midland bank plc

Graham Beaver Nottingham Business School

Peter L. Jennings Southampton Business School

Introduction

Midland Bank, for years one of the Big Four in British banking and now an international financial group, started life in August 1836, when the Birmingham and Midland Bank was formed. Under the bold guidance of its 2 8 year-old founder and first manager, Charles Geach, the new bank rapidly prospered, and in 1891 moved its headquarters to London. Midland arguably set the scene for a complete transformation of 19th century banking.

Midland Bank’s expansion was primarily funded by the profits generated by the large industrial organizations of the late 19th and early 20th centuries. The aggressive and visionary leadership of Sir Edward Holden, a brilliant and authoritarian manager, trans formed Midland from a provincial bank in Birmingham to the largest clearing bank in the world through a series of aggressive takeovers.

?Be long decline in British manufacturing industry inflicted serious damage

By the mid-l970s, Midland was a huge corporate organization whose financial services ranged from domestic and international

’This case study was prepared by Graham Beaver, Principal Lecturer in Corporate Strategy at Nottingham Business School and Peter L Jennings, Head of Business Strategy at Southampton Business School, from published sources. It is intended as a basis for discussion and not as an illustration of either good or bad management practice.

Midland Bank PLC1

banking to investment finance, insurance, travel and merchant banking. However, the long decline in British manufacturing industry inflicted serious damage on the fortunes of the bank. Midland had the biggest branch network in the UK but it was heavily concentrated in those areas most affected by industrial decline, with the inevitable consequence that its branches were much less profitable than many of its competitors that had chosen to locate across the more prosperous south.

The full extent of Midland’s difficulties had been first exposed in 1970 when all the UK banks, which had always maintained secret reserves, disclosed their true profits for the first time. This had a profound effect on Midland whose management was genuinely surprised to discover that it was by far the least profitable of the clearing banks. Although Midland was determined to respond and improve its market position, it now faced serious competition as its high-street rivals had grown stronger through mergers and takeovers. Furthermore, serious international competition, notably from American banks such as Chase, were attracting Midland’s industrial customers.

By the 1980s its branch network in the UK provided a wide range of ‘products’ to its personal customers, which were tailored to the saving and borrowing needs of specific sections of its home market. The bank and its subsidiaries also offered a wide choice of services to UK and overseas companies, varying from start-up loans and venture capital for small firms, to corporate finance and money market facilities for major corporations. By the summer of 1992 Midland was the

I86 G. Beaver and P. L Jennings

weakest of the UK clearing banks and living on borrowed time. It had experienced a collapse in profits, and had recorded the first dividend cut by a major bank since 1930.

The banking environment

By the mid-I 980s, banks throughout were offering their customers an range of financial services. The

the world immense available

options included not only the traditional bank functions of handling payments, lending and receiving deposits, they also included investment and insurance activities on a massive scale, mortgage finance, export and import services plus a multitude of consultancy and advisory services. This diversification of banking business reflected great variations within the marketplace from small private accounts, to the affairs of global corporations and government finance.

With the continuing advance in the provi- sion of financial products and services both in the UK and abroad, many large organizations discovered that they really did not need traditional banking services. By cutting out the banking middleman, and going direct to the financial markets, companies could not only make savings on their borrowing costs, they could tailor their lending or equity package to suit their own particular require- ments, for example by issuing IOUs direct to financial investors.

However, the economic problems of the late 1980s meant the banking industry was set for a big shake-out. There were just too many banks chasing too few accounts. Midland Bank, like any other bank, had no decreed rights to survival at a time when the sector was suffering from overcapacity, increasing pressure on margins and capital ratios, and intense competition.

Midland's am bitions

In the early 1980s, Midland had increased its shareholding in the merchant bank Samuel Montague to 100% and acquired the international travel agency, Thomas Cook. In an attempt to recapture the ground lost to its rivals, Midland began to expand in Europe. It bought banks in France (Midland Bank SA) and Germany flrinkaus and Burkhardt). However, the most promising country for flamboyant banking acquisitions was the US which Mid- land began to target with real ambition. By the end of the 1970s most of Midland's rivals had acquired American banks and Midland was already conscious of being left behind.

"The Board, after reviewing the future allocated $ I billion to acquire a suitable bank in the United States. If you examine the press comment at the time, the opinion was that Midland was not really credible until it had made a major international move." Geoffrey Taylor, Chief Executive, Midland Bank 1982-1 986.

Deregulation bad allowed new market entrants

Financial deregulation had allowed new market entrants to attack the clearing banks' previously exclusive territory and the British high street had become a financial battlefield, with banks and building societies offering similar products and services. During the 1980s, Midland's rivals had invested heavily in their retail portfolio making their branches more attractive and productive.

However, the American banking industry was becoming increasingly sensitive to international mergers and acquisitions and regula- tions were about to be introduced which would considerably restrict future takeover activity.

Crocker Bank

Midland's search for a suitable American partner became known to Tom Willcox (known to the American banking fraternity

Stratepic Chanae. Aupust 1996

Midland Bank plc 187

as ‘Atomic Tommy’), the head of Crocker Bank based in Southern California. Crocker Bank was the largest bank in the state with its main branch located proudly at No.1 Montgomery Street, and self-styled, ‘the Wall Street of the West Coast’. Crocker was an old and respected bank, with a clientele dominated by rich, establishment Californians. Up to 1974, it had a reputation for conservatism and lacklustre performance, but under its new head, that was about to change. Willcox was a seasoned New York banker who had narrowly failed to secure the top job at Citicorp, America’s biggest bank and was known in the industry to be a man with wide-ranging ambition. When he was appointed as the head of Crocker Bank, it became common knowledge that he wanted to make it the preeminent bank in California. During the next 5 years (1974-1979) WiUcox expanded Crocker Bank at an incredible pace making a substantial push into the booming Southern California property market.

However, by 1980, Crocker Bank was running out of capital and needed a massive injection of new money if its expansion plans were not to be jeopardized. A press comment at the time summarizes the situation:

((The banking regulators were beginning to enforce capital ratios on the industry. . . those banks with capital were going to be the players and those without capital were not, Crocker had always been undercapi- talised during thatperiod of time and here was the chance to get a really massive capital infusion.”

Despite problems Crocker Bank had real attraction

for Midland

Despite these problems Crocker Bank had real attraction for Midland. It was seen as a prize acquisition and indeed it was far larger than any of the American banks bought by Midland’s British rivals and located in California.

“Theprincipal attraction (of CrockerBank) was that it was in California, which i f it was a separate country, would be the seventh largest in the world. California was seen as the main growthpoint in the US and that satisfied our ambitions.” Geoffrey Taylor, Chief Executive, Midland Bank 1982-1986.

Midland were offered a controlling stake in Crocker Bank at two times the present stock market value of the shares, subject to two conditions.

1 Crocker Bank would have access to Midland’s capital to back its lending plans wherever, and to whoever, it wanted. Crocker was to be managed on the strict condition of non-interference from the Midland unless Midland’s investment was perceived to be in jeopardy, i.e. Crocker was to have maximum operational authority.

2

Some of the professional advisors to Mid- land were less than enthusiastic about the negotiated deal, believing that Midland would be foolish to agree to the autonomy clause. However, to Tom WiUcox this was a condition precedent and he would not give any ground at all. The deal was agreed in July 1980 and was the biggest in American banking history. In its annual report to shareholders in 1981, Midland proudly stated: ‘Midland is now a truly international banking institution amongst the top ten leading banks in the world.’

Midland Bank management were truly delighted with their acquisition. Press comment at the time offered a range of opinions as to the suitability and logic of the deal with several sources commenting on the ‘panic- buy’ mentality of Midland, wondering how much over the odds it had paid for the Californian bank. Midland Bank management, in response to such comments, claimed to have acted professionally, securing the best deal available. However, it did not seem to know what everyone else in Californian banking knew, that the scale and quality of Crocker’s lending over the previous few years left a great deal to be desired.

Strategic Change, August 1996

188 G. Beaver and P. L. Jennings

“D?e dominant objective for Crocker Bank was to grow the lending por@olio and to get it big, fast. When you do that you end up taking the marginal credits and the projects that are somewhat shaky as to whether they are going to be successful.” Steve McLin, former strategist with Bank of America.

Interestingly, before the Midland deal, Crocker Bank had engaged in a strategic exercise which suggested that it should focus on a much more Limited range of activities. However, with the injection of Midland’s new capital, Crocker continued lending in the face of a deepening recession, with huge loans being made to the agricultural sector, when a strong US dollar made exporting extremely difficult. Additionally, a great deal of money was lent to finance property transactions at a time when many other Californian banks were holding back. This aggressive lending policy resulted in Crocker’s portfolio being further marginalized. Crocker’s lending was not just contained to California. It accelerated its lending to South America. A statement from the bank in 1982 announced: ‘Outstanding loans over the last two years have more than doubled . . . This growth was made possible and is supported by our new capital.’

Midland Bank did not yet realize that the Americans were throwing its money

away

Midland Bank did not yet realize that the Americans were throwing its money away. Many of the vast loans in California and Latin America would never be repaid. It was only at the end of 1983 that Midland felt obliged to act after Crocker set aside a growing amount for bad and doubtful debts. Despite a new management team and strict financial controls, more and more Crocker loans went sour. By the end of 1984, Crocker was virtually bank- rupt and only a massive emergency rescue

package from Midland prevented Crocker going into liquidation.

It was clear that the Midland Board had had enough. Crocker Bank was sold to Wells Fargo in early 1986 and was the largest merger in US banking history. The news that Midland had disposed of Crocker Bank to its arch rival rocked the California banking fraternity, but a bigger shock was the price that Wells Fargo paid. Before the sale, Midland had transformed Crocker by taking all its domestic bad debt plus all its South American loans - some $2 billion - on to its own books in London. Wells Fargo paid $1 billion - regarded as the banking deal of the decade, made even sweeter as Crocker was virtually free of bad debts.

Crocker Bank was Midland’s most expensive disaster in its

I 5 0-year history

Midland was not the only British bank to suffer losses in America; what was different was the scale. Crocker Bank was Midland’s most expensive disaster in its 150-year history, ultimately costing &1 billion. Furthermore, the situation was made worse by Midland itself lending hundreds of millions of pounds to Latin America since the late seventies. With the Crocker debts this left Midland with a Third World exposure of $6 billion - a legacy that was to haunt Midland right up to the present day.

Domestic operations

While Midland was distracted both in Califor- nia and Latin America, its core business in the UK had been sorely neglected, with the branch network suffering through a serious lack of investment.

“The branch network nee& constant refurbishment both in a physical sense, as well as signaficant investment on training, as a constant, ongoing cost. I think it’s fair to say that both of those



features, as well as systems development were neglected throughout that period.” Brian Goldthorpe, Deputy Chief Executive, Midland Bank.

The timing could not have been worse, as the new financial era in the mid-1980s had dawned, with new legislation enabling the building societies to compete more aggres sively in the high streets. Midland needed urgently to invest at home, but its international activities had eaten deeply into its capital and profits. To aggravate matters even further, many of Midland’s domestic customers in manufacturing and engineering had failed to survive the recession of the early 1980s. Its traditional position as the banker to British industry meant that a lot of Midland’s traditional customers were heavily affected by the poor economic climate, resulting in the bank having a disproportionate share of corporate lending problems.

Midland’s branch infrastructure on the other hand had been neglected, the victim of under investment and overseas losses. Automation, a necessary prerequisite for banking in the 1980s and beyond, had been rapidly installed by the competition, as the amount of paper generated by the industry and requiring processing had increased. In the majority of Midland’s branches, staff were still laboriously processing cheques by hand and paperwork was taking up more time and space than customers. Costs were the highest of all the UK clearing banks.

Midland’s response was to deploy the very latest in processing and servicing technology and to embrace the latest marketing techni- ques in a radical bid to recapture lost ground. The branch infrastructure was to be converted into ‘financial supermarkets’ in an attempt to make them contemporary, attractive and more efficient. An important part of Midland’s retail strategy was to offer ‘designer’ or ‘branded’ products in order to differentiate itself from rival offerings.

“If you have both intense competitive pressure as well as a changed environment in terms of the nature of theproducts, you

have to figure out a way to respond. Midland Bank’s response was to compete on ‘branded products’. We introduced a series of products that we felt had customer appeal, launched early in 1989 with heazy fanfare and took off quite aggressively in our branch network.” Gene Lockhart, Head of UK Banking, Midland Bank.

First Direct was promoted as a totally new bank without

branches

One of the most innovative competitive responses to come from Midland at this time was the launch of First Direct. This was promoted as a totally new bank, one without branches, operating 24 hours a day, with no daunting bank managers and all transactions done on the telephone. Midland spent heavily on the launch of First Direct, which played down the Midland connection. The strategy was to entice customers away from other banks. As this massive investment programme in

personal banking gathered pace, attention was turned to promoting Midland’s business with industry. Midland Montague was the hub of the bank’s lending to industry and it competed aggressively in its chosen market sectors. Like many other banks, Midland had also sought to confront its problem through diversification and had bought a stockbroking business- Greenwells, in anticipation of Big Bang, the technological revolution on Britain’s Stock Exchange, which took place in October 1986. Midland’s logic for the acquisition was simple, believing that it would lose out on the future financing of UK industry as companies would go direct to the financial markets. Buying a stock-broking house meant that Midland would have at least some measure of indirect control of the flow of money to industry and commerce.


G. Beaver and P. L Jennings 190

Greenwells lost Midland &35 million on its equity

share dealings

Within 15 months of Big Bang, Greenwells had lost Midland &35 million on its equity share dealings. The response was to close down the equity trading arm of Greenwell- Montague thus ensuring that Midland lost much less than its major rivals in the years ahead. Other strategic moves included raising badly needed capital to consolidate the bank’s market standing. Accordingly, the two profitable subsidiaries, Clydesdale Bank in Scotland and Northern Bank in Northern Ireland were sold. With the issue of new Midland Group shares this raised a total of &1 billion which could be used immediately to offset potential losses on Third World debt.

It appeared that these moves were finally reversing Midland’s decline. Midland had climbed out of the red from a deficit of &505 million in 1967, to respectable profits of ~€693 million in 1988. However, the Executive Committee of the bank charged with managing the group’s assets and liabilities in the financial markets had taken a huge gamble. The committee, chaired by Sir Kitt McMa- hon - Chairman and Chief Executive of Mid- land Bank-had borrowed money and invested it in the markets on the assumption that interest rates would fall during 1989. The reverse happened and the bill for this speculative risk amounted to &200 million.

“All banks to some extent bet on interest rates - in Midlands case it was a very big loss which came at a time when it could not afford that sort of sum. A good example of the ‘in one leap we are free syndrome.’ It seems to me that when you are in aprecariousposition, you should not be taking unsuitable bets.” Patrick Frazer - Davis International Banking Consultants.

Meanwhile, the deadweight of Midland’s Third World debt had reemerged. In 1989,

Midland was required to set aside a massive 32346 million against bad debts with the inevitable result that it again reported losses of &261 million. To further add to Midland’s troubles, the really grim news was the onset of the worst recession for 60 years. Midland, like its rivals, was soon to be exposed to large corporate losses as business failure worsened. To make matters worse, the bank com- pounded corporate failure rates by calling in loans and overdrafts from companies who, with perhaps sympathetic financial restructur- ing, could have traded their way out of the recession. Although all the high-street banks suffered from the recession, Midland, weakened by its past, felt the pain most.

“The difference is that Midland’s inherent core proBtability is much weaker than the other banks, so when bad debtsgo up, the other banks see their profits slashed by 50%; with Midland it leaves them at breakeven, i.e. not generating any po$t at all.” PeterTeaman, UBS Phillips and Drew.

By mid-IW0, it became clear that things were getting

worse for Midland

By mid-1990, it became clear that things were getting worse for Midland and no amount of bullish comment from McMahon and other senior bank figures could disguise the fact. The huge investment in products, technology and branch infrastructure all promised long-term benefits but the high fixed costs were eroding Midland’s diminishing earnings before it all started to pay off. The bank was also paying the price of trying to recapture lost market presence when it had been seriously weakened by past mistakes.

“The timing has been unfortunate. Take the case of First Direct. To attract customers into a bank without branches, you need a lot of advertising. The advertising spend at First Direct was very heavy and



came at a time when Midland’s revenues were already under pressure from the recession. They ended up spending a lot of money for a relatively small number of accounts when they could least afford it.” Peter Teeman, UBS, Phillips and Drew.

“We don’t have a strong income stream - it has been very much reduced by the LDC problems (third world debt) and others. We have been running big investment programmes to centralise our processing against a low income stream and then we have run into bad economic weather. The whole thing has gone very low.” Sir Kit McMahon, Chairman and Chief Executive, Midland Bank, August 1990.

As the recession deepened in 1990, McMa- hon was forced to act, closing scores of marginal branches and shedding thousands of jobs. McMahon’s final hope of securing Midland’s long-term future lay with a merger with another, preferably capital-rich, bank.

Acquisition

Paradoxically, as the bank’s capital position was strengthened, the dilution of control through a new share issue rendered it vulnerable to takeover. When the Hanson Group acquired a 6% stake in Midland, there was much speculation about the possibility of acquisition, especially when Kleinwort Benson, a leading merchant bank, stated that it would be capable of raising the necessary finance to support a takeover bid. The situation was prevented from developing any further by the intervention of the Bank of England which made it clear that it would not allow any takeover from outside the banking industry. McMahon had been granted a valuable reprieve because had the Bank of England not had the regulatory authority, there is little doubt that Midland would have been taken over. However, the idea of an alliance with a banking partner of Midland’s own choosing was an attractive defence against future aggression and as fate would

have it, the concept appealed very much to one of the world’s leading bankers, William FWves, the Chairman and Chief Executive of the Hong Kong and Shanghai Banking Cor- poration (HSBC).

Hong Kong and Shanghai Banking Corporation (HSBC)

Hong Kong’s mixed and booming economy, makes it the 12th largest trading power in the world and arguably, at the heart of this growth, is the powerful HSBC. The bank’s development has been presided over by a board of ex-patriate Scottish directors, who to quote McMahon, ‘do very good business indeed.’

However, the HSBC would be the first to admit that their whirlwind expansion was made possible by the happy accident of being in the right place at the right time, funding the ventures of Chinese entrepreneurs who fled to the colony in their thousands. Despite assur- ances from China as to the future government of the colony, there is a degree of anxiety within Hong Kong as 1997 approaches and sovereignty reverts to its massive neighbour.

The HSBC had already made acquisitions outside the colony in an attempt both to broaden its base and hedge its bets. It has sizeable business interests throughout Asia and America, but its attempts to expand into Europe were rebuffed when it failed to acquire the Royal Bank of Scotland. Not surprisingly, when the talk of takeover rumours for Midland reached the HSBC, the idea of mutual self-help was an attractive one to pursue.

“At the time, Midland’s future was under discussion with almost weekly mentions by the press. As we had an interest in Europe, it seemed prudent to have a discussion with Midland to see if we could help them and help ourselves.” William Purves, Chairman and Chief Executive, HSBC.

The Hong Kong Bank performs some of the functions of a central bank in the colony and

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192 G. Beaver and P. L Jennings

also has a political role, with William mWes sitting on the Governor’s most important decision-making body, the Executive Council. The initial indications, however, were that China’s communist government would not seriously question a deal with Midland. The Hong Kong Financial Secretary placed the merger proposals in the context of the HSBC’s long-term strategy of internationalization by stating:

“Hong Kong Bank will continue toplay its important role within Hong Kong’s _finan- cial vstem. Its role as one of the two note- issuing banks in Hong Kong will not be affected.” Hamish Mackod, Financial Secretary, Government of Hong Kong.

Takeover activity

On Tuesday 17 March 1992, Midland Bank and the HSBC made official their intentions of a full merger, which if the deal went through, would create the world’s largest genuinely transcontinental bank and one of its 15 largest in terms of assets. The deal, which required the approval of governments in the UK, Hong Kong and China and of bank regulators, would create an organization with a market value of about &8 billion ($14.6 billion). It would also involve the first takeover of an English clearing bank by an organization which, to all intents and purposes, is not British, even though its holding company is domiciled in the UK. The two banks made only the tersest of public statements when they announced their plans. They said that they had agreed: “a merger of the two groups would now be in the best interests of both companies and their shareholders.”

Bankers and industry watchers with a close knowledge of the deal said however, that the deal would effectively be a takeover of Midland. The Hong Kong Bank was expected to offer one of its shares for each Midland share, valuing Midland at around &3 billion. Furthermore, Purves was expected to be the chairman of the combined operations and firmy in control. One press comment issued

the day after the deal was announced left no room for ambiguity.

“i%e goal was a full merger-at the outset, there was hope within Midland that it would be a marriage of equals. . . A merger between Midland and Hong Kong Bank to create an eight billion pounds group . . . would not be a marriage of equals.” Robert Peston, Financial Times, Wednesday, 18 March, 1992.

Midland and the Hong Kong Bank, in announcing their intentions of impending union, seemed to display very different emotions. Directors of the HSBC could barely contain their excitement at the prospect of carrying off a large European bank after more than 30 years of courtship. “We have been looking for an acquisition in the UK since the late 1950s.” HSBC executive.

However, Mr Brian Pearse, Midland’s chief executive told his staff: “Although we were not seeking a partner, we received an approach from Hong Kong Bank. This a p proach was made after Midland announced its 1991 results on 27 February 1991.” “Midland independence remains an option, but that the board considers the commercial case for joining forces to be a clear one.”

Pearse also emphasized that Midland would continue to trade under its own name, adding that: “Midland would continue to have its own Board. ’ ’

It was also made clear by Pearse that although Midland was likely to be taken over, the combined organization would have a strong British identity.

“In concept this (the takeover) would lead to the creation of a UK based bankinggroup with unparalleled global capabilities and regional banking strength in the UKJ Europe, Asia Pacific and North America.”

Directors of both companies were con- strained by UK takeover rules from making further statements, pending the announce- ment of formal bid terms. In 1987, the HSBC acquired a 15% stake in Midland Bank and in



return made a capital injection of &383 million, with the prospect of a full merger in 1990, afcer a 3-year ‘engagement’ period. If the final marriage went ahead then the HSBC and Midland would then become one of the top 10 banks in the world with McMahon as Chairman and Purves as Chief Executive. The deal with the HSBC was regarded as a triumph for McMahon as he had secured a badly needed capital injection well above Midland’s share values and closed the door on unwel- come predators, with the HSBC’s 15% holding acting as a significant deterrent. It had other attractions too, as it raised the possibility that in 3 years time, Midland’s senior managers would be able to fulfil their yet unrealized ambition to play a wider international role.

In November 1987, Sir Kit McMahon stated,

“Hong Kong Bank is a very good bank - it is not run by Chinese, but by tough Presbyterian, ex-patriate Scotsmen who do good business. We have also noticed that their business is complementary to ours - that is to say, they are strong where we are weak and we are weak where they are strong.”

During their 3-year engagement, both banks edged closer together. They linked up their automated teller machines and reached an agreement about who would get the top jobs. In December 1990 as the agreed deadline for the final marriage of the two organizations drew nearer, it became very clear that the Hong Kong Bank, troubled by big losses of its own and the falling value of its Midland investment, was having serious second thoughts. Equally, the reservations of the HSBC Group directors were shared by the Midland Board who were disturbed at the performance of the HSBC over the last trading year.

“Members of my own Board were perhaps taken somewhat by surprise as to the rather poor results announced by Midland at the end of their hapyear. Last autumn, the World looked quite a troubled place. There was a lot of talk about large bank failures in America and there was a lot of

uncertainty generally - the Middle East crisis was on our hands and much else besides. It just seemed to be a very uncertain time to be contemplating a merger.” William Purves, Chairman and Chief Executive, HSBC

“Both banks could see quite clearly that the recession was going to give them serious problems and that they should concentrate on their own particular bank, rather than contemplate a merger- which would have been the bigsest in banking history. That would have been a signtpcant management challenge in itself and call for a diversion of effort which should have been concentrated on their own businesses.” Brian Goldthorpe, Deputy Chief Executive, Midland Bank.

Inevitably, the merger was called off - the second time in a decade that Midland’s global ambitions had not been realized. The key element in McMahon’s strategy for the future disintegrated. It was a bitter personal blow and indeed the final blow. Despite the boldest attempt yet to restore the troubled bank to profitability, McMahon had been found want- ing.

At the end of 1991, HSBC bad rekindled its takeover

am bitions

Re-enter the dragon

During 1991, Midland had conversations with some 15 banks which said they were inter- ested in acquiring part or all of the group, but nothing could happen until the Hong Kong Bank decided what it wanted to do with its shares (15%) in Midland. At the end of 1991, Midland was aware that the HSBC had rekindled its takeover ambitions as its confidence had returned following diminishing overseas losses and record profit levels fkom its core domestic business. Midland got its first hint from an interview with the Hong Kong

- Strategic Change, August I996


Bank’s Deputy Chairman, John Gray, which was carried in the South China Morning Post. “We started to dust off our Hong Kong merger files”, stated a Midland executive.

Then the day after Midland’s 1991 results were published, Purves became less coy and both banks started to work around the clock on the details of the merger.

“There will be a group chairman and a group chief executive both with an over- view of Hong Kong Bank and Midland. Both will be executives with the chairman doing a lot of the representational work, but the buck will stop with the chief executive, who will reside in London.” William Purves, Chairman and Chief Executive, HSBC, 15 April 1992.

Thus London was chosen as the headquarters of the holding company and the base for senior executives who would hold the main functional responsibilities. The group’s individual banks - in Hong Kong, the Midland in the UK, Marine Midland in the US -would all retain their identities but they would focus more on retail business, leaving treasury management and technology to the centre. A central team, described in the offer documents in April 1992 as “an enhanced International Corporate Accounts capability”, would keep a close eye on big customers. Midland’s high- profile corporate bankers expected to fmd themselves reined in. There appeared to be no lack of confidence that the Hong Kong team could run the merged group. “We have been in international banking for 130 years . . . and I would like to think we’ve learned our lessons.” (John Gray, Deputy Chairman, HSBC Holdings.)

A similar point was made by Purves who would move to London at some future stage to chair the combined group. “I think I can be criticised for not making management changes in Australia, the UK and the US soon enough.”

It appeared that the new group management intended to keep a close grip on its subsidiaries, but with important businesses on three continents, its inbred management culture was likely to be stretched to the limit.

A bid for Midland was officially announced on Wednesday, 14 April, 1992 by HSBC which, according to many industry commentators, was its boldest gamble to date. The bid, which had been carefully constructed to minimize the need for luck, was an all-paper offer amounting to k3.1 billion, rather than the part cash bid that Midland’s management had requested. The offer was pitched at the cautious end of the bid range and the Hong Kong Bank went to inordinate lengths to square as many of the regulatory authorities as possible. The bid valued Midland Bank at 375 pence a share which brought with it the inevitable comments on suitability, expectations and likelihood of success - all part of the posturing game that any takeover activity encourages.

Stockbrokers’ analysts and many institutional shareholders expressed immediate dis- appointment at the recommended offer from the Hong Kong Bank, stating that they had expected at least 400 pence - and that the bid would have to be raised. Indeed, some of the smaller institutional shareholders, including the Prudential, Norwich Union and Mercury Asset Management hoped a counter-bid would be made. One senior fund manager was reported as saying that:

“ n e Hong Kong Bank is pricing this one on the nail. If Lloyd counter bid with a bigger offer it would almost certainly be accepted, nor should anyone automati- cally assume that the offer will be accepted without a counter bid. Midland’s management have not done themselves any credit, they have failed to secure a good price for the stock.”

But not everyone shared this view:

“Our view of a bid from another clearer was that it was extremely unlikely that it would have received the approval of the Monopolies and Mergers Commission. Even if it did, the complementary factors were few apart from the possible cost savings from big redundancies. There is no doubt that a combined Lloyds and



Midland would have had even more of an emphasis on the UK than atpresent.” Brian Pearse, Chief Executive, Midland Bank.

Other comments at the time of the bid were:

“Midland has squandered a chance to deliver a much better deal for shareholders. Hong Kong Bank is a forced buyer and there is a moral case for a higher offer because interest has been show2 by another party.” John Aitken, banking analyst, County Nat West.

“Hong Kong Bank is getting about 13% of the UK banking market with only a slight premium to net asset uaZue, when Midland has good recovey prospects. Given the risks in the Far East our clients wanted to see a bigger bid at around 400 pence.” David Poutney, UBS Phillips and Drew.

A white knight on a black horse

As the weekend approached after the bid from the Hong Kong Bank speculation was rife as to whether Lloyds would make a counter-bid for the Midand. Brian Pitman, the Chief Executive of Lloyds and Sir Jeremy Morse, the Lloyds Chairman, were arguably the most successful team in British banking at that time. In 1991 Lloyds was the most profitable UK clearer and for the first time the only bank whose shares outperformed the FTSE index. However, Lloyds has had to live with the ‘nearly bank’ tag ever since the mid-1970s, when it failed to acquire the Royal Bank of Scotland. The S1.3 billion bid for Standard Chartered Bank in 1986 also failed, leaving Lloyds with a 4.7% holding, it also acquired a 60% stake in Abbey Life in 1989. Despite its popularity with fund managers, it remains the smallest of the Big Four banks but would like to take pride of place.

Morse, Pitman and other senior colleagues had been debating the merits of a hostile counter-bid ever since their own planned offer for Midland was thwarted by Midland’s preferred agreement with the Hong Kong

Bank. It was an open secret that Lloyds, according to one sector watcher I ‘ . . . has, after all, been champing at the bit for years.”

Morse, who was due to retire in 1993 “wants a swan song”, to quote another sector analyst, so too does the respected Pitman, who was also due to retire soon. Lloyds appeared to be coming to the end of an era during which it generated cash by focusing on its core business and approaching another in which it can no longer maintain profit growth without finding new business to rationalize. Morse and Pitman, seen as mutually complementary, understood the changes brought to their industry by deregulation and the huge risks in lending to the Third World. Further- more, they were the first to act. From the mid- 1980s Lloyds sold overseas businesses whilst simultaneously making huge provisions against write-offs on developing country loans. Also, it pulled out of gilts and reduced wholesale international lending. What Pitman chooses to describe as “focus not diversity” appeared to be a brave strategy at a time when the banking buzzword was ‘globalization’.

The second part of Lloyds’ plan was to cut the costs of domestic retail banking. In 1990 alone, it shed some 8500 staff with group salary costs falling by 3%. In 1991, the full effect of the savings came through-Lloyds increased profits by 9% to &645 million despite having the same bad debt burden as its competitors.

“The optimum size for any bank is big. Lloyak have done well by shrinking its business, but it is fast approaching the stage where it will lose its economies of scale.” John Aitken, County Nat West.

On 28 April 1992 Lloyds Bank announced details of its S3.7 billion counter-bid for the Midland, but with Morse insisting that the bid would be confirmed only if his bank and the HSBC both faced the same treatment from the competition authorities. Lloyds tacitly con- ceded that it could not hope to merge with the Midland, forming a bank bigger than Barclays and National Westminster, without being scrutinized by the Monopolies and



Mergers Commission. In making the counter- bid for Midland, Lloyds appeared to be pinning its hopes on lobbying Brussels to hand responsibility for the HSBC/Midland decision back to London and then calling successfully for a fufl enquiry by the Monopolies and Mergers Commission in Britain.

Lloyds argued that because virtually all HSBC’s A15 billion European assets are in Britain-and less than &1 billion are else- where - it is a matter for the Monopolies and Mergers Commission. Although the HSBC is technically domiciled in London, it has no retail network in Britain; this would be a central plank of the HSBC’s argument for why its bid for Midland would require no detailed scrutiny by the Monopolies and Mergers Commission. In responding to the Lloyds’ counter bid for Midland, the HSBC chairman said that:

“The offer from HSBC gives rise to no issues of competition. Lloyds’proposal does so and yet seeks to have HSBC’s offer referred. Let me stress that there are no grounds for ourproposed merger with the Midland to be referred to any competition authority. Lloyds is proposing an offer which, if ever completed, would reduce competition and whose rationale depends upon contraction and cost cutting. Effect- ing such a merger would mean the destruction of Midland. As the largest shareholder in Midland, we are appalled at this possibility.” William Purves, Chairman, HSBC.

The Midland Chairman endorsed this view and wrote to all his shareholders once again heavily supporting the Hong Kong Bank. He also let slip that he and Pearse had been offered the roles of Chairman and Deputy Chief Executive of a combined Lloyds/Midland just in case shareholders feared that their support for HSBC was driven by self-interest.

“A merger with Lloyds will focus narrowly on UK banking and emphasise retrench- ment rather than growth. We are con- vinced, however, that the right strategy for Midlands future is to be a major part of

HSBC as a unique UK based international banking group with capital strength and strong growth prospects.” Sir Peter Walters, Chairman, Midland Bank.

‘%rankly, a takeover by Uoyds represents something which at the end of the day is simply boring. We are not in desperate need of capital. Our problem is that we are currently managing a lowprofitability business, which means that at the moment we are running hand-tumouth on certain projects. Our profits will improve, but Hong Kong will give us access to extra capital more quickly.” Brian Pearse, Chief Executive, Midland Bank.

When asked specifically whether Midland would embrace the Lloyds strategy of focusing more specifically on retail business, Pearse replied:

“No I don’t think so. We regard ourselves vety much as a balzk that requires to service both personal and retail customers and provide a wider service to our colporate customers. The personal market where we have the services, machinety and enthusiastic people will of course be a top priority for us. Furthermore, I see our investment banking business as continuing to be strong. Indeed, we have got one of the strongest correspondent banking businesses in London-we have a strong foreign exchange business, Samuel Mon- tague is a well respected and profitable merchant bank. All that linked together with our European network, will put us in a goodposition in four orfive years time.” Brian Pearse, Chief Executive, Midland Bank, June 1991.

There appeared little doubt that Lloyds would have to severely prune a merged organization. According to most sector watchers, up to 800 branches might be closed, Midland’s headquarters at Poultry would be sold and up to 20,000 jobs eliminated. Such incisive cuts could generate &650 million in savings by 1994. However, a deal with



Midland could create risks for Lloyds’ shareholders. Since Pitman became Chief Executive in 1983, they had enjoyed an underlying return on their equity 50% higher than the shareholders of other clearing banks. ‘‘LZoyds is highly profitable in its own right and I would be concerned 17 it did anything to damage its high stock market rating.” (Keith Brown, Morgan Stanley International.)

There were no other likely bidders, so if luck favoured the Hong Kong Bank and Lloyds made no counter-bid, then the offer would be considered on its merits. Midland’s shareholders, who received only 4.53 pence per share in dividends last year, would get 13.57 pence in dividends from their new shares in HSBC Holdings and another 11 pence interest on the loan stock which constituted part of the offer. Investors would have to balance the short-term gain against the possibility of a sharp rise in post-tax earnings from an independent Midland Bank once the recession ended. One big shareholder, the Kuwait Investment Office, had been trying to sell most of its 10% holding of Midland shares from the moment terms were announced - a clear indication that it preferred cash today to the Hong Kong offer, or to the possibility of a higher price from Lloyds.

It would appear that logic for the takeover bid was growth through increased business, but Purves believed that there would also be considerable scope for rationalization with the effect of enhanced efficiency appearing on the combined organizational ‘bottom line’. Furthermore, Purves has gone on record as stating that the synergies from the resultant deal would be considerable, with the principal areas being technology, trade finance, treasury and investment banking.

Epilogue: 1992-1996

As history bears out the take-over victory fell to HSBC now fully incorporated as a major UK organization with a market capitalisation of 28,537 (Sm) and currently ranking number 3 in the mSE 100.

Lloyds was denied yet again the spoils of victory of a major acquisition and has made an agreed bid for the TSB, subject to the inevitable approval of the Monopolies and Mergers Commission.

Acquisition activity in whatever sector, always comes complete with its special claims and strategic justification for synergy, enhanced performance and competitive advantage. Much of it is without foundation as sustained research activity over the last 30 years or so bears out. For Midland Bank denied as it was, consistent strategic leadership and sensitive communications for such a long time, the future as a major player on the UK and international scene is assured but as a group member of a larger corporate enter- prise. Midland’s future strategy will be dictated not just by the volatility of the changing market for financial services but by the demands and expectations of its corporate parent that had the knowledge of the expiry of the British lease of Hong Kong in 1997 on its strategic agenda.

At the time of writing Lloyds and the TSB are making considerable financial claims based on rationalization and commonality of shared assets that such a merger will provide. Ambitious statements have been advanced for the development of more aggressive mortgage lending using the recently acquired Cheltenham & Gloucester Building Society. There have also been claims that minimum estimated savings of “at least &350 million per annum can be made more or less immediately.”

Porter (1985) and Moss Kanter (1989) both warned of strategic mediocrity in the pursuit of competitive advantage. If strategic change resulting in superior corporate performance is to be achieved in an industry characterized by overcapacity, lacklustre middle management, high levels of customer dissatisfaction and increasing competitive rivalry, then clearly there is the need to think imaginatively about strategy. There have been bold, innovative moves by several players such as Direct Line Insurance and the Leeds Building Society that have startled their rivals and resulted in real gains in market share. What is very clear in this

Strategic Change, August 29%

198 G. Beaver and P. L Jennings

industry is that acquisition activity brings with it special problems of digestion and integra- tion that present real managerial difficulties and wasted opportunity costs. It is time to put again the case for measured, sustained strategic change against the managerially recognized and understood criteria of suitability, feasibiltiy and acceptability (Johnson and Scholes 1993).

References

Johnson G. and Scholes K. (1993). Exploring Corporate Strategy: Text and Cases, Prentice Hall, Heme1 Hempstead, UK.

Moss Kantor R. (1989). When Giants Learn to Dance, Unwin, London.

Porter, M. E. (1985). Competitive Advantage: Creating and Sustaining Superior Perfor- mance, Free Press, New York.

Biographical Notes

Graham Beaver is a Principal Lecturer in Corporate Strategy and the MBA Programme Director at Nottingham Business School. He is responsible for much of the academic and consultancy work on Business Development and Strategic Management.

Peter Jennings is Head of Business Strategy at Southampton Business School. His specialist subjects include Strategic Management with particular reference to the Small Business sector.

CCC 1086- 1718/96/040185- 14 0 1996 by John Wiky & Sons Ltd.


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