Hubris: How HBOS Wrecked the Best Bank in Britain (19 page)

The extra pay would not stop with the end of employment. Since bank employees enjoyed pensions based on their final salary at age 60 – typically at two-thirds – the HBOS executives
could look forward to retirements considerably more comfortable than they had been expecting before the merger.

The late 1990s and early years of the new millennium saw a rapid explosion in top corporate remuneration, serviced by a new specialism – corporate pay consultants. These experts could
produce tables of comparative salaries paid by other companies in the same sector showing why boards had to agree to match remuneration for fear that they would lose top talent to competitors,
although actual instances of the highest level executives moving from one bank to another were comparatively rare. Rates also had to keep up with those paid in other countries, especially the
United States, although movement between countries was even rarer. In 2001 the only recent immigrant to the
highest echelon of British banking had been the Canadian Matt
Barrett, hired by Barclays as chief executive. Barrett brought with him an expectation of higher pay and immediately set a benchmark for other bank chiefs. Boards were bamboozled by the
calculations produced by the top pay experts and cowed into accepting their arguments. ‘We didn’t like it but we found it impossible to resist the consultants and go against the
tide,’ commented one director.

Consultancies also devised complex bonus structures including short-term incentives, long-term incentives, cash payments and the award of shares or options to acquire shares at a later date at a
fixed price. These awards were granted on an assessment of performance against a cocktail of measures including earnings per share (EPS), return on equity (RoE) and profit performance. To make the
whole process ‘transparent’, to use the jargon of the time, extensive notes to the accounts purported to explain each scheme. Ten pages were devoted to the report of the remuneration
committee of the board in the 2001 HBOS accounts. Even for a professional shareholder, working through that volume of words and figures to determine whether the exalted salaries and bonuses were
being earned or not was a daunting business.

A simpler and cruder calculation illustrates how the pay of top executives had changed. In 1990 Bruce Pattullo, as the highest-paid director in Bank of Scotland, earned £176,000, 16 times
the average salary of all staff in the Bank. There was no bonus, although these began to be introduced a few years later. By 2000 Peter Burt’s salary as chief executive and highest-paid
director had risen to £426,000, some 18 times the average. One year later James Crosby’s basic pay was 25 times the average. If you add in his bonus – which nearly doubled his
total remuneration – he was paid more than 43 times the average HBOS employee.

These increases did not go totally unremarked, particularly among small shareholders who expressed their disquiet at the group’s first annual meeting, with one questioner calling them
‘obscene’. A long-term bonus scheme which could have seen Crosby and Burt earn up to £7 million more over the following three years came in for special condemnation, with even
some institutional shareholders voicing concern. But small shareholders discovered the limit to their power when the chairman revealed that he already had votes in favour from institutional
investors representing three-quarters of the total shareholding.
The meeting also illustrated a sharp difference in style between the old days of the Bank and the new HBOS.
Stevenson’s easy, casual approach contrasted sharply with the formal manner of Sir Jack Shaw and his predecessors as Bank Governors and upset at least one small shareholder who demanded an
end to the ‘Andys, Bobs and Georges’ and a return to formal titles.

Inside the Bank Stevenson’s familiar style and eclectic mind divided opinion. Some saw him as a breath of fresh air, to others ‘He was a right plonker’.

The job of integrating the two organisations had now begun in earnest and was felt in some areas much more than in others. In corporate banking it was almost business as usual. Most of the staff
and management had come from Bank of Scotland and they were still trading under the same name, with the only difference being that they had more firepower at their disposal, but in branch banking
the difference was felt acutely.

Bank of Scotland staff had been through a half-revolution of their own. With Gavin Masterton as Treasurer and Chief General Manager there had been much more emphasis on sales, with counter staff
being expected to ask customers what more the Bank could do for them, rather than waiting for the customer to volunteer the information as in the old days. But the transformation had only been
partially completed. ‘We were trying to downsize the branch network because of the costs and the old idea of customer service had to change. We had to move to relationship banking. But people
were used to having the same manager for three or four years – when they found they had three different managers in 12 months, they got pissed off,’ recalls one executive.

The upheaval not only discomfited customers, there was also resistance from staff. ‘Everyone realised that things had to change, that our network was old-fashioned, but a lot of people
were steeped in their ways and didn’t like change with the result that the transformation was not done as well as it should have been. There were teething problems – we would have got
them fixed, but before we knew it we were into the merger.’

Bank of Scotland employees had not been prepared for the sales-driven culture which Andy Hornby, using the retail experience and skills he had learned at Asda, had introduced into Halifax. Staff
were expected to sell products rather than provide a service and were given
targets to reach, and training in how to achieve them. Branch premises were also undergoing a
makeover, doing away with mahogany counters and bandit screens and making them into bright, modern retail outlets. If they weren’t in the right locations they were closed and new premises
opened in shopping malls and other high-footfall areas.

Older, more traditional bank customers were unsettled and to make matters worse, the switchover of computer systems did not go smoothly. Personal customers had their accounts moved from the Bank
system to the Halifax network, being given a ‘roll number’, a traditional building society identifier, in the process. Business customers stayed with the Bank system. This was a
physical severing of the old Bank principle of seeing the business relationship as an extension of the personal relationship and created problems where customers had personal and business accounts
with HBOS. I was one of many customers to experience difficulties when I unwittingly paid cash into my personal account in a branch which was connected to the business banking computer network. The
money disappeared without trace, my account went into unauthorised overdraft and the bank started refusing to pay my standing orders and direct debits. It took me ten days to sort out the mess,
with bank staff apparently powerless to help me. The threatening letters from the gas, electricity and telephone companies went on for much longer. I ended my 20-year relationship with the Bank. A
personal apology from Hornby was sent to all Scottish account holders and staff, but by that time it was too late. Many loyal customers had left.

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.’
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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’.