Hubris: How HBOS Wrecked the Best Bank in Britain (31 page)

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 expected 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.

Hornby and Stevenson also argued that the ‘closure’ of the wholesale markets was an unforeseen and, in fact, an unforeseeable event. Apart from the short period of dislocation after
the Twin Towers attacks in 2001, markets had not suffered a general seize-up since the
Wall Street crash. This was also true, but the market did not cease to operate
altogether, although it treated different banks in different ways. Lloyds and HSBC, for example, both much more conservatively run institutions than HBOS and each with much less reliance on the
inter-bank market, found it more difficult to raise money in the autumn of 2008 than they had six months earlier, but were able to fund themselves nonetheless. It was possible even for HBOS to
borrow, although the terms of its borrowings had shrunk to a day at a time and the price had risen to levels at which it could not operate profitably.

HBOS bore the mark of Cain on its forehead. This had happened to a single bank before, although in a less public way. In 1974 NatWest had got into such trouble by over-extending itself in the
property market that other banks were reluctant to lend to it and it faced a liquidity crisis. But the world was different then and the Bank of England could create time to resolve the crisis by
keeping the whole issue private. The Bank and NatWest itself told the public a deliberate lie – that NatWest was not in trouble – in order not to shake confidence in the whole banking
system. The market was also smaller. Behind closed doors the Bank of England lent heavily on other banks to support NatWest and itself pumped in money to keep it going.

By 2008 regulatory disclosure and a much more active press meant that it was impossible to keep the predicament of HBOS a secret. It was also impossible for the central bank to influence the
behaviour of the inter-bank market, which had become global. This time it was the Treasury rather than the Bank of England that took the lead and Lloyds was a willing rather than a reluctant
participant in the rescue. But in 1974 NatWest could survive its crisis. This time it was different: HBOS’s losses were so heavy and its management had lost so much credibility that it could
not continue as an independent bank.

How had it got itself into this position?

To answer that question we need to go back to its beginning. The justification given for the merger in 2001 was to marry Halifax’s large, low-risk, but slow growing balance sheet with Bank
of Scotland’s fast-growing lending book. Analysts were sceptical about the ability of Halifax to expand when it had few skills or experience outside personal financial services. Its dominant
market share in its core business, mortgages, would be hard to defend against aggressive competition. Bank of Scotland, on the other hand, had been dogged
by concerns over
its increasing reliance on wholesale funding, which threatened to curtail its growth. The merger appeared to answer both concerns. By being able to tap into Halifax’s market-leading share of
retail deposit accounts, the Bank would be able to continue to fund its expansion and the combined group would be able to increase its profitability safely.

That may have been the common perception of how the newly created group would progress, but it was not one held by the management of Halifax. From the beginning James Crosby set startlingly
demanding targets – to achieve a 15–20 per cent share of each of the markets in which it operated. That was a huge stretch for corporate and business banking, where the initial market
share was in low single figures. In retail banking it meant an aggressive drive to attract new mortgages which inevitably diluted Halifax’s safe and solid traditional mortgage book. With a
share of existing mortgages of 20 per cent, in some years HBOS also took more than 30 per cent of new mortgages.

How did it do this? The first annual report of HBOS made lofty claims about being on the side of the consumer, but in view of the fines imposed subsequently by the FSA for various lapses in
customer service, we can dismiss this as cynical marketing. In common with many other banks, HBOS’ most profitable product was payment protection insurance (PPI), one of the most blatant
examples of mis-selling by financial services companies. In 2011 Lloyds Banking Group had to set aside £3.2 billion to compensate customers who had been mis-sold PPI, including many from
Halifax and Bank of Scotland. The competitive advantage of HBOS was not service or concern for its customers, it was price. It sold products at margins so thin as to be unsustainable; some even
though they made a loss. This was market share at any price.

Along with low prices went a willingness to take more risks than its competitors. This led to a rapid increase in unsecured personal loans, credit card lending and ‘specialist’
mortgages – a euphemism for self-certified, buy-to-let and mortgages with very high loan-to-value ratios, including the notorious 125 per cent loans. Competition in retail financial services
was intense and HBOS staff were under constant pressure to keep up with their rivals. Supersalesman Andy Hornby always ended his monthly newsletter to staff with the injunction ‘Keep smiling,
keep selling’ and staff who did sell well
were rewarded with cash and other incentives. According to one nonexecutive director: ‘The impression was,
‘‘Never mind the quality, feel the bonus’’.’ As Chapter 22 will show, this pattern was repeated in corporate banking.

While the market was booming the policy paid off for everyone. HBOS directors saw the benefits in their salaries and bonuses. Direct comparisons are complicated by changes of role, but in 2001
James Crosby as chief executive received a total of £1,073,000, whereas in 2007 Andy Hornby in the same job received £1,926,000 – an increase of 80 per cent.
⁵

In 2001 George Mitchell as head of corporate banking, received £678,000, but in 2007 Peter Cummings received £2,606,000 – an increase of 284 per cent. Lower down the pecking
order rewards were not quite so spectacular, but bank staff did well with average staff salaries growing by 40 per cent over the same time period.

The high-pressure sales culture was not unique to HBOS, but it was not shared by all banks. Among the top five big banks in the UK, HBOS, The Royal Bank of Scotland and Barclays followed
aggressive expansion policies, while Lloyds and HSBC were known for being more conservatively run. This can be seen in their results. Between 2001 and 2007 HBOS grew its total lending by nearly 120
per cent, while the increase in Lloyds during the same period was less than 70 per cent. HBOS’ profits increased by 90 per cent, whereas Lloyds’ rose by only 13 per cent.

It was not only the management which saw big rewards. HBOS investors saw the benefits of the rapid expansion in the share price, which outperformed the FT banking index for most of the period,
whereas Lloyds consistently under-performed.

When the market turned, the risks in the policy should have begun to show, yet the pressure on staff to sell continued even after the financial crisis began: ‘Despite the recession caused
by this financial crisis, the company [did] not reduce staff targets significantly in any area. In some cases the targets [were] increased for retail staff. So if you’re in a little branch of
HBOS in Auchtermuchty . . . and you were meant to sell five mortgages a week, or three personal loans a
day, you’re still meant to be doing that even though
potentially five per cent of your customers are now unemployed or they’re probably on salary freezes, you’re still meant to be doing that.’
²

By then, however, the momentum was hard to arrest. ‘The whole mood at the top was that everything had been going so well that anything was possible and nothing could go wrong,’
remembers a former director of the bank.

Paul Moore, dismissed as HBOS head of regulatory risk by Crosby in 2005, told the Commons Treasury Committee:

Ordinary staff in the Bank were not rocket scientists, but they had doubts about the sales policy being followed: