Powerful story of failure, foolishness and greed as a bank dumped tradition for bonus culture
HUBRIS: How HBOS Wrecked the Best Bank in Britain by Ray Perman, foreword by Alistair Darling
Birlinn, 256pp, £20
For those who fear the title of this book is over the top, I could not agree more. For Ray Perman has gravely understated his case. HBOS did not just wreck one good bank. It wrecked three: Bank of Scotland, the pre-merger Halifax; and Lloyds TSB, widely regarded as a solid, reliable and conservative banking giant. Its chief executive Eric Daniels was regarded as so somnolently dull as to earn himself the nickname “Mr Carpet Slippers”.
How HBOS came to wreck three highly reputable banks is one of the most improbable – and improbably horrific – stories in modern finance. That the Financial Services Authority, the body charged with regulating UK banks at this time has not yet seen its way clear to publishing its report is itself little short of scandalous.
So it is to Ray Perman that we are all the more indebted for this succinct, authoritative and well-marshalled account of arguably the biggest financial disaster to befall Scotland since Darien. It is on the wrecking of the Bank of Scotland that he rightly concentrates, because of the bank’s once prominent position in Scottish life. It is deeply woven into the history of Scotland. Its former headquarters dominates the Edinburgh skyline. And in its golden era running between the mid-1970s and the late 1990s, the Bank of Scotland came to be hailed by fund managers, investors and analysts as the best managed bank in Britain. Scots had every reason to be proud, not just of what the bank achieved under Bruce Pattullo but, as important, what it chose not to do – keeping a wide berth from the fashionable stampede into estate agency, stockbroking and “bancassurance”. It was what it wasn’t that best defined what made it great.
All this changed with its failed take-over bid for National Westminster Bank at the hands of its historical rival, RBS. In the aftermath BoS looked vulnerable to a hostile take-over. It was to avoid this fate that chief executive Peter Burt entered into merger talks with the Halifax, Britain’s biggest mortgage provider.
Perman’s account concentrates on the dramatic change of culture that ensued as business banking was souped up as an alternative source of profits to mortgage lending. The Halifax had already changed, from a conservatively run building society into a plc with a relentless focus on building market share.
The group’s share of business and corporate accounts was tiny, as was the contribution of business banking to group profits. But all that was supposed to change under the regime of James Crosby and subsequently Andy Hornby – even as mortgage lending continued to boom. As the corporate lending book grew, Hornby continued to drive the mortgage book even harder. Before long the group was winning almost one-third of all new mortgages – its dependence on the housing market became more, not less.
The feeling among former Bank of Scotland staffers was that the business was being pushed by men with little experience and no understanding of banking. But that critique was blind to the BoS phenomenon that was Peter Cummings, head of corporate banking. By 2003 Cummings was estimated to have lent £2.3 billion to the retail sector, “much of it to people who had become his personal friends”. Well, no wonder you may think.
And this is how it went: in 2003 HBOS corporate had lent £35bn, only one-quarter of the total provided by the retail business. In 2003 the figure rose to £50bn and in 2007 it hit £108bn. It had £430bn outstanding in loans to customers, more than half of this (£235bn) in residential mortgages. Another £35bn was lent to construction firms and a further £8bn to the hotel and retail trades. Overseas mortgage and commercial property lending added a further £51bn. Add all this together, and three-quarters of all lending was secured on land, bricks and mortar.
It was astonishing for the bank to believe that such an explosive growth in one market sector was not without risk; that such growth had occurred without a diminution in the quality of the loan book; and even more astonishing that the HBOS share price which had soared to £11 was gleefully assuming this rocket-fuel pace of advance could continue.
Thus did HBOS career into the heart of the global storm in 2007, with one-quarter of the £250bn mortgage book classed as specialist – either buy-to-let or self-certified mortgages (aka “liar loans”). By the time of the group’s emergency rights issue in June of 2008, the bank had £5bn of souring home loans. Business growth was fuelled by securitisation – packaging of groups of mortgages and on-selling these to third parties – and growing dependence on wholesale funding rather than deposits from customers. It also increased its exposure to US Alt-A mortgages riddled with liar loans and mortgages to those with poor credit histories.
The fateful collapse in credit quality and the bank’s vulnerability to changes in wholesale funding was woefully under-appreciated by a labyrinthine risk monitoring department that employed no less than 100 staff. Thus right to the end, the directors were still reassuring shareholders and the public that the bank’s lending policies were conservative and risks were under control. The opposite was the case. HBOS was kept going by hidden Treasury subventions not revealed to MPs until some 18 months later.
It is an appalling story, one where almost every page leaves you in furious despair as the runaway train smashed through feeble internal supervision, laughable external auditing, silent non-executive directors and an utterly ineffectual Financial Services Authority. All this, in Perman’s view, was the result of a colossal cultural failure as the bank switched from a service ethos to one of pushy targetitis and driving products down customers’ throats in the name of bonus.
Ironically, some of the worst hit victims were among the 50,000 HBOS staff who had accumulated shares over the years and who hoped this would augment their retirement. They have suffered a 90 per cent plus collapse in value. Their story has yet to be told.
All this was a monstrous failure of the financial system. But on a wider view, it could be argued that it worked as it should. The bank failed. Trust has been shattered; the responsible directors and managers have been driven out; the bonus-driven sales culture is discredited; fat cat pay for directors despised; complacent investors have learnt that share ownership confers obligations as well as rights; the FSA is being scrapped and the regulatory system reformed. In short, the banking system has been delivered of a shock so painful as to stamp a warning of moral hazard through the national memory for at least a generation.
Thus does a corrupted system correct itself through the cycle of crime and punishment. It will govern banking for decades. We are indebted to Ray Perman for giving us a powerful lesson on what happens when you usurp the wisdom of a banking culture acquired over centuries for the pursuit of market share and profit at all and any cost.