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Kirk Houghton

Author of The Dividing Lines and Bad Things to Good People

Kirk's Book Reviews

Kirk's Book Reviews

Review of Hubris: How HBOS Wrecked the Best Bank in Britain by Ray Perman

Posted on September 3, 2016 at 6:55 PM

Hubris: How HBOS Wrecked the Best Bank in BritainHubris: How HBOS Wrecked the Best Bank in Britain by Ray Perman

My rating: 4 of 5 stars

The people behind the merger of Bank of Scotland and Halifax in 2001 are villains today, but at least they had the foresight not to call the new behemoth BOSH. A lending institution with that name would be remembered more widely, yet HBOS is the forgotten bank of the 2008 credit crunch. It entered into a shotgun marriage with Lloyds TSB and landed its rescuer with write downs of £18 billion within the space of months. The subsequent outrage settled on Lloyds rather than its newest acquisition, while RBS and Northern Rock came to symbolise the excesses and criminal irresponsibility of the UK banking sector.

Eight years on, it’s worth recalling just how close the Halifax and Bank of Scotland came to bringing down the British economy. Few public companies suffered more after Lehman Brothers filed for bankruptcy on Monday 15th September 2008. Indeed, the HBOS share price tanked by 17.5 percent within hours and at one point suffered a staggering collapse of 56 percent. No wonder 72,000 staff, 22 million customers and 1.2 million investors wondered if their money would be safe. Depositors withdrew an estimated £30 billion from the bank in two weeks. How could this happen to a financial institution that held less than 1 percent of its assets in US sub-prime securities and had no presence in the investment banking world?

Ray Perman, a former journalist at the Financial Times, gives us the answer in his expert analysis of banking fundamentals. HBOS simply outgrew its liabilities in search of more assets until by 2007 it could fund only 50 percent of its new lending with customer deposits. This left it exposed, like Northern Rock, to a downturn in the inter-bank lending market once it became clear write downs on sub-prime securities had spread to other assets. The £82 billion of mortgages HBOS securitised and passed on to other investors in the period 2001 to 2007 came back to haunt them. Though the losses were not on their balance sheet, it caused the wider credit markets to seize up and threatened their day-to-day funding operations.

These should have been the conditions for a classic bank run, but the Bank of England’s £20 billion loan in September 2008 remained a secret and spared HBOS the ignominy of Northern Rock’s experience of people queuing outside the branches to get their money out. Nevertheless, the bank faced £164 billion in maturing loans to rollover on the wholesale markets in the next twelve months. How could it repay these without cutting its own lending operations? Only 9 percent of shareholders took up the bank’s rights issue of £4 billion in July 2008 – investors would be foolish to commit anymore equity after the fallout from Lehman.

Perman also highlights the bank’s exposure to Grampian Funding, an arbitrage investment operation fully owned by HBOS, which held assets up to the value of $36 billion. Investors were happy to buy Grampian’s Asset Backed Commercial Paper (ABCP) at low rates of interest because they knew it could rely on HBOS’s retail deposits if it ran into trouble. Grampian’s appetite for high yields paid for by short-term borrowing saw it accumulate $30 billion worth of Triple A and Alt-A securities in the US secondary markets. At first the transformation between borrowing at low rates and investing in assets with higher yields of interest worked wonders and rewarded the fund with hundreds of millions in profit. But this soon came to an end when inter-bank lending rates shot up in 2007. The higher cost of issuing ABCP left Grampian facing the double nightmare of increased funding costs and falling profits. Indeed, HBOS’s exposure to Grampian is one of the reasons it ended up seeing its spreads in the borrowing markets increase five-fold between June and September 2007.

Of course, no bank goes to the wall without reckless lending and outlandish risk-taking. Halifax is now infamous for extending mortgages to home-buyers at a multiple of five times the borrower’s salary. It was also happy to compete with Northern Rock’s aggressive lending expansion by issuing 125 percent mortgages. This led to the inevitable fall in lending standards associated with the stupidity of this period as banks turned a blind eye to a person’s ability to repay. Everything was sacrificed on the altar of growing the loan book and flattering returns on equity.

The Corporate Banking Division was even more of a basket case. It seems any company or individual involved in the commercial property or construction industry qualified for a loan as late as 2008 when the UK housing market already showed signs of overheating. A third of all lending – up from £35 billion in 2001 to £109 billion in 2007 – went to the property sector and brought the Corporate Banking Division record profits of £2.3 billion at the zenith of the property boom. The fall was just as impressive: a HBOS investment in Retirement Homes Builder, McCarthy & Stone, resulted in a write-down of £1.1 billion on a single asset in 2009, one of the biggest losses of all time in the history of commercial lending.

The fact this happened on the watch of Lord Stevenson, Sir James Crosby and Andy Hornby – all three from the Halifax camp – gives the author an easy opportunity to present this as an English stitch-up that corrupted Scotland’s oldest bank with a heritage stretching back to Europe’s Enlightenment. Perman is at pains to eulogise about the Presbyterian culture at the Bank of Scotland and how it once represented the virtues of prudence and cautious lending that characterise sound finance. On occasions this sounds like a bizarre wish for a return to the days when bankers followed the 3-6-3 rule (borrow at 3 percent; lend at 6 percent; golf course at 3pm) and could look forward to a job for life as respectable citizens of their local communities. Then came the 1980s when Thatcher’s Government abolished exchange controls, allowed building societies to offer cheque accounts and stockbroking services, and gave the go ahead for banks to buy up all manner of insurance companies and brokerages once off limit.

Perman’s hero is Sir Bruce Patullo, appointed Treasurer (CEO) of the Bank of Scotland at age 41 in 1980. This is the man who launched the first electronic banking system in the UK and had the lowest cost-to-income ratio of the era. Only Lloyds had a better record of Return on Equity in the period 1975-1985 and his penultimate year at the helm in 1997 saw him lead the best performing company in the FTSE 100 with the share price rising by an incredible 85 percent.

However, Patullo is also the man who presided over the bank’s continuing reliance on the wholesale lending markets in its quest for relentless growth. The deposit base covered 90 percent of all lending in 1978; this was down to 50 percent by 1985. Perman doesn’t dwell on this long enough to offer criticism, but appears to blame UK savers for the bank’s reliance on the wholesale market. Yes, UK household savings ratios fell from 12 percent in 1995 to 6 percent by 2000. But surely the banks were partly responsible for this trend? Perhaps Patullo was a victim of his own success. McKinsey’s findings presented the dilemma in 1996/97 – the Bank would need to rely more on the wholesale lending market if it wanted to grow at its current pace; this would make it a takeover target. Alternatively, a deliberate slow-down would hurt the share price and put them in play. Bank of Scotland needed a new deposit base and an acquisition to restore its stability.

Though only a sideshow to later events Perman’s summary of Bank of Scotland’s epic battle with RBS for the acquisition of Nat West in 2000 is one of the most exciting chapters of the book and lays bare the reality – Bank of Scotland needed Halifax after the defeat to its arch rival for one of England’s major prizes. There’s no reason why anybody would have seen the Halifax tie-up as a bad merger when one considers that the former building society ‘had deposits coming out of its ears.’

A brief history of Halifax as a Building Society founded in 1853 to its eventual demutualisation into a publically traded bank in 1997 is the one thing missing from this book. The result is an imbalanced assessment of HBOS’s failings and a one-sided portrayal of Halifax as the iconoclast responsible for wrecking Britain’s oldest commercial bank.

Yet Bank of Scotland had long introduced a sales approach at branch level and once boasted how it would give Nat West a dose of upselling targets if successful in its acquisition. The culture at the two banks was not too dissimilar in 2001; Andy Hornby had no problem introducing sales targets learned from his time in the supermarket sector. In reality, Bank of Scotland was well on the way to pushing loans and credit cards on risky customers before it merged with its English counterpart. And let’s not forget Peter Cummings, a Bank of Scotland lifer, ran the Corporate Banking Division that came close to bankrupting Lloyds in 2009 when the full scale of losses at HBOS became known.

To be fair, the author is not ignorant of these minor criticisms and the title of the book gives an indication of which side he’s on in the fall of HBOS. The 243 pages are easy to surmount and written with a level of confidence that matches the author’s talent for articulation. Few books are as good at explaining the rationale behind securitisation as this one; in this case with a summary of the $55 million bond issued by David Bowie in 1997 and bought by the Prudential Insurance Company in the US. This guaranteed investors a steady stream of future royalties from all his hit singles, and Bowie was able to use the proceeds to buy back ownership of his back catalogue from a former manager. Like the Anthropologist and Financial Times journalist, Gillan Tett, Perman has a gift for explaining complex financial products to a wider audience. All readers will come away from this study with an expanded knowledge base.

Ivan Fallon, Iain Martin and Ian Fraser have all published magisterial accounts of the crisis that engulfed Britain’s top banks in 2008/09. Perman’s book is worthy of such company and will stand as the definitive account of HBOS during this critical time in Britain’s recent history. The Bank of Scotland is a classic example of how break-neck growth became unsustainable in the long run without a drastic change, in this case a merger with a solid English institution. But would things have been any different if they, and not RBS, had acquired Nat West in 2000? The evidence suggests the author is all too aware of the dilemma that forces many public companies to pursue increased shareholder value while taking on more risk.

Maybe the Bank of Scotland is not as innocent as we are led to believe.

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