The chosen few of the City

Banks poised to splash out on their rivals

Money will be no object for Lloyds TSB on the trail of its next big acquisition. Sir Brian Pitman, the venerable chairman of the bank, sneers at the suggestion that the next deal will be anything less than monumental. "When you're talking about size, if you think we're limited to pounds 1bn or pounds 2bn, that's absolute nonsense," he said.

Sir Brian wants another acquisition and if he makes a move in 1998, analysts predict it will be only one of several big mergers that will leave the UK financial industry in the hands of just a few huge companies.

National Westminster could well be one of the likely victims of any shake- up. Problems in its investment banking division led to the business being sold off to Bankers Trust and Deutsche Morgan Grenfell. And pressure from the City to improve returns to shareholders in its traditional banking business remain intense.

Barclays has all but declared an interest in buying NatWest, despite the regulatory obstacles posed by possible monopoly concerns. For that reason, analysts are sceptical - the merged company would control about 60 per cent of the small business lending market and 50 per cent of the credit-card market.

All this follows a year of rapid change for the banking sector: four building societies converted to banks; Birmingham Midshires is in the midst of being swallowed up by the Royal Bank of Scotland for pounds 630m; and three British investment banks were sold off in bits and pieces to foreign buyers. Barclays and NatWest both sold off their equities and corporate finance businesses and Hambros has also begun dismantling itself, with Societe Generale of France paying pounds 300m for the group's banking arm.

For banks in the UK, the pressure is on to reduce costs. With so many active on the high street, next year looks set to see a spate of mega- mergers. The big names in British finance want to offer consumers a full range of products, from deposits through to mortgages, credit cards and insurance. And they want to reach customers through new, low-cost distribution channels such as telephones or supermarkets, as well as the traditional retail network.

"We've got an industry with low-growth characteristics, massive oversupply, a great pressure to cut costs but also generating capital at an enormous rate," said Richard Coleman, bank analyst at Merrill Lynch. "We've got the reasons, the motivations and also the wherewithal to drive a consolidation story."

Lloyds TSB is considered the prototype for this trend, having established itself as one of the top three in deposits, insurance, business lending and mortgages. Its costs are only 52 per cent of its income, low compared to many of its competitors. The former Lloyds Bank bought TSB Group, followed by building society Cheltenham & Gloucester in 1995, and followed up by buying all the shares it did not already own in Lloyds Abbey Life a year later.

John Aitken, banking analyst at UBS, said he expects two or three mergers in 1998 - most probably "across product lines", meaning pairings of banks, mortgage lenders or insurance companies.

"The interesting thing about this deal is you don't get the immediate cost savings you get from merging banks and ripping out branches," he said. "You may get extra revenue and you would hope that the quality of both bits of the group would be better."

The most likely candidates for merger or takeover are the five mortgage banks because mortgages are a stable stream of long-term income. Halifax, Woolwich, Alliance & Leicester and Northern Rock all converted from building society status in 1997, distributed free shares to members and listed them on the stock market, creating an unprecedented windfall of pounds 31bn for savers.

Halifax and Abbey National, the two top mortgage lenders, could well pounce on other companies. Halifax has an estimated pounds 3.5bn in surplus capital which it can use for acquisitions or returns to shareholders. There is also the prospect that one or both of these could be on the receiving end of an offer.

The remaining building societies - especially Nationwide, Britannia and Bradford & Bingley - are also possible targets for takeover, even though their managers insist they will remain independent and mutually owned.

In July, 70 per cent of Nationwide customers voted down board candidates who wanted to take the company into the banking sector.

Insurers are regarded as attractive acquisition fodder, although banks may find it difficult to buy them, as Abbey National found out. In January, it launched a bid for the mutual Scottish Amicable only to be outbid by Prudential, the largest UK insurer. Prudential used its policyholders' funds to help pay for the pounds 1.75bn bid, whereas Abbey National could use only shareholders' money.

Insurance companies will have an edge in bidding for one another, although mergers between insurers and banks are also on the cards.

NatWest held merger talks with Prudential and with Abbey National in 1997, although both ended unsuccessfully.

On the Continent, the merger of Union Bank of Switzerland and Swiss Bank Corporation earlier this month focused attention on the possibility of two huge banks merging as long as they do not dominate a single market. Therefore, NatWest and Barclays are an unlikely combination, as are the two mortgage giants Abbey National and Halifax.

The two banks that make most of their money in Asia may take advantage of the turbulence and opening markets to buy institutions in the Far East. Standard Chartered has said it is interested in such acquisitions while HSBC Holdings has refused to make its intentions known.