Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  Hornby and Daniels had held tentative discussions over the summer, now they began urgent negotiations.

  There was a symmetry to the beginning and end of the life of HBOS. On 16 September Hornby, his finance director, Mike Ellis, and main adviser Simon Robey of Morgan Stanley, met Daniels, Tim Tookey, Lloyds’ finance director, and their adviser Matthew Greenburgh from Merrill Lynch, in the HBOS corporate flat in St James’s. Seven years before it had been the venue for the meeting between Peter Burt and James Crosby when the merger between Halifax and Bank of Scotland had been hammered out. Then the air had been light with optimism and excitement. Now it was heavy with dejection and resignation.

  Daniels knew he had the upper hand and Hornby knew he could not leave the room without a deal. According to the The Daily Telegraph: ‘ “Andy was in a state of panic,” one person at the meeting said. There was a lot of aggression between the two teams. You always get that in a bid but this was compressed into a few moments and the stakes were enormous. Obviously, it got heated.’6 The talks dragged on into the early hours of the following morning before the outline of a deal was agreed. HBOS would be bought by LloydsTSB at ‘around’ £2.85 a share, a much higher level than the current share price on the Stock Exchange, but less than half of the value at the time the company had started life in 2002. The two sides broke up expecting to meet later that morning, but someone at HBOS leaked the news to Robert Peston at the BBC who wrote on his blog at 9 a.m. that a deal was close at near to £3 a share. Daniels was furious and an hour and a half later Peston blogged: ‘Maybe I’ve slightly over-egged the price that Lloyds TSB will pay for HBOS. Perhaps it will be nearer £2 than £3.’

  News of the deal did nothing to steady the HBOS share price and the value of LloydsTSB’s shares also dropped as investors worried about what the bank was taking on. All bank shares were tumbling and in a desperate attempt to steady the market the FSA imposed a three-month ban on short selling and the Bank of England announced an extension of its special liquidity scheme, which was keeping several banks afloat.

  There was still the competition issue to overcome and later that day Daniels met Darling to ask the Government to suspend competition law to allow a takeover to go ahead. Darling agreed to discuss it with Gordon Brown, but he was still not convinced that Lloyds knew what it was getting into or that a deal was possible at all. He instructed his officials to prepare two alternative statements, one welcoming a takeover by LloydsTSB, the other explaining the nationalisation of HBOS. Victor Blank had already raised the competition issue with the Prime Minister while they were flying back from a trade mission to Israel and Palestine, but had not got a final answer.

  The collapse of HBOS, with 30 million customers, was unthinkable, but neither of the alternatives was appealing for the Government either. It had taken nearly six months to decide to take Northern Rock into public ownership, and apart from the political opposition and practical problems it was also threatened with legal action by some shareholders for expropriating their investments. It did not want to go through that again on a much larger scale with HBOS if an alternative could be found. But allowing Lloyds to acquire HBOS had the potential to create a fearsome monopoly. The combination would give Lloyds market leadership in seven key product areas: in current accounts and mortgages it would have over 30 per cent of the market; in savings, credit cards and small businesses it would have over 20 per cent and it would also lead the personal lending and home insurance markets too.7

  The Prime Minister’s final consent to suspend competition law was signalled to Blank during cocktails before a dinner both men were attending during the week of the final negotiations, but a picture of the two in deep conversation published in the Financial Times on the day the deal was finally announced gave the impression that it was a political stitch-up.

  Later that day, 17 September, Daniels agreed to an offer at £2.32, some 20 per cent less than his sighting shot a few hours earlier. Hornby had little option but to accept. Now began a second sleepless night as teams from both banks worked through the dark at the City offices of Linklaters, Lloyds’ lawyers, to complete the paperwork. Tookey left the meeting at 4.15 a.m., only to find that his hotel room had been given to someone else. He slept for an hour on a colleague’s couch in the Lloyds’ City office before meeting Hornby at 7 a.m. in Daniels’ office for the Stock Exchange announcement and the press calls.

  By the time of the press conference on 19 September Hornby had recovered his composure and Daniels had forgotten his anger. The two men shook hands, watched over by Sir Victor Blank. Both sides thought they had got the best from the negotiation. Daniels had acquired a bank bigger than his own, giving him a commanding position in the retail market without spending cash and giving his own shareholders a majority of the equity. He could hardly contain his enthusiasm: ‘We just did an enormously good deal. This is fantastic. I rarely use superlatives, but this is really a good deal.’ Hornby was congratulated by members of his board for pulling off ‘an unbelieveably good deal’. The price may have been half what could have been achieved six months before, but it was well above the market price of the shares and he had secured the future of his bank.

  Both men were fooling themselves, but neither yet realised it.

  For the Government it also looked like a good deal. Brown and Darling had not had to pledge any guarantees in exchange for LloydsTSB taking a problem off their hands and the strength of Lloyds’ balance sheet would make it that much more likely that the money lent to HBOS by the Bank of England would be repaid. As an added bonus Lloyds made unsolicited pledges to keep the headquarters in Edinburgh, to keep printing Bank of Scotland banknotes and to try to safeguard jobs in Scotland. This last pleased the Scottish Labour Party which was fighting a tough by-election in the constituency next to Gordon Brown’s, but angered the MP for Halifax, where no such promise had been given.

  The deal may have satisfied the two banks’ boards, but it changed nothing in the real world. In the following weeks more US banks went bust and the Federal Reserve injected $85 billion into the giant insurance company AIG, which had insured sub-prime securities, to keep it afloat. Icelandic banks, which had expanded massively in the UK, were also collapsing, nearly bringing their country down with them. So were banks in Ireland. On the London Stock Exchange shares in LloydsTSB and HBOS continued to fall, the latter touching 90p at one stage. With each piece of bad news, the capital of banks was being eroded, the economy was getting weaker and their potential losses were climbing.

  Gordon Brown realised before the banks that they needed capital as well as liquidity. Some might be able to raise it from their shareholders, but the experience of HBOS in its summer rights issue clearly showed it could not. A plan was hammered out by teams from the Treasury, Downing Street, the FSA and the Bank of England. Darling explained it to the bank chief executives in late night meetings. They did not like it, but they could not reject it. The Royal Bank was in the worst position, but Fred Goodwin remained impassive. HBOS was next, but Hornby was unable to hide his terror and sat with his arms tightly clutched around himself. ‘He looked as though he might explode,’ said Darling.8 ‘I wouldn’t put my money in his bank,’ remarked one Treasury official. ‘Just look at his body language.’

  On 8 October the Government announced its funding package: £50 billion in new capital, £250 billion in guarantees to underpin bank borrowing and £100 billion more for the Bank of England’s special liquidity scheme. The Royal Bank of Scotland was the first to agree to take more capital, then HBOS and finally Lloyds. The scheme was portrayed as voluntary, but in fact it was mandatory and there were conditions: remuneration was to be cut, dividends suspended and Hornby and Stevenson were to be fired as soon as the merger was complete.9 The HBOS chairman took it badly: ‘He was absolutely furious,’ a Government source told me. ‘He didn’t see what he had done wrong and why he couldn’t stay.’

  The takeover was finally agreed in October after the terms had been reduced again. Now HBOS share
holders would get fewer Lloyds shares in exchange for their old ones. The Government would be the largest shareholder, owning 43.5 per cent of the merged company; next came Lloyds shareholders with 36.5 per cent and finally HBOS with 20 per cent – less than half what they would have received with the initial offer. Since the Lloyds’ share price was also falling, the cash value of HBOS was dropping by the day.

  Inside HBOS staff who were also shareholders were watching their savings evaporate. Employee and trade union rep Margaret Taylor: ‘Since the 1990s staff had often taken part of their salary increase in shares or indeed all of it; after all there was a tax incentive to do so. It would not be uncommon for somebody working in the back office who had £3,000 in a bonus to think “I’m going to put some of that into shares.” It is not uncommon for somebody working as a teller on £15,000 to £18,000, who’s been with the company for 15 years, to have built up £20,000 in shares. Most people thought that anyone who didn’t buy into these schemes was crazy because it seemed that you were, you know, why wouldn’t you? Based on their own experience the share prices had only gone up for a number of years.

  ‘When the HBOS share price began to go down, nobody believed that it would collapse. It was at £11 and then to go to £9, £8 . . . Staff couldn’t believe that had happened but people did still have a feeling that they trusted their employer. Nobody sold their shares because they all thought that it would go back up. The message we got from senior management on a weekly basis was: “This is a strong bank; today we have held a meeting with our most significant investors, and we have told them, we have told the City, this is a strong bank. We have a strong asset base.” People really watched in disbelief – and I do mean watched, because the share price was on the intranet and they could watch it daily, live, every 15 minutes – as they began to lose their savings.’10

  For the HBOS board there was one final humiliation before they were booted out without compensation. They had to face shareholders to recommend the deal.

  Daniels, however, put an optimistic gloss on events: if it was a good deal before, it was an even better one now, he claimed.

  19

  Nemesis strikes

  Scotland has been home to many lost causes, and consternation at the loss of the country’s oldest bank provoked a rash of hopeless attempts to save it. Sir Peter Burt, Bank of Scotland’s last chief executive, called his old adversary Sir George Mathewson, now retired from the chairmanship of the Royal Bank of Scotland, and the two wrote to the HBOS board with a typically radical and outspoken alternative future for the company: Stevenson and Hornby should be kicked out, to be replaced by themselves; the Lloyds deal should be rejected and HBOS should continue as an independent company, bolstered by the injection of government capital and loans.

  The move sought to tap into an increasing disquiet among HBOS shareholders that they were being herded into accepting the Lloyds offer without knowing the full facts. ‘A properly recapitalised, properly run and independent HBOS appears to be in the interests of the shareholders, its employees, its customers and all stakeholders, avoiding the dangers of an anti-competitive over-mighty leviathan,’ said a statement from Burt and Mathewson. ‘There has been a complete absence of both transparency and debate on whether or not HBOS shareholders are receiving reasonable terms.’1 Predictably, the proposal was rejected by the HBOS board and in a circular to shareholders Lord Stevenson raised the spectre of total nationalisation if the Lloyds deal was rejected.

  Burt and Mathewson continued for another fortnight before throwing in the towel. They had received 40,000 messages of support from small investors, but the institutions which held the vast majority of HBOS shares were not enthusiastic and neither was the Government. Burt finally admitted defeat: ‘The Government’s statement has raised several hurdles very high and has made it crystal clear that they do not want and are not prepared to facilitate HBOS remaining independent. The deal had been billed the deal of the century. It is a very good deal for Lloyds. I wish them well through gritted teeth. It’s very sad. A lot of people will lose their jobs and families will be devastated by it unnecessarily.’ He also criticised the ‘apparent apathy’ of the HBOS board for failing to explore other options at the time of the Government’s bailout.2

  A separate attempt to provide another choice was made by Jim Spowart, the man who had founded Intelligent Finance, the HBOS telephone and internet bank, but had left in 2003. He tried to interest Bank of China into making a counter-bid, but again met with a blank refusal by the Government to consider alternatives. ‘Tens of thousands of extra families will now see their lives blighted by unemployment and its resultant misery,’ said Mr Spowart. ‘Why? Because politicians put their own egos and political agendas before the welfare of the people they purport to represent.’3

  In December 2008 a last ditch attempt was made by a group of Edinburgh businessmen who launched a challenge to the Government’s agreement to set aside competition policy. A special sitting of the Competition Appeals Tribunal was convened at short notice in London to rule on the appeal before the HBOS shareholders’ meeting, but rejected it as having no basis. Trustees of the company pension scheme also threatened action, demanding that Lloyds say how it would make up the £3–£5 billion shortfall in the HBOS pension fund, but that too failed.

  The deal had to be agreed by both sets of shareholders. As a concession made at the time of the Lloyds merger with TSB, that company was registered in Scotland, although for all practical purposes based in London. It chose the Scottish Exhibition Centre, a vast, cold, industrial shed on the banks of the Clyde in Glasgow for its meeting. Sir Victor Blank did his emollient best to sell the deal, but small investors were not impressed. ‘The [Lloyds] strategy has been very successful . . . why does the board think it is in the interests of shareholders to compromise that success?’ asked one. ‘I find it profoundly disturbing that this deal was cooked up at a cocktail party with the Prime Minister who set aside competition law. Most of us think this deal stinks,’ said another. One investor who travelled from Devon, said the board was ‘putting its head in a noose’ with the HBOS deal and added: ‘It smacks of an ego trip.’4 Sir Victor, with the proxy votes of institutional shareholders in his pocket, knew the deal was safe and announced its approval by 96 per cent.

  For its meeting HBOS kept clear of its Scottish and Yorkshire heartlands, where most of its small shareholders lived, but many journeyed to the equally soulless National Exhibition Centre in Birmingham anyway. They heard Stevenson and Hornby apologise for the state to which the bank had sunk. The chairman told the meeting he had spent £1 million buying HBOS shares during the past year. ‘You might ask what kind of chump is that? Andy Hornby has put every single cent of his bonuses into the company’s shares – not into yachts and grand houses.’ Again, the result was a foregone conclusion, but that did not stop small shareholders from voicing their disgust. One said he was appalled that the board had ‘turned a £50 billion company into a basket case in 12 months’ and he demanded the board return bonuses they had received in previous years.

  Among the attendees was Mike Blackburn, the last chief executive of Halifax before the merger with Bank of Scotland. His remarks echoed the feelings of many Scottish ex-managers: ‘I don’t think you can put all the blame on what has happened in the US,’ he said. ‘HSBC, for example, has not had recourse to Government money. There is a benefit to banking being boring. Banking is as much about saying “no” as saying “yes”.’5

  The deal was now cleared to go ahead, but the ground was still shifting and it was apparent no one knew exactly the real state of HBOS, including its own management and board. In November it issued a trading statement for the first nine months of the year, which showed a significant deterioration in its performance. Arrears on mortgages and unsecured personal loans were again up; so were the provisions against bad debts in the corporate banking division, with property-related lending particularly hard hit. The corporate investment portfolio – the nest egg built up by Pete
r Cummings – was showing a loss of £93 million, compared to a profit of £124 million three months earlier. There were also further write-downs to the American mortgages held in the treasury division and losses from the collapse of Lehman Brothers, US bank Washington Mutual and the Icelandic banks. One piece of good news was the sale of Bankwest in Australia, which brought in much needed cash, but also prompted another write-off of goodwill in the balance sheet.6

  Despite some small good patches, the general message was negative, but there was no hint of the bad news that was to come so soon afterwards. A month later a trading statement showed a much worse position: mortgage bad debts again up, to £700 million, and £1 billion lost on unsecured lending. In corporate, the losses had nearly doubled in a month, from £1.7 billion to £3.3 billion, while the loss on the investment portfolio had gone up by eight times to £800 million. Write-downs in the treasury division now totalled £4.5 billion.7 What was most shocking was not that these figures were so awful, nor that the pace of losses seemed to be accelerating, but that the management did not appear to know about them just a few weeks previously.

  ‘HBOS is flying blind’, said the Financial Times. ‘That the bank was apparently unaware that October was one of the worst months in its 313-year history when it issued its interim trading statement on November 3 is an alarming indictment of its information management systems. That is why yesterday’s profits warning, which was accompanied by the announcement of £3.2 billion of fresh writedowns to duff debts incurred in October and November, knocked a fifth off the value of its shares.’8

  Given the scale of the problems and the rate at which they were increasing, there now began to be doubts whether Lloyds was strong enough to save HBOS, which was admitting that it would have to write off £8 billion in the full year. That would consume more than half the new capital it had raised from its summer rights issue and from the Government injection. Just two months previously the FSA had ‘stress tested’ British banks – inventing worst-case scenarios and calculating how much capital they would need to survive them. But the worst cases were not worst enough. If HBOS’s losses continued at the same rate, its capital would soon fall below the danger level, meaning that it would have to raise more. But from whom? With its shares still falling and future losses still unquantifiable, the private sector would not provide it. That left the taxpayer and the prospect of Government control.