):
RBS NATW EST
Share of Share of
1998 MARKET SHARE % Market Market
Market Market
Share Share
Growth Growth
Mortgage Lending 2 4 4 3
Credit Card Lending 8 13 10 4
Other Personal 3 5 5 4
Lending
Personal Deposits 2 6 5 5
Total Assets 7 11 15 1
Figure 4: RBS MARKET SHARE AND MARKET GROWTH RATIO

Between 1992 and 1998, the period before the acquisition of NatWest, RBS
transformed almost every part of its core business in UK retail banking. The
transformation was achieved through a substantial business re-engineering
programs which reduced branch staff by 27%; removed the majority branch-based
processing and achieved a separation between retail and corporate activities and
created specialists sales force for personal, small business and corporate customers
(Rothnie, 1999). This shows the strength of the bank in managing change to create
and increase the shareholders values.

Weaknesses

The integration of the IT systems of NatWest into the system of RBS proved to be
the weakness of the deal as it took two years to complete. In the early 2000, during
the post-merger integration process there was skepticism about whether RBS would
be able to merge the IT system. The integration of the IT system involved almost
3,000 development staff and the retraining of 40,000 Staff (Financial Times, 2003).
Although the integration of the system was completed on time and without any
serious errors but it was a capital intensive work for the RBS Group.

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The 21bn takeover bid and the increased costs of the takeover coupled with the
recession years of 2001 and 2002, proved to be another weakness for the bank. This
could have been damaging for the bank, but the proper change management by the
RBS proved fruitful in such circumstances.

Opportunity

The UK business cycle (HM Treasury, 2005) shows that the current cycle
started in the early 1999; peaked in 2001 and then saw its lowest point in
2003. It can also be inferred from the cycle diagram provided below that long
term government economic policies and stable inflation rates have made
these cycles less pronounced than before. This provided an opportunity for
the post-integration period to be less turbulent than expected and was good
news for all the businesses in UK as these cycles have less impact on them
now than before. The diagram of the UK business cycle adopted from HM
Treasury Report 2005 is provided as follows:

Figure 5:UK Business Cycle

In order to expand across the UK, this acquisition by RBS which was 1/3 rd the
size of NatWest proved vital. It provided opportunities of cross selling the products of
the two banks to better serve the changing demands of the customers.

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 The Banking sector in the UK has seen compounded annual growth rate of
9% in the period 1999-2003 (Data monitor, 2003), the period of the acquisition
and post-acquisition integration of the NatWest into the RBS Group. The
strongest growth was seen in 2002 when the market grew by 9.5%. This
provided opportunity for the enlarged RBS Group to continue to grow even in
the capital intensive post-integration times. The following table shows the
growth in the industry:

YEAR BILLION % GROWTH

1999 665.3
2000 728.0 9.4%
2001 795.9 9.3%
2002 871.6 9.5%
2003 940.3 7.9%
CAGR, 1993 2003 9.0%
Figure 6: RBS CAPITAL ASSET GROWTH RATIO

Threats

The model of expansion based only on acquisitions can prove risky for
the Royal Bank of Scotland Group in the future. Especially, if the bank
decides to move into the unrelated areas, where it has no expertise.
Thus the risk of new locations and markets is high with the strategy
adopted by RBS.
The downturn in the economy in 2001 till 2003 was an imminent threat
for the post-merger integration and restructuring of the bank.

3.4 Main Financial Ratios for Both Banks:

It can also be deduced from the annual reports of RBS that it had the skills and
capabilities in the pre-merger period that resulted in the low cost to income ratios
than the average in the UK banking sector. These capabilities include human capital,

20
innovative strategies, cost cutting, efficient processes and systems. The
improvement of the banks cost to income ratios calculated by the researcher from
the data provided by Goldman (1999) before acquisition of NatWest can be
summarized as follows:
65% 65%
60%
58%
55% 52%

94 95 96 97 98 99
RBS COST: INCOME RATIOS

Figure 7: RBS Cost: Income Ratios

The main financial ratios and their fluctuations in the pre-merger, due diligence and
post-merger conditions has been calculated and presented in the following table
(RBS, 2005; RBS, 1999; NatWest, 1999; Goldman, 1999; Business Insight, 2004) for
comparison:

Royal Bank of 1999 2000 2001 2002 2003

Scotland
Net Interest Margin 2.5 2.8 2.4 2.4 2.3
Cost to Income Ratio 64 68 64 64 60
ROAE 23 13 11 12 15
NatWest 1999 2000 2001 2002 2003
Net Interest Margin 2.3 2.2 2.4 2.7 2.6
Cost to Income Ratio 68 70 59 60 49
ROAE 19 27 24 21 24

Figure 8: Main financial ratios

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According to Data monitor (2003) the average net interest margin for the top 5 UK
banks has been 2.0 during the 2003, which according to these calculations show that
both NatWest and RBS have done well in terms of their investment in the acquisition.
This also defies the predictions by many practitioners and researchers that although
the financial indicators were suitable for the merger but still the structural and
intellectual capital integration can result in lower financial performance of the
combined group.

2003
2002

Cost to income ratio 2001

2000
1999

56 58 60 62 64 66 68

Figure 9: Cost to income ratio of the Royal bank of Scotland group (1999-2003)

The cost to income ratio can be considered as the financial indicator that suggest
how efficiently and effectively the company is managed and this was where RBS
wanted to capitalize after the integration of the two banks. According to the figures,
this financial indicator of both RBS and NatWest also looks positive as the industry
average during 2003 has been estimated as 55. Although the indicator is higher for
RBS but it can be explained due to the aggressive mergers and acquisitions strategy
adopted by the bank during this period of time. On the other hand, the costs for the
acquired and integrated NatWest into the enlarged group shows signs of significant

22
improvements from a value of 68 to 49, which can be seen as a shift from the
highest in 1999 to the lowest in 2003 in the whole industry.

25

20
1999
15 2000
2001
10
2003
2002
2002
5 2003
2001
0 2000
RETURN ON 1999
EQUITY

Figure 10: RBS Return on Equity ratios (1999-2003)

The return on equity has seen a steady increase for both the banks in the post-
merger period, although RBS has seen a decline during the due-diligence period.
This growth should be seen in the light of the global recession during the years 2001
and 2002 combined with the post-merger integration costs. Even under such
immense pressures from the integration and the macro environment, the bank kept
its return on equity positive. The banking sector average according to Data monitor
(2003) in 2003 has been 15 for return on equity and both RBS and NatWest have
seen more than average ROCE.

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3.5 Operational consequences of the merger between Royal
bank of Scotland and NatWest bank

Business Synergy

The plan started by articulating a vision of how the RBS-NatWest combination would
create a powerful new force in banking. Due to the high degree of overlap across the
two institutions in their core retail and commercial banking businesses, as well as
their strengths in other businesses, the combined group would have leading market
positions in the UK. Specifically, the new RBS would immediately become the #1
corporate bank, the #2 retail bank, the #1 private bank, and the #1offshore bank.

RBS planned to retain the NatWest retail brand, as well as other prominent brands
that were part of the NatWest Group, such as Coutts in private banking and Ulster
Bank in Ireland. Thus, the combined group would control several of the most
powerful brands in the UK. These brands, the plan contended, could drive revenue
growth, by leveraging the expanded distribution capability the combined group would
enjoy in the UK. The combined group would also enjoy a stronger international
presence and options for future growth outside the UK.
The RBS-NatWest combination potentially could also create a bank with a highly
competitive cost structure, due to opportunities to capture economies of scale in
back-office and corporate services functions. Finally, RBS promised the combined
group would foster a culture, Once the deal was closed, RBS had access to
NatWest information that was not easy to get during the hostile bid process. Based
on that information, unit heads were asked to review the performance enhancement
initiatives to which they had initially committed. The benefits of some initiatives were
scaled back and others were scaled up. Some initiatives were dropped entirely and
others were added.

24
Each business unit prepared detailed action plans and 3-year operating budgets
consistent with these revised estimates. Incentive and bonus plans for each
executive were linked to the achievement of the various initiatives outlined in these
plans. Following the acquisition, RBS brought an increased customer focus to the
NatWest corporate business. One manager explained, for example, that when
NatWest centralized its back office, the same people handled both retail and smaller
commercial customers. The focus was on cost efficiencies. Also With the
acquisition, the new organization formed dedicated customer service teams for
corporate customers. The commitment to the customer extended to the integration
process itself. The integration required that some customers make changes to their
own systems. RBS relationship managers worked with customers to explain and
facilitate the needed changes. Further, RBS instituted a policy of reimbursing
customers for the expense they incurred.

Systems Compatibility

Adopting common processes would be more complicated, yet it was essential for
RBS integration with NatWest Bank. Moving to a common technology platform in 30
months was perhaps the most daunting task in the plan, yet RBS leadership
reassured investors that its IT integration plan was feasible RBS also moved quickly
to create an aligned and consistent set of internal control systems. The delegation of
various authorities, such as spending and credit limits, was made consistent
throughout the new organization. Internal accounting and reporting systems were
integrated, so that it was a success it had been carefully reviewed and endorsed by
IBM and Price Water house Coopers.

Employee Consequences

The HR organization working with an outside consultant reviewed and recommended

executives for all positions in the new architecture. Both RBS and NatWest
executives received consideration for each position. Yet, appointments were made
quickly and decisively. Those who could not be deployed in the new organization
were removed. During 2002, prior to NatWest changing over to the Royal Banks
manufacturing platform, each RBS had granted branch employee underwent

25
approximately 40 hours of training over a six-month period. This stressed branch
managers and employees were also responsible for meeting the on-going
Businesses objectives and maintaining customer service levels. One manager
explained that before the change date, there was a feeling that too much training
was being done and that perhaps it would be better to learn on the job after the
changeover date. In addition to revenue, cost, and profit targets, the integration plan
also called for the elimination of 18,000 positions. In keeping with RBSs avowed
intention to generate revenue growth through increased customer focus, the cuts
primarily came from the Manufacturing and head office functions and not from
customer facing areas.
While RBS cut thousands of positions, the total employee count grew from 2000-
2003 because of organic growth in the customer facing units and growth from
several other smaller acquisitions RBS executives like Neil Roden, Group Director of
Human Resources, also prided themselves that in an industry characterized by
strong labour unions, the HR function was able to integrate over 42,000 NatWest
employees onto RBSs terms and conditions of employment without significant
labour difficulties. Indeed, despite the headcount reduction and relentless pressure
of the integration process, employee morale remained high and improved over time
(based on data from annual employee surveys conducted by International Survey
Research, an independent firm)
Roden explained that people were willing to do what it took to succeed because they
wanted to be a part of the biggest and best integration ever accomplished in the
industry. They also felt confident of RBSs commitment to its employees, because
the bank had invested over 70,000 training days to help employees gain the skills
necessary to succeed. Their enthusiasm was further fuelled by the positive feedback
they were receiving from customers and investors. As RBS consistently met and
exceeded each of its interim promises, investor confidence grew and the companys
stock price soared, planned staff reduction and the Actual staff reduction (Nitin, N et
al.2005) are represented in the figures below

26
Staff Dec Dec Dec Dec
reductions 2000 2001 2002 2003

Cumulative
total
plan 9000 14000 16000 18000
Revised plan 18000 18000
Actual 13000 17000 18000

Figure 11:RBS table of Staff reduction

18000
16000
14000
12000
2000
10000
2001
8000
6000 2002
4000 2003 2003
2000 2002
0 2001
Staff 2000
reductions

Figure 12: RBS Staff reductions

Change in Marketing Strategy

The new group architecture that RBS implemented in the first 30 days was designed
to promote both revenue growth and cost efficiencies. The architecture called for
various RBS and NatWest brands and businesses to be clustered into eight
customer-facing units, each focused on different customer segments. Wherever
possible, back-office activities were transferred to a centralized Manufacturing unit.
Several other centralized group functions were designed to provide shared services
to the organization. In the words of one executive, The new architecture

27
immediately broke the spell that RBS was here and NatWest was there. Everyone
had to come together in new units in a new group with a new operating model.

The new architectures goal was to free up the customer-facing businesses to

concentrate on growing revenues. Meanwhile, the primary goal of the Manufacturing
unit and other central services was to realize economies of scale, cut costs, and
improve efficiency.

Change in Product Mix

The retail side of both the Royal Bank and NatWest business were combined into a
single division that maintained both brands. Gordon Pell, Executive Director and
Chief Executive, Retail Banking, contended that RBSs multi-brand strategy was
particularly advantageous in retail banking because it made the change in ownership
of NatWest branches nearly invisible to existing customers.
Additionally, he suggested that most retail customers had little concerns regarding
the parent company; The Corporate Banking and Financial Markets(CBFM) division
was formed by combining a collection of historically independent businesses at the
Royal Bank and their counterparts from NatWest. The combined organization
became the largest corporate banking group in the United Kingdom with over 75,000
corporate customers, over 130 corporate banking offices in the United Kingdom, and
serving 200 of the FTSE 250 companies. The integration of Corporate Banking and
Financial Markets (CBFM), according to its Chief Executive Iain Robertson, was
greatly assisted by combining similar businesses from NatWest and Royal Bank and
co-locating them in the same physical space. Breaking down the spatial separation
among these businesses quickly broke down other barriers to integration as well
their local branch. In addition to sharing a common manufacturing platform, the new
retail division was supported

28
3.6 Financial consequences of the merger between the Royal
bank of Scotland and NatWest bank

Economies of Scale

The benefits resulting from the creation of a common manufacturing division was
the driving force of the business plan, accounting for 930 million of the anticipated
1420 million in total profit.
RBS was committed to maximizing scale economies by creating common products,
common processes, common platforms and common policies. Due to the high
degree of functional overlap in most of the products offered by the two groups,
managers believed that moving to common products would be relatively
straightforward.

Benefits to shareholders

As a result of the acquisition deal RBS group Earnings per share rose by 15.2%
from 66.9 pence to 76.9 pence as shown in the table and figure below

29
Equity ratios 2000 2001 2002 2003
Earnings per 66.9 67.6 70.6 76.9
share (pence)
Dividends per 33.0 38.0 43.7 50.3
share
Dividend pay- 56.1% 58.1% 62.3% 66.1%
out ratio
Share price at 15.82 16.72 14.88 16.46
end of period
()

Figure 13: RBS Equity ratios

78
76
74 2000
72 2003 2001
70
2002 2002
68
66 2003
2001
64
62
60 2000

EARNINGS PER
SHARE(PENCE)

Figure 14: RBS earnings per share ratio

There was also a slight increase in RBS share price of 4.04% from 15.82 to 16.46
this is also represented in the figure below.

30
 17

16.5
2000
16
2001
2003
15.5 2002
15 2002
2003
14.5 2001
14
13.5 2000

SHARE PRICE ()

Figure 15: RBS Share price (2000-2003)

Revenue Benefits and Cost Savings

The post-merger integration transformed RBS from an institution with 80,000 billion
in asset (RBS, 1999) to a giant with 250,000 billion (Goldman, 1999). According to
RBS, (2000), the first earnings came as a surprise, with revenue growing by 10%,
pretax profits up by 11% and share price up by 11%. The successful post-merger
integration resulted in the creation of 2nd largest bank after Lloyds TSB in respect of
total income. The results of the profit and loss accounts of the largest four banks
operating in the UK during the fiscal year ended 31st January 2000 (Business
Insight, 2004) can be summarized as follows:

RBS Barclays HSBC Lloyds TSB

Net interest income 5.2 4.6 4.8 7.4
Non-interest income 5.9 3.7 3.2 5.9
Total income 11.1 8.3 8.0 13.3

Figure 16: Income ratios

31
Total income rose by 74.8% from 10995m to 19229m (RBS, 2003) due to growth
in customer deposits and secured consumer lending, also as a result of the
acquisition of the NatWest Bank this is also represented in the figures below.

Year 2000 2001 2002 2003

Revenue (m) 10995 14558 16815 19229

20000

18000

16000

14000
2000
12000
2001
10000
2002
8000
2003
6000

4000

2000

0
Revenue(m)

Figure 17: RBS Revenue (2000-2003)

Annualised revenue benefits of 805 million and annualised cost savings of 1,350
million were delivered by December 2002.

In February 2003, all integration initiatives had been completed. As a result the full
programme annualised benefits, comprising 890 million revenue benefits and
1,440 million cost savings, had been achieved less than three years after the
acquisition of NatWest. Cumulative combined revenue and cost benefits to the

32
profits for the period 2000 to 2002 amounted to 3.6 billion, which was 1.1 billion
ahead of the original plan (Nitin Nohria, James Weber 2005) these are shown in the
table below.

Revenue Dec Dec Dec Dec

Benefits 2000 2001 2002 2003
Cumulative gross
revenue initiative
implemented(m)

Plan 120 350 550 595

Revised plan 800 890
Actual 147 605 805
Cost savings Dec Dec Dec Dec
2000 2001 2002 2003

Cumulative cost
savings
implemented at
the end of each
period (m)
Plan 550 900 1200 1340
Revised Plan 1340 1440
Actual 653 1205 1350

Figure 18: Revenue and Cost benefits analysis

33
3.7 Conclusion

In reaching a conclusion on the success of this acquisition deal by RBS group there
are evidence to substantiate that the integration had increased the companys
revenues, profits, and market capitalization, market growth and market share. It had
improved RBSs competitive position in all of its businesses as illustrated in the
SWOT analysis performed on the group. RBSs cost-income ratio had been reduced
as seen in the financial ratio analysis so that it was now one of the most efficient
players in the industry. The acquisition had brought new customers to all segments
of the bank and increased the satisfaction of existing customers. It had also
increased employee morale and the pride they felt in being a part of a winning
organization.

The post-integration RBS looked almost exactly like what was promised in
early 2000, as the Daily Telegraph reported RBS has delivered on every target it
set for itself when it acquired NatWest, plus more besides. The integration
exceeded every business goal that RBS promised in its original bid for NatWest
goals that had initially been greeted sceptically by the financial community, but the
accomplishment of which was now being widely applauded. Forbes magazine had
named Goodwin Global Businessman of the Year and Reuters had named him Best
Bank CEO. Goodwin believed that these awards were recognition of what the entire
organization had achieved. Having touched on the main objectives of this research
analysis earlier, a conclusion has been reached in answering the research question
that had been raised earlier which is Did Royal Bank of Scotland acquisition of
NatWest deliver the target result it had promised? Without any benefit of doubt one
can say that this was an acquisition that had delivered its target result.

34
3.8 Recommendation

RBS price per earnings ratio had decline during the period of the acquisition,
shareholder/ investors confidence in the bank has to be increased by
implementing less risky strategies , since potential investors saw the whole
acquisition process has being risky coupled with the 2000/2001 recession.
The 21 billion takeover bid and increased costs of the takeover was deemed
to be quite high considering the situation of the economy as at 2000/2001,
less aggressive approach to acquisitions should be taken in the future.

35