RBS (pg. 2)

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So how did a 282-year-old regional bank go so awry, especially in Scotland, a place proud of its reputation for canny, frugal finance? In irate Britain today, most people - from government ministers to street protesters to shareholders - have no doubt: It was mostly the fault of former CEO Goodwin, 50.

He undoubtedly bears much of the responsibility, but he had a lot of accomplices. The crucial mistake was his last and most audacious deal, a $100 billion hostile takeover in 2007 of Dutch bank ABN Amro. It proved to be one deal too many, a critical error, as he himself acknowledged to a parliamentary committee. But Goodwin was also Britain's foremost practitioner of the sort of highly leveraged banking that shareholders, institutional investors, and regulators all cheered on - until the whole thing collapsed.

For much of the past decade, his moniker "Fred the Shred" was actually a compliment. Born in a tough Glasgow neighborhood, Goodwin trained as an accountant before moving into banking. In the early 1980s he helped liquidate the scandal-ridden Pakistani bank BCCI, and went on to his first CEO job as head of a small Scottish bank, Clydesdale, which he quickly whipped into shape.

He jumped to RBS in 1998 and rapidly elevated it to the international stage with an audacious $34 billion hostile takeover of NatWest, which was more than twice the size of RBS. Having won the battle, he went on to wow investors by delivering results that far beat their expectations. His reputation was made, and a pattern set. More than 20 other deals followed in quick succession, including some in the U.S., where RBS acquired Mellon Financial Corp.'s retail banking arm and Charter One Financial.

The accolades poured in: Forbes magazine in 2003 named Goodwin the Global Businessman of the Year. (In the U.S., RBS now operates both a retail banking arm and an investment banking operation that focuses on trading. Its Greenwich Capital unit was a player in asset-backed securities until that market dried up.)

Former colleagues describe Goodwin as blunt, often cutting in manner, ferociously focused on detail - and impatient with anyone he considers a fool. By 2005 investors started to worry about overreach. He responded with stock buybacks and a promise to slow the pace of acquisitions; there were no deals he could see that were "desirable, doable, or affordable," he declared in March 2007. Two months later he was back in action with the most audacious takeover of them all: the hostile bid for ABN.

The Dutch bank had been shopping itself around for a while. One French bank's CEO who took a look says he found the assets - a clutch of wholesale banking businesses in Northern Europe, a small Italian bank, and some U.S. operations, including Chicago's LaSalle - "too mediocre." One bank did take the bait: Barclays (BCS), which made an $89 billion offer, mainly in stock. Goodwin, however, together with the Spanish bank Santander and Belgium's Fortis, cooked up a competing offer of $100 billion for ABN.

It was the biggest deal in European banking history, and aside from its size and the fact that the offer was 93% in cash, two aspects were notable. The first is that Goodwin was ready to pay a very steep price for a bank that he himself considered mediocre. "ABN has many businesses, some of them strong, but the majority not," he told analysts when he announced the bid. "There are too many subscale businesses in the group." The subtext: He would be able to extract value out of the deal with the same sort of aggressive tactics that had helped RBS to grow.

Also, hostile bids are all but unknown in European banking; indeed, about the only precedent was RBS's purchase of NatWest seven years earlier. One consequence was that the consortium had only a superficial idea of what it was bidding for. "The parties acknowledge and agree that they do not know many of the key facts relating to the ABN Amro Group," reads one of several unusually blunt warnings in the bid prospectus.

Goodwin and his Spanish and Belgian colleagues had two big opportunities to walk away. The first was in April 2007, when ABN sought to defend itself by selling LaSalle to Bank of America (BAC, Fortune 500). The Chicago bank was a jewel that RBS craved, and without it ABN was suddenly less interesting - and less valuable. But the consortium plowed ahead without reducing its bid.

The second opportunity came five months later, amid the first signs that financial markets were headed south. RBS was stretched extremely thin. Analysts calculated that the ABN deal would reduce RBS's core Tier One capital ratio to a paltry 4.25%, just a whisker over the legal minimum and by far the lowest of any big European bank. Together the three bidders still needed to raise more than $20 billion in fresh Tier One capital to finance the acquisition.

In August 2007, RBS held a shareholders' meeting to approve the deal. Markets were starting to behave oddly. Some mortgage lenders in the U.S. were having troubles, which were beginning to spill over into Europe. The day before the meeting, the European Central Bank had pumped an emergency $130 billion of liquidity into money markets. But not Goodwin, nor his board, nor regulators, nor shareholders - 94.5% of whom voted in favor of the deal - appeared to have serious concerns. If the bank couldn't get funding, Goodwin told any last doubters, "then there would be much bigger difficulties and more things for people to worry about."

Some saw the dangers clearly. Barclays didn't raise its bid, although the value of its stock offer had dropped sharply. In September, more than a month before the deal formally closed, J.P. Morgan's banking analyst in London, Kian Abouhoussein, issued a scathing report titled "Consortium Wins by Overpaying." He argued that RBS and its co-bidders were offering at least 13% more than ABN was worth. In hindsight, they overpaid by far more.

What kept Goodwin so adamant about the deal? Hubris, say his critics. If he'd made the acquisition work, Goodwin would have emerged not just as Britain's preeminent banker, but as Europe's. Convenience, say some more neutral bankers: The legal arrangement that bound the three consortium members may have made it too hard to abort the deal. Two members of Parliament recently wrote to Turner, the financial regulator, asking for an investigation of allegations that Goodwin may have bullied or intimidated nonexecutive directors. That's nonsense, says a person close to the former board, who insists that there was serious, reasoned discussion of the bid. "The directors weren't patsies," this person says. Goodwin would not comment for this article.

Whatever Goodwin's motivations were, most observers agree that the ABN deal brought the bank down. The consortium closed the acquisition and then failed to get the funding, just as interbank markets seized up. Hampton says that even after including the impact of credit market write-downs and other asset impairments, RBS would have made an operating profit in 2008 had it not been saddled with ABN. Adds CEO Hester: "All banks made similar mistakes, but our mistakes were double the size."

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After weeks of going through the books, Hampton and Hester say they have found no evidence of any malfeasance, such as false statements to shareholders about the bank's position. Some stockholders, many of whom have lost more than 95% of their investment, and bondholders, who are also being asked to take a haircut, aren't so sure. In the U.S. several law firms are seeking to mount class-action suits alleging that RBS management made misleading statements. In Britain, too, aggrieved shareholders are studying their options.

Once Hampton and Hester are done with their strategic plan, RBS will be a shadow of its former self, one that focuses primarily on plain-vanilla British commercial lending. The strategic plan foresees the bank's becoming strong enough for the government to eventually disengage and sell off its majority stake.

Tellingly, nobody yet has a clear idea of how and when that could happen. American bankers take heed.  

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