Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  Lloyds’ takeover was finally completed in January 2009. Only two of the HBOS top team were kept on: Harry Baine, the company secretary, and Jo Dawson, head of retail and insurance. In fact the purge of HBOS managers was to reach almost Stalinesque proportions. Lloyds committed itself to the replacement of all the senior management responsible for the collapse of HBOS. No ex-HBOS executives were to be on the new Lloyds Banking Group board and of the nine senior executives reporting to Daniels, only one was ex-HBOS. Further down the organisation, despite HBOS now making up more than half the enlarged group, ex-HBOS managers accounted for less than a third of the top two layers of management.

  In Greek mythology the goddess Nemesis extracted vengeful retribution against those guilty of hubris – arrogance before the gods. Now she visited the HBOS board. Lord Stevenson and all the non-executive directors were fired. Andy Hornby, whose head had been demanded by Gordon Brown as a condition of the Government bailout, had already gone. He had been retained by Lloyds on a £60,000 a month consultancy to help with the integration, but a public outcry forced him to give it up.

  Colin Matthew and Peter Cummings were the last survivors from the old Bank of Scotland. Cummings’ leaving triggered a wave of vilification in the press that continued for several years. He was described as a reckless gambler, a man who almost single-handedly wrecked the bank. Reporters door-stepped his home in Dumbarton and photographers lurked to snatch grainy pictures of him and his wife shopping at the local supermarket. He was bracketed with the Royal Bank of Scotland chief executive Sir Fred Goodwin as the focus for public anger at the collapse of the two banks and, like Goodwin, his generous pension was seen as an ill-gotten gain. The Sun headlined: ‘Bungling Fred “The Shred” Goodwin was last night joined in Britain’s banking hall of shame – by Pete The Pocket.’9

  Nemesis, however, did not force them to go empty-handed. Peter Cummings received £702,080 as a redundancy payment, Mike Ellis £670,500, Philip Gore-Randall £568,000 and Colin Matthew £656,405. All had also built up large pension funds: Cummings’ £7 million would give him an annual pension of £369,000; Matthew’s £9 million a pension of £416,000 and Hornby’s £2 million would produce £240,000 on retirement. They had received large salaries and cash incentives, paid as part of a scheme covering 2007 and 2008, but waived their right to the 2008 payments – the year in which the company was effectively bankrupted. Cummings was revealed in the subsequent annual report to have also waived his right to £1.3 million ‘earned’ in 2007.

  The goddess was not entirely done with HBOS. A year later Paul Moore, who had been head of Group Regulatory Risk at HBOS between 2002 and 2005, gave evidence before the House of Commons Treasury Select Committee. He alleged that he had repeatedly warned James Crosby, then chief executive, and other directors that the rapid expansion of the group was exposing it to grave risks. Moore had been fired by Crosby. His allegations were disputed by HBOS directors, but his evidence was enough to force Crosby’s resignation from the deputy chairmanship of the FSA.

  The demise of HBOS and the clear-out of the board left the way open for attention to be focused on Lloyds. When the final results for HBOS were published it became clear that Lloyds had taken on far greater liabilities than it had realised. The loss was a staggering £10 billion, with corporate banking accounting for two-thirds of that and further losses on the US mortgage portfolios for the rest. It was a final nail in the coffins of the reputations of Hornby, Stevenson and Cummings, but it also cast doubt on the judgement of Daniels and Blank. The deal had been rushed because of the danger that HBOS might collapse before it could be taken over and the Lloyds chief executive admitted that only a third or a fifth of the usual amount of due diligence – the painstaking detailed forensic examination of the books – had been done. It began to look as though the Devon shareholder at the Lloyds meeting had been right: it had been a corporate ego trip. Blinded by the scale of the prize, which would give them unrivalled dominance in the British retail banking market, the Lloyds’ board and shareholders had cut too many corners. One analyst commented: ‘This looks bad for Lloyds as they may have failed to spot the level of toxicity in HBOS’s book. The worry now is that they may have blown up two banks instead of one.’10

  Lloyds’ reputation as a cautious bank which had survived the credit crunch in better shape than its rivals was now shattered. The fear was that the mounting losses would eat up all the extra capital it and HBOS had taken from the Government and that the combined group would be forced to seek more. That could mean the publicly-owned share of the bank rising to above 50 per cent. The ratings agency Moody’s took a pessimistic view and downgraded Lloyds’ credit status.

  Daniels fought against Government control, but he did not have many cards to play. In March Lloyds was forced to take advantage of a government scheme to insure £260 billion of toxic loans, 80 per cent of it made up of HBOS mortgages, commercial property and corporate lending. That lifted the pressure on its capital, but there was a heavy price; the insurance premium would cost several billion pounds. Unless Lloyds could pay that in cash, the Government would up its stake in the company to a level which would give it 60–70 per cent of the shares. To avoid this Lloyds went to its own private shareholders to ask for money in a rights issue. Although a quarter refused to buy more shares, the bank raised enough cash to pay the Government its fee, repay some of its borrowing and avoid nationalisation.

  The situation had been saved, but shareholders still wanted someone to pay for the botched takeover. The value of their investment had been reduced by three-quarters by the HBOS acquisition. Pressure mounted on Sir Victor Blank and at the annual meeting in May he announced his intention to ‘retire’ at the next annual meeting in a year’s time. In fact he did not last that long and left early to make way for a new chairman, retired banker Sir Win Bischoff, who began a clear-out of the board members who had voted through the HBOS deal. He replaced them with people with banking experience.

  But the misery was not over for Lloyds. In November Eric Daniels had to go back to shareholders again for £13.5 billion in new equity and £7.5 billion in bonds – the biggest capital-raising exercise ever by a UK company. It meant another injection of £5.9 billion in Government money and another massive dilution for Lloyds’ and HBOS’ shareholders, reducing the value of their investments yet again. There was more pain to come. The British Government may have waived competition law, but the European Commission was not so compliant. It ordered Lloyds to work towards the lower-risk strategy it had followed prior to the HBOS acquisition. This included reducing its loan book by £181 billion. To answer monopolies concerns the bank was also required to sell off 632 of its high-street branches and its TSB and Cheltenham & Gloucester brands. All LloydsTSB branches in Scotland were also to be sold and market share in residential mortgages and current accounts was to be reduced.

  Daniels survived repeated calls for his resignation, but was forced to give up a £2.3 million bonus for 2009 when Lloyds had recorded a £6.3 billion loss. Daniels left Lloyds in 2011, six months before his retirement age and dogged until the last by bad news from his HBOS move. Some £500 million had to be spent compensating 300,000 Halifax customers for badly written mortgage contracts, and bad debt provisions on Irish loans cost another £2 billion. He spent his last six months on the Lloyds’ payroll sitting at home while his successor, Antonio Horta-Osorio ran the bank, but even in retirement he could not escape the ghost of his acquisition. At the beginning of 2012 a retired Scottish sea captain living in New Orleans raised an action in the US courts against Daniels and Blank claiming that a ‘reckless disregard for the truth’ during the takeover had cost Lloyds shareholders billions of dollars. The Lloyds board also decided that a share issue worth £840,000 to Daniels for his integration of HBOS should be scrapped.

  In 2012 Lloyds estimated that the write-offs from its acquisition of HBOS would total £45–48 billion. Sir Win Bischoff said: ‘With the benefit of hindsight now, obviously it has not been as good an idea a
s people thought at the time, and that includes all the shareholders who voted in favour of it.’11

  In any big corporate transaction like this, press attention focuses on the high-profile casualties at the top, while those at the bottom are merely mass statistics. Thousands of HBOS employees paid for the debacle with their jobs and savings. At the time the deal was struck Lloyds denied that it would lead to 40,000 jobs being lost, although analysts could not see how the bank could save the £1.5 billion a year in costs it had predicted without this scale of reduction in employment. By the middle of 2011 more than 28,000 jobs had been shed, but it was estimated that a strategy review by Horta-Osorio could result in a further 15,000.12 Their redundancy payments would be in the thousands rather than the hundreds of thousands and their pensions a fraction of those their former bosses received. Many of those who lost their jobs would also have lost their savings through having been shareholders in the HBOS and Lloyds share-save schemes.

  ‘I estimate that 90 per cent of HBOS staff had shares,’ said one Bank of Scotland manager. ‘Some had tens of thousands in savings. If any of us had suspected things were that bad we would have sold, but we didn’t. Andy Hornby kept telling us it was a safe bank; the message was worded slightly differently, but it was the same every month – and we believed him.’

  While this was going on Lloyds also began dismantling the property portfolio and the equity stakes built up by Bank of Scotland Corporate under Peter Cummings. At one stage Lloyds had 1,000 people unwinding the HBOS property book. A number of property companies to which HBOS had lent collapsed into administration or receivership, or the bank was forced to accept equity in exchange for loans which could not be repaid. Others were sold at fractions of the levels at which they had been valued just a few years before, giving the bank some of its money back.

  To try to recover some value on the Cummings’ ‘nest egg’ share stakes, Lloyds entered into a joint venture with Coller Capital, a private equity firm, to try to sell the holdings. The new venture, in which Lloyds had a minority share, was headed by Graeme Shankland, formerly head of HBOS’s integrated finance unit. An anonymous commentator told the Financial Times: ‘These guys made some horrendous mistakes, but that doesn’t make them incompetent. They know the assets better than anyone else and are best placed to clear up their own mess.’13

  It was not all fire sales. In 2010 PSN, an oilfield services company which had been a management buyout backed by HBOS and Tom Hunter in 2006, was sold to the Wood Group for £600 million and the following year Mint Hotels (formerly City Inn) was sold to Blackstone for £600 million. In both deals Lloyds recovered debt and equity.

  In 2010 Lloyds gave Bank of Scotland branches a makeover. The Halifax name was removed and a new advertising campaign sought to focus on ‘traditional banking values’. Television commercials voiced by actor Dougray Scott followed a couple from their meeting, through marriage, having a family and buying a home. Its brand promise: ‘With you all the way’ echoed the ‘Friend for Life’ campaign of a quarter of a century before. Media consultant Richard Gold commented: ‘In the context of recent crises, the claim and the homely way it is delivered may seem almost ironic – it is as if the past couple of years never happened. Yet viewed within the context of the bank’s centuries-old relationship with Scottish people (it was founded in 1695), and at a time when a host of new entrants are trying to establish a high street banking presence to take advantage of public mistrust of the incumbents, it is a bold and sensible approach.

  ‘Bank of Scotland is digging deep into its DNA to recapture and amplify the institution’s most appealing brand assets.’14

  20

  Hungry for risk

  What went wrong? In the next few chapters I will attempt to find some answers to this question. To say what happened is easier than to say why it happened. In trying to discover the latter I have been hampered by the fact that, although many senior managers and some non-executive board members have been ready to speak to me, the key executives, including Sir James Crosby, first chief executive of HBOS, Andy Hornby, his successor, and Mike Ellis, finance director, have all declined to meet me. I do not criticise them for this: mine is a personal rather than an official inquiry and they did not know how objective or how accurate I would be. But I mention it as a qualification to my conclusions. Their actions are, to a large extent, documented and well known. We can guess at their motivations, but without any certainty because they have refused to speak. Peter Cummings also declined to explain his part, but with a specific justification. At the time of writing he was the only HBOS executive to be notified of possible ‘enforcement’ actions by the FSA and is understandably talking to no one until the result of that action is known.

  I am not the only person seeking answers. The House of Commons Treasury Select Committee conducted extensive hearings and produced two comprehensive reports on the failure of UK banks, including HBOS and the Royal Bank of Scotland. The European Commission touched on the reasons for the HBOS failure in its report on the competition issues raised by the Lloyds takeover. The Independent Commission on Banking has also examined the components of the collapse and suggested ways in which they would be mitigated in the future. I shall draw on all these, plus numerous press and academic reports. The FSA initially said its report on the collapse of HBOS would be internal only and not made public, but under pressure from MPs and the press it has conceded it will be published. When is another matter. The FSA will give no guidance. At the time of writing (Spring 2012) it looks as though it will be at least 2013 – four years after the collapse of HBOS – before the financial regulator gives a full account.

  What precipitated the crash of HBOS? It can be very simply stated: HBOS broke the basic rules of banking; it ran out of cash and it lent to people who could not repay. From the failure of the City of Glasgow Bank in 1878 to the collapse of the secondary banks a century later, the history of banking is littered with examples of banks that failed for just these reasons. These lessons were not learned. Why not?

  There has been criticism of James Crosby, the first chief executive of HBOS, and Andy Hornby, his successor, for their lack of banking qualifications and experience, although Crosby was an actuary with a deep intellectual understanding of risk. For the first few years of HBOS’ existence there were several experienced and trained bankers among the executive directors: Peter Burt, George Mitchell, Colin Matthew and Gordon McQueen. At the end there were only Matthew and Cummings. The new promotions to the executive board had financial services backgrounds, but not much banking experience. Was this a critical factor? It is hard to believe that possessing a banking qualification would have altered the behaviour of Hornby. Would things have turned out differently had George Mitchell become the successor to James Crosby rather than Andy Hornby? Perhaps, but that would probably have been as a consequence of his maturity, his temperament and the culture he had imbibed during 30 years at Bank of Scotland rather than the certificate in banking he had earned at the beginning of his career.

  The culture at HBOS at its height was very different from that at the old Bank 20 years before. It is tempting to believe that it changed on the day of the merger, but the sales culture had been creeping into most British banks for a decade before 2001 and the Bank was no exception. I remember clearly the day I first noticed that change in the early 1990s when, having discussed a major expansion of my business with my bank manager, he called with an urgent query: could we possibly see our way to draw down the money before the end of the month so that he could meet his target? It was not even a low pressure sell, but it would not have happened even five years before and was the beginning of a process which eventually led to personal account holders being called at home in the evenings to be ‘informed’ about new products and asked if they wanted to buy. But the change of culture in Bank of Scotland was incremental prior to the merger in 2001. In HBOS it had become revolutionary. One Bank executive making his first visit to the Halifax headquarters shortly after the merger ex
pected to find it like his traditional image of a building society, dusty and conservative. He was shocked to find it like the sales office of a supermarket.

  Lord Stevenson and Andy Hornby argued before the select committee that the closure of the wholesale inter-bank market was the sole reason for the collapse of HBOS. They claimed that the Bank had been taking prudent steps to try to reduce this liquidity risk by increasing the length of its borrowings, by trying to increase its retail deposits and so reduce its reliance on wholesale funding and by curtailing the growth of its lending. All this is true, but it was too little, too late. The select committee did not believe them. Its report on the banking crisis was clear where the blame lay: ‘Capital and liquidity indiscipline were at the heart of HBOS’s downfall, and rather more emphasis was placed in HBOS’s evidence to us on the catastrophic global context of recent events than on a genuine recognition that responsibility for the Company’s plight lay with the Board and the Board alone.’1

  By the end of 2008 HBOS was more dependent on short-term funding from the wholesale market than any other major UK bank (Northern Rock having already failed) and its name in the market had been tarnished by doubts over the quality of its assets, exacerbated by the relentless increase in doubtful lending in mortgages, unsecured personal loans and corporate advances. There were also rising provisions against its holdings of US mortgages, the Alt-A securities. Every time it had to restate the level of its ‘impaired loans’ or written-down assets it lost more credibility. The market was not convinced that the HBOS management knew the depth of the hole into which it had dug itself. Its creditworthiness was undermined and this was reflected in the downgrading of its rating by the credit agencies. This in turn damaged its ability to fund itself.