Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  The determination with which the Halifax way of working was imposed on the Bank was reflected in the nickname given to the men from Yorkshire, which compared them to the religious fanatics of Afganistan – ‘the Haliban’. Some senior personal banking managers from the Bank transferred to the Halifax retail headquarters in Yorkshire, but found they had little or no influence in determining direction. ‘Andy had four or five people around him who were clones of Andy Hornby. They didn’t have much latitude. They could hear us bleating about things, but they weren’t going to change the model for one little bit of the market north of the border. Back in Scotland we couldn’t go out socially because of the constant complaints from friends.’

  The differences in the new approach went deeper than style. Experienced retail bankers were at a loss to understand the logic behind Hornby’s strategy. With its history of being a building society only a few years behind it, Halifax was still predominantly a home loans and savings institution. It had a dominant market share in mortgages. This was a low-risk and solid business on which it made an excellent return – in fact almost half the profit from the new group came from mortgages. But it was under sustained assault from other banks, building societies and new entrants to the market, such as the telephone and internet banks Egg, Direct Line and Standard Life Bank. They were offering much finer deals, not only to new borrowers, but to existing home owners to persuade them to switch.

  It made sense to hang on to as many mortgage customers as possible by offering those who showed signs of wanting to leave a better deal. However, the original intention of the merger, as far as Bank staff were concerned, was to lessen the group’s dependence on this big, but threatened, market share by diversifying away from mortgages, particularly into corporate and business banking. Hornby showed no signs of allowing this to happen. As the corporate lending book grew, he expanded the mortgage book, competing hard, going head to head with rivals to offer the best deals. Each new loan was less profitable than an old one, but would also eat up some of the bank’s capital and liquidity (funding), meaning that it couldn’t be used to support lending elsewhere.

  The drive also upset existing Halifax customers, many of whom had been loyal for a long time. They now saw new borrowers being offered interest rates lower than they were paying. Complaints began to be received and the Financial Ombudsman stepped in, fining HBOS, along with several other banks, for treating existing customers unfairly. The Bank agreed to pay £7 million compensation to 30,000 customers who had complained, but said it would not similarly recompense a further 400,000 who had not yet registered a complaint. This grudging attitude, which contrasted with that of competitors like the building society Nationwide which had put up £200 million to compensate all its customers, brought a torrent of criticism down on the Bank. BBC Radio 4’s Money Box programme commented: ‘Halifax, the high street bank, is fighting for its reputation this weekend after an unprecedented onslaught in the press and an accusation by the Financial Ombudsman of misleading its customers.’2 The programme’s presenter, Paul Lewis, listed the adjectives used to describe the Bank: ‘Shameful, pitiful, bizarre, penny pinching, a blunder, descended to the gutter, are just some of the terms used against Halifax Bank of Scotland, which likes to call itself a new force in banking. After this week “new farce” might be closer.’ So much for Crosby’s promise in the annual report of being the consumer’s champion.

  To compound matters, Halifax had also started its own internet and telephone bank, called Intelligent Finance (IF). To lead it the bank had poached Jim Spowart, a veteran banker who had started his career with the Royal Bank of Scotland, but already had done two start-ups with the insurers Direct Line and Standard Life. IF had been phenomenally successful in its first year, gaining 155,000 customers, grabbing a 9 per cent share of new mortgages and lending £5.2 billion. Add this to the success of the main Bank and HBOS was winning nearly a third of all new mortgages. Its dependence on the housing market was becoming more rather than less.

  Another puzzling aspect of the strategy was the campaign to win more current accounts. As a former building society, Halifax had a relatively small share of this market but traditional bankers from both sides of the merger were not over-keen to increase it. Current accounts were the necessary evil of retail banking – in supermarket terms they were loss leaders. Cheques, still the main form of bill payment in 2002, were expensive to process and although customers might have high cash balances on pay day, the average in an account over the month was much less and canny customers withdrew spare cash to put it into interest-earning deposit accounts. At one time banks had charged fees on current accounts in order to break even but competition and government pressure had forced them first to introduce free banking and then to pay a grudging amount of interest on credit balances. The going rate was a measly one-tenth of 1 per cent. Halifax went all out to grab a larger share of this business, with a market-beating promise to pay forty times as much interest – 4 per cent.

  Traditional bankers looked on in disbelief. No wonder retail profits were down; it was estimated that paying the extra interest cost Halifax £100 million a year.3 Extending that to customers of Bank of Scotland, which already had a much larger share in its own market north of the border, could increase this cost by £50 million – and all to gain accounts on which it would be hard to earn any profit. The theory was that once acquired, current account customers could be sold other products – insurance, savings, loans – but that was in the future.

  To make things worse from the traditionalists’ point of view, Hornby was undeniably superb at marketing and selling and even the former Bank of Scotland board members were impressed. ‘Hornby was a most able and most likeable marketing person. His ability to get things on TV and to sell was amazing. When you saw him in action with his people and his charts and all his modern thinking, it was difficult to believe there was anything he could not do.’

  His great innovation was to allow his advertising agency to launch a television and press campaign which turned traditional stereotypes on their heads. Instead of using celebrities or actors the ads featured ordinary members of the HBOS staff singing and dancing in front of the cameras. Although there were Scottish staff north of the border, the most popular by far of these amateur stars was Birmingham-born, bald, bespectacled Howard Brown, who sang specially written lyrics around the theme of ‘Who gives you extra?’ to well-known hits such as Tom Jones’ Sex Bomb and Who Let the Dogs Out by Baha Men. Brown became extremely popular and HBOS used him extensively, adapting hits such as Rod Stewart’s Sailing, with the word ‘Saving’ and Aretha Franklin’s Think with the title-word changed to ‘Extra’.

  Brown became so well known that he was recognised in the street and the Bank sent him on a tour of branches so that customers could meet him face to face. He made guest appearances in television shows but the novelty wore off and the over-exposure of Howard began to provide irritation rather than delight. The Bank withdrew him from public performances and for a while gave him a job in the public relations department, but eventually he left banking and went back to his previous trade as a locksmith.

  Meanwhile the bank was trying to boost its presence in the small- and medium-sized business market under a new department headed by Colin Matthew. This was a lucrative sector, with profit margins more than twice those in personal banking. Bank of Scotland led this market in Scotland but without a branch presence in the south had found it difficult to break the stranglehold of the London banks. The plan was to pilot new business banking services in 15 Halifax branches in England and then roll them out to 100 more. Matthew announced that he would recruit 1,500 experienced staff – mostly from other banks – and HBOS would match its offer to personal customers by paying interest on cash held in business accounts.

  But the initiative got off to a disappointing start. Branches were geared towards personal customers and business people were not keen to discuss their company’s problems in busy, noisy retail malls. Halifax branch staff we
re unused to dealing with commercial customers and did not understand their needs. They were also not equipped to handle large volumes of cash, particularly coins. The campaign received a major setback when, after a training session in an open-plan branch in the Trafford shopping centre in Manchester, a flip-chart was left in full view of customers. It listed all those businesses that Halifax did not want and that staff should discourage. They included new business start-ups, taxi drivers, window cleaners, market traders, shops and supermarkets. The Sun, the largest selling daily newspaper in Britain, got hold of a photograph of the chart and ran a story on its front page under the heading ‘Halifax couldn’t give a XXXX’.4 It went on to quote affronted taxi drivers and window cleaners and carried a cartoon, which Bank of Scotland staff felt ‘captured all our frustrations’. The Daily Mail called HBOS ‘The bank that likes to say “no” to small business’.

  The hapless Bank tried to explain that it was merely discouraging those businesses with cash-handling requirements which it could not yet meet, but the impression that it was rejecting a whole class of basic small businesses proved hard to shake off. Other newspapers took up the story and small-business associations made loud complaints. James Crosby had to admit to a major embarrassment over the gaffe but its campaign to break into the smaller end of the market received a blow from which it was hard to recover. Persuading small firm owners to change their bank had always been a long job, involving them in considerable upheaval and disruption to their business. Now it looked even harder.

  The flip-chart incident was bad enough, but there was a starker illustration of the change in culture to come. A cabbage was placed on the desk of a cashier who had not hit targets in a branch in Glasgow, while in Paisley a cauliflower was the brassica which was chosen to represent under-achievement. The banking union was horrified and the incident provided another reason for the press and broadcasters to criticise selling methods in financial services. The company’s apology looked lame.

  13

  Room at the top

  With the embarrassment of the ‘no taxi drivers’ story still ringing in his ears, James Crosby delivered another bombshell when he went back to HBOS shareholders to raise £1.37 billion in new capital. The market did not take it well and the share price, already trailing that of the Bank’s competitors, fell 8 per cent on the announcement. Officially HBOS explained that it was having to put more money into its life assurance and pensions business because of changes in regulatory rules, but the feeling inside and outside the company was that it was being driven too fast, particularly in selling new mortgages and corporate loans. Adding new business was sustainable if it could be done profitably so that some of the surplus generated could provide extra capital. The worry was that new mortgages were being sold which were not profitable, or not profitable enough, and that the fast pace of growth Crosby was setting would lead HBOS corporate banking into lowering its standards.

  Newspapers voiced the fears of some City analysts:

  It is not hard to see why HBOS’ share placing should have sent investors reaching for the panic button. Banks have squandered shareholders’ money so often that it is almost a core activity – think of the billions that have been lost in Latin America, the US, property or investment banking, to name but a few follies of the past two decades. HBOS chief executive James Crosby insists that if it cannot find a profitable way of investing the cash, he will hand it back to shareholders. While that might please the City advisers, who would generate yet more fees from such a deal, it is hardly reassuring. The general rule is that banks with money to burn inevitably find a way to do so. The real concern is that the money will be channelled towards Bank of Scotland’s corporate banking business. Under Peter Burt, that bank was a model of probity and Scottish parsimony. While everyone fretted that it did not have enough capital to fund its rapid growth, Burt set about delivering it year after year, apparently on a shoestring. It has not taken Crosby long to destroy that reputation.1

  Crosby also fuelled the fears himself when he admitted that HBOS could not fund its own expansion. ‘We are growing too fast to do that. Three years ago the bank had surplus capital and no growth. Now we have got the strongest growth seen at a bank for years. I know it costs a lot to raise the money, but when you need money you have to ask for it.’2 Crosby had set demanding targets for the group and all its divisions. He wanted a return on equity of 20 per cent – a stretching goal at the best of times but made more difficult by the decision to raise more equity. He also wanted each division to meet the return criteria and achieve a share of 15–20 per cent of its market. Retail could already claim that in mortgages and deposit accounts but in other respects HBOS was still a small player. To ‘eat the lunch’ of the Big Four as Crosby promised, it would have to run very hard.

  The pace of growth was causing strains inside the company too. ‘The annual budgeting process was quite tense,’ remembers one senior manager. ‘The divisional chiefs would draw up their budgets and send them up to Mike Ellis [finance director]. When they came back they had been pushed up, but were then carved in stone and you had to deliver. If you were to compete, you just had to lend more.’ The feeling among former Bank of Scotland people was that HBOS was being pushed by men with little experience and no understanding of banking and the row boiled over at a board meeting. ‘George Mitchell [head of corporate banking] lost his temper and shouted across the table, “We joined you on the basis that you had a lot of assets – but now you are throwing those assets away.” ’

  Peter Burt retired in January 2003 after 27 years with the Bank. He had been knighted in the New Year Honours List. His internal titles, now largely honorific, were passed on. George Mitchell became Governor and got his name on Bank of Scotland banknotes, and Sir Ron Garrick stepped up as deputy chairman, although without executive responsibilities. The market had an inkling Burt was about to announce his departure when he sold £2 million of HBOS shares. He had gone a year before his normal retirement age but still received a pension of £334,000 a year from a total ‘pot’ of £5.4 million. The Daily Telegraph reported that he also received a bonus of £347,000 in his last year and retained 529,414 shares – worth about £3.5 million.3 The annual report was careful to say that he had ‘elected to retire’ and that no severance payment had been paid, but added: ‘Sir Peter Burt’s pension was based on his accrued benefit with no actuarial reduction for early payment. The cost of waiving the actuarial reduction was £614,000.’ A pay-off of two-thirds of a million pounds is more than the vast majority of people can expect when they leave their jobs, but this was not an exceptional amount in banking and, hidden away in the notes, provoked little attention.

  Other salary increases were modest, except for Lord Stevenson, who saw his remuneration as part-time chairman rise by nearly a third to £472,500, partly paid to him directly and partly through his company, Cloaca Maxima, named after the sewerage system of Ancient Rome.

  Gordon McQueen, who had been running the treasury operation, left later the same year, again retiring early. His place was taken by Lindsay Mackay, a treasury veteran who had joined Bank of Scotland in 1982. A big, quiet and serious man, he had a reputation for prudent management and calm judgement, but he was not given a place on the main board, where treasury was represented by George Mitchell. The board also lost Sir Bob Reid, the former Shell executive who had served as a director of Bank of Scotland and had been senior non-executive director on the HBOS board. He had long experience and had not been afraid to speak his mind.

  There was still disquiet in Scotland that HBOS had been a takeover rather than a merger and the trigger which turned the concerns into public anger was the decision to refurbish the Bank’s 200-year-old headquarters on The Mound. To create a double-height central hall with views over Edinburgh which, it was unwisely announced, would be used for corporate entertaining, the working branch was being closed and moved elsewhere. The public would no longer be admitted into the building, which still had in its foyer the 300-year-old iron-
bound wooden chest which had served as the Scottish Treasury. Not only that, but the gallery, a first-floor landing running around the foyer, was also removed. Off it had been the offices of the chief executive, treasurer and six other general managers of the Old Bank. The traditional collegiate management structure had gone, to be replaced by ‘hot desking’.

  For those who had opposed the merger, this was proof that the Scottish capital had lost an important head office, now being turned from a working building into little more than a dining room. A campaign was launched headed by Hugh Young, a former secretary of the Bank, and it gathered political and civic support, but it could not prevent the remodelling from going ahead. Despite the assurances that the building now housed more working executives than it had done under the old Bank of Scotland regime, it was difficult to believe that the Bank was being run from Scotland in anything but name.