Darkest day for Scottish banking as the Bank of Scotland faces its end

This was the blackest day in Scottish banking. An appalling day of shock, confusion and disbelief.

Many this morning will still be aghast at the speed of the bank's share collapse. Anger and a reckoning will come later. Today, the fate of HBOS, the savings of its 22 million customers, the prospects for its 72,000 staff and the final reckoning for its 1.2 million hapless investors – whose shares have been savaged – rest on the merger with rival Lloyds TSB.

Yesterday, in conditions of near pandemonium, shares in HBOS had by far their worst day since the onset of the credit crisis. Monday and Tuesday were train-wreck enough – the value of HBOS had plunged by 7 billion by Tuesday night. So there was a surge of relief when the shares opened firmer at the start of trading yesterday. It did not last long.

The shares opened at 200p, rose to 214p, then plunged to only 88p – an astonishing collapse of 56 per cent in less than an hour. Then came reports of "advanced" merger talks with Lloyds TSB, at a price of 300p a share.

The shares rallied – only to fall back again. Amid ever-growing confusion in the market, the mooted bid terms were now corrected – to 200p a share.

By the close, shares in HBOS were still being traded – astonishing for a company said to be in "advanced merger talks". They finished at 147.10p, down almost 20 per cent – a further loss of value of 1.9 billion.

That suggests an ominous lack of confidence. The price-tag on HBOS, Britain's biggest mortgage lender, has now sunk to only 9.6 billion, 83 per cent down on the level a year ago.

IN THE rolling credit crisis, more than 46 billion of the bank's shareholder value has evaporated into thin air. The collapse has hit pension funds, wiped out the nest-eggs of many investors – and added to the misery of staff, many of whom had built up substantial holdings of HBOS shares.

Earlier this year, in a desperate attempt to shore up confidence in the bank, 250 senior managers together bought 1.4 million shares at 446.25p out of their own savings. The cost of the investment was 6 million. By last night, that investment had tumbled to barely 2 million – a loss of two-thirds in barely six months.

Bank of Scotland, formed in 1695 and merged with the Halifax to form HBOS less than a decade ago, was a bank that loved its history.

Its founding constitution and articles are kept like sacred relics in a special glass container and screened off behind a polished wooden panel near the boardroom in the bank's recently refurbished headquarters on The Mound in Edinburgh.

THE bank has survived European revolutions, agricultural depressions, two world wars, stock market crashes and too many recessions to mention. Now it has succumbed to the greatest convulsion in financial markets since 1929.

In hundreds of bank branches across Scotland yesterday, staff maintained the pretence of business as usual. There were no queues of fearful customers anxious to withdraw their savings.

But sources in the bank say it was different among wealthier customers with accounts at the bank's headquarters.

"We've seen a number withdrawing their savings in recent weeks," one said. "Younger customers have taken the share fall this year in their stride. It's the older customers – 50-plus – with their pensions and life savings who've been really anxious."

As for corporate clients, one HBOS business customer told me: "I was speaking to our account manager at HBOS a few days ago. I said, 'Things are looking shaky'. His reply was not exactly reassuring: 'Not half as shaky as they are in here'."

And where has the leadership been? The chief executive, Andy Hornby, and the chairman, Sir Dennis Stephenson, have barely been seen. There have been few public appearances to reassure customers and rally the staff.

THE first thing staff at HBOS knew about merger talks was when they read the news on the BBC website yesterday.

Later yesterday, it fell to me, as a routine HBOS customer, to tell the staff at my local branch the takeover talks had been confirmed. "You're telling us", the staffer said. "We know nothing about it."

This reluctance of the bank's leaders to step up is a recurring feature. Did they know more than Stock Exchange regulations would allow them to say?

Anxious though many staffers now are about the future, at branch level there seems little loyalty to the leadership.

For centuries, Scotland has prided itself on its skills in banking and finance. Our banks, with their unique legal constitution and distinctive notes, became part of our national definition.

But the manner of this collapse – from the misjudgments of its management through the flabbiness of regulators to the final orgy by short-sellers – "City spivs", in the scathing denunciation of Alex Salmond, the First Minister, yesterday – has dealt a smashing blow, not just to Scottish banking but to Scottish pride.

AND it may not be the only one. A source familiar with the situation yesterday warned that Scotland may be in danger of losing both its banks.

"This is a revolutionary day for the banking sector," the source said. "Nothing is ever going to be the same. Look at the state of the markets. There's still another shoe to fall – a merger of Royal Bank of Scotland with HSBC."

There is no suggestion such a move is being contemplated, but in the febrile chaos of this week – with bank shares reeling on Wall Street and in London – nothing can be ruled out.

Snarled one broker: "The mood is bad, bad, bad out there. People in the City are worrying about their jobs. They don't know if they are going to get paid. If Lehman can go down and AIG can fall apart, that makes everyone very nervous indeed."

The acute worry yesterday for the bank, the regulatory authorities and the government was that the run on HBOS shares would create enough fear among its financiers – providers of wholesale credit who give the bank its money – for there to be a withdrawal of credit for HBOS.

It emerged that the Prime Minister, desperate to avoid another Northern Rock, had urged Sir Victor Blank, the Lloyds TSB chairman, to avoid a systemic crisis by buying HBOS.

Bank of Scotland's golden era was in the late 1980s and 1990s when, under the stewardship of Bruce Patullo, it built up a corporate lending business and introduced electronic home banking for business customers.

AND it was what Patullo did not do, as much as what he did, that built the reputation and strength of BoS. He avoided the fads and fashions of the stock market. He resisted pressure for the bank to buy a stockbroker. And he turned down offer after offer for the bank to go into estate agency.

Critics accused the bank of over-caution. But the City and the shareholders – or proprietors as they were known up until 1999 – loved it.

BoS market capitalisation overtook that of rival Royal Bank of Scotland. And it was BoS that opened the bidding battle for National Westminster Bank. But RBS came in later with a higher offer, and defeat in that battle left BoS looking vulnerable to a predator. Soon after came a merger with the Halifax.

In the jostling for key positions, senior BoS executives found themselves losing out to what became nicknamed "The Haliban". Many BoS "lifers" left.

As interest rates were cut and house prices took off, the HBOS business model looked a winner. But the world of 125 per cent loan-to-value mortgages and house price to income multiples stretching to seven times appalled those of the old guard who remained.

THE chief executive, James Crosby, wanted to rein back on mortgage lending. But he lost out in a power struggle. Soon after, he bowed out, to be replaced by Andy Hornby, a young executive from the supermarket group Asda.

HBOS was to have one last Great Hurrah in the mortgage market. Early in 2007, there was a declaration it intended to get its market share back up to 20 per cent. But within months, the credit crisis had struck. HBOS was to face "the perfect storm".

Anger is building among the financial community over poor regulation. Simon Mansell, an independent financial adviser, said last night: "HBOS has 20 per cent of the UK mortgage market at a time when a 25 per cent fall in UK house prices is predicted.

"Where was the FSA (Financial Services Authority] when it came to income multiples of nine times salary? The FSA has been too busy regulating the monkey, not the organ grinder."

Fear for 40,000 jobs

A GOVERNMENT-backed deal to push through a merger today between HBOS and Lloyds TSB could result in up to 40,000 job cuts across the UK.

The tie-up – prompted after speculative trading led to massive falls in HBOS's share price – would create a banking colossus with almost a third of the UK's mortgage market.

Last night, it was reported the boards of the two banks had agreed a 12 billion deal for HBOS, at a price of 232p per HBOS share.

The deal can be traced to Monday night when , at a private event hosted by Citigroup in London, Gordon Brown, the Prime Minister, personally met Sir Victor Blank, the City grandee who chairs Lloyds-TSB – a bank which has been looking for some time to expand by merging with a rival.

At 10am the following morning, Mr Brown met Mervyn King, the Bank of England Governor, and Alistair Darling, the Chancellor, at Downing Street. Spokesmen would later claim it was a routine, pre-arranged meeting, but the subject under discussion was anything but normal. After intense negotiations, the deal was clinched shortly after 9:30pm last night and was set to be announced this morning.

It has also emerged that the Financial Services Authority contacted a number of other banks in recent days over a possible merger, including HSBC. However, Lloyds was the only lender willing to take on HBOS without a large government guarantee.

As the negotiations were supported by the Prime Minister, the Treasury and the FSA watchdog, analysts said this suggested the usual competition rules would be suspended to allow the deal to proceed.

A Treasury source told The Scotsman the Enterprise Act would be amended "because there may be issues of competition and this is so serious we would want to override them". It is understood a public interest get-out clause would be used. The "key things" were "stability and protecting savers", the source said.

The London stock market was rocked by further turmoil yesterday, with the FTSE 100 index closing below 5,000 for the first time since June 2005. Meanwhile, on Wall Street, the Dow Jones Industrial Average shed 4.1 per cent as traders reeled from the US government's bailout of insurance giant AIG.

The HBOS deal would combine a UK workforce of about 145,000 and, although there was no confirmation of job cuts, sources warned losses could hit 40,000. Unions have warned they would not accept any compulsory redundancies.

Following the deal, Lloyds chief executive Eric Daniels is expected to take the helm of the enlarged group. The future of HBOS chief Andy Hornby, who joined three years ago, is unclear.

The merger could signal the end of decades of tradition – Bank of Scotland could lose its right to print banknotes if it loses its individual plc status.

News of the negotiations broke the day after shares in HBOS plummeted by 40 per cent. When the City became aware of the talks, shares in both banks gained great ground.

The combined bank would become a lending and savings giant, with more than 330 billion of mortgages and 300 billion of deposits. Analysts were split over whether the marriage would be good news for customers.

Ken Murray, the Edinburgh-based chief executive of Blue Planet Investment Management, said: "This is very good news. But there was never any need to worry in the first place, as the problems were greatly exaggerated."

Richard Hunter, head of equities at the stockbroker Hargreaves Lansdown, said: "You can see the logic between a tie-up between HBOS and Lloyds TSB. It would help stabilise both companies in terms of the jitters we are experiencing in the financial sector."

However, Ray Boulger, the senior technical manager at John Charcol, said: "It is bad news for consumers – any reduction in competition is nearly always bad news for consumers."

He said the big concern would be that most of the brands at HBOS – which includes Halifax, Bank of Scotland and Birmingham Midshires – would be collapsed into the brands of the company that was taking it over.

He said while Lloyds TSB's mortgage firm Cheltenham & Gloucester's rates generally had the edge over the ones being offered by Halifax, the HBOS group had a far wider product portfolio and was still lending to people with only a 5 per cent deposit, whereas C&G demands 10 per cent.

Mr Boulger also said that, while the Competition Commission was likely to raise concerns about a merger, it was unlikely it would block it.

Kevin Mountford, the head of banking at moneysupermarket.com, said: "A shotgun marriage of HBOS and Lloyds TSB would not be in the best interests of British consumers."

He said with Alliance & Leicester being taken over by Abbey's parent, Santander, and Nationwide taking over two building societies, there was a big reduction in competition and consumer choice.

Nic Clarke, an analyst at Charles Stanley Stockbrokers, said: "Lloyds might think that HBOS is historically very cheap – it was trading at 11 a share at its recent peak, but shares were worth just 1.40 after (yesterday] morning's sell-off. Maybe they saw that the price outweighed the negatives."

Rival banking giant HSBC was said to be interested in acquiring HBOS but was unwilling to pay anything for the bank's shares.

Keith Bowman, of Hargreaves Lansdown, said: "Lloyds finds itself in an opportune position with cash to spend on an acquisition in very difficult times. If the price is reasonably good, that will hopefully result in the Lloyds share price going forward."

HBOS staff admitted they were concerned for their jobs, while furious union leaders blamed "corporate greed" for bringing the financial sector to its knees.

Graham Goddard, the deputy general secretary of Unite, said: "With an economic downturn biting, thousands of staff at both banks will be very worried about the consequences of a merger. Unite is calling for urgent talks at the highest level with the banks. We will not accept any compulsory redundancies as a result of this merger."

Mark Lazarowicz, the MP for Edinburgh North and Leith, who has many HBOS staff among his constituents, said: "If HBOS does merge with Lloyds TSB, there will be a lot of concerns amongst those who work for the bank or whose jobs depend indirectly on the activities of HBOS.

"The Scottish base of HBOS is one of its strengths, and it is important that the headquarters operations of HBOS in Edinburgh, and elsewhere in Scotland, are not lost or diminished as a result of any merger."

Lindsay McIntosh

Attention turns to future of RBS – and nothing's ruled out

HBOS is on the brink of a bombshell "rescue" takeover by Lloyds TSB.

But even before that dust settles, the City is wondering about the prospects for that other – even bigger – Scottish-domiciled banking giant, Royal Bank of Scotland.

Is there another massive name to drop among Britain's big five banks in the wake of the mayhem being exported across the Atlantic from Wall Street? And could it be RBS?

The odds suggest that such a move on the Royal – some traders have mentioned HSBC to play the Lloyds TSB "rescuer" role – is pretty unlikely.

Does RBS need "rescuing"? The bank is a lot bigger than HBOS, much more geographically diversified, better-funded, and has far less dependence on the frozen money markets than its Scottish rival.

In addition, RBS has only a 6 per cent share of the troubled UK mortgage market compared to the 20 per cent share that many saw as HBOS's Achilles' heel in these difficult times.

RBS also recently raised three times more than HBOS on the stock market to beef up its balance sheet, 12 billion compared with 4 billion.

But analysts are saying nothing can be ruled out given the extraordinary failures in the western banking world this year, and particularly the past unprecedentedly traumatic few days. RBS is well-capitalised. But so was Merrill Lynch, so was HBOS...

They point to RBS's recent posting of a near-700 million interim loss on the back of 5.9 billion of credit market- related writedowns.

Its management credibility under chief executive Sir Fred Goodwin and chairman Sir Tom McKillop has suffered accordingly.

RBS also has a heavy exposure to the United States via its Citizens Bank subsidiary.

One banking analyst last night said: "The British bank whose stock has tracked HBOS most closely in the past difficult year has been RBS.

"That is why there have been concerns that the speculators would target it, or perhaps Barclays, following the raid on HBOS shares."

And the HSBC rumour? Both it and RBS have a big American presence.

HSBC is big in Asia, and RBS, via its 5 per cent stake in Bank of China, has signalled its ambitions there.

The balance of percentages suggest RBS being taken out remains very unlikely. But, in this febrile climate, the truth is: who knows?

Martin Flanagan