Author: Laura Dewis

HBOS: Breaking the Bank

Updated Tuesday, 25th November 2008
Transcript of the BBC TWO Credit Crash Britain programme.

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The global financial crisis has shaken our economy to its foundations and all across Britain we’re feeling the impact. Bills are rising fast, while jobs are disappearing and house prices are falling. So, how did we get into this mess?


Tonight in the first part of Credit Crash Britain, we examine the extraordinary events of the week that changed British banking for ever as HBOS, one of the most trusted names in the city and on the high street, collapsed.


We tell the story of how a storm from Wall Street engulfed the British financial markets, bringing about the dramatic rescue of a once admired institution.



The graph of HBOS just went down and down…



Every five minutes ‘Auction Auction Auction’ I’d never seen the likes of it, this is a major institution tottering between bankruptcy and rescue…



We explain the last minute takeover by Lloyds TSB against a backdrop of plummeting shares, and ask - how did it happen?



House prices were going up, it seemed like a great boom, a great opportunity to be expanding loan books. And HBOS exploited that.



We reveal an internal HBOS document from 2004 in which the financial regulator voiced concerns about the bank’s risk controls.





And speaking out about the bank’s sales culture for the first time - HBOS’s former Head of Regulatory Risk.



The retail bank was going at breakneck speed. An internal risk and compliance function feels a little bit like a man in a rowing boat trying to slow down an oil tanker.



It’s 6pm in Downing Street on the sixth of October. We’ve been tipped off about high level talks that are underway to rescue Britain’s banks from collapse.


Some of the biggest names in finance have been coming and going all day - and it is rumoured that an announcement might be imminent.


Shriti Vadera. Any news on the banking bailout Lady Badera? Shriti – any news?


Baroness Shriti Vadera, Gordon Brown’s closest economic adviser, is here to broker a possible bailout.


Hold on she was there.


But twenty four hours later, there is still no word of a deal - and the crisis has deepened.


What are the chances of a bailout for the banking system? Can we open the stock markets tomorrow without one?


How did the banking system get into such a mess?


To understand what happened, and why HBOS was so badly hit, we need to go back to four momentous days in September.


It’s six am in the City of London. After a unprecedented weekend of crises on Wall Street, the City is about to be hit by the shockwaves of a financial tsunami.


Good morning, the world’s fourth biggest investment bank Lehman brothers is teetering on the edge of existence. It has this morning announced that it is going to file for bankruptcy protection.



Humphries: which is not, just to pause you for a second there, which is not the same as saying they are bankrupt


Peston: (laughs) Yes it is, it’s the same as saying they are bankrupt


Humphries: It is really?


Peston: Yes it is



This is a once in a half century, probably once in a century type of event.



As workers arrived in the City, there were just minutes to take in the news before the markets opened at eight.


With the giant Lehman’s allowed to go bust, anything was possible.



Over the weekend we knew the end Lehman was coming. And here this market in the UK and indeed across Europe, across the world, it was taken as a very, very great shock. Fear and panic uh, set in and of course everybody was looking around for who's next.



Now the pressure would switch to the British banks - and the banking giant HBOS was seen as vulnerable. Over the next three days the bank would fight for its survival.


In the first two hours of trading, shares in HBOS, the country’s biggest mortgage and savings bank, took an unprecedented hit - along with other in British banks.


Our cameras were there as the seismic effects of Lehman’s collapse were felt in trading floors across the city.



If you are a trader, you want volatility which means you want share prices that really move.

My point of view was that HBOS was not gonna go broke its not going to be another northern rock.The trouble is that if you get it wrong it can rip your face off.



Movements in HBOS were spectacular. Literally the screens were all red on that day.


And the graph of HBOS just went down and down. The market makers had just written off HBOS, they had decided that this bank was going to go and they wanted to be risk adverse, they wanted to clear the decks.



By eleven o’clock its shares had plummeted by a quarter - wiping billions off its value. But in fact HBOS had been in trouble for months. With the downturn in the housing market, investors were concerned about risky mortgage lending.


In expanding its business, HBOS had borrowed tens of billions in short term loans - far more than other high street banks – but now credit was drying up.


With the share price falling sharply, savers were also starting to lose confidence in HBOS.


There was the potential for a Northern Rock style run on the bank – but behind the scenes HBOS was looking around for someone big with a lot of money.


Here in Gresham Street at the city HQ of Lloyds TSB, Chairman Sir Victor Blank had already received overtures from the Chairman of HBOS.


Conservations that had begun over the weekend were now urgent. As workers went home, the future of HBOS was in serious doubt. And around the world the contagion spread.


In the US the huge insurer AIG looked close to collapse.


The banking system was in crisis.


At a private banking function hosted here in at Spencer House, in St James, London Lloyds TSB’s chairman Victor Blank spoke to Gordon Brown.


The Prime Minister said that if Lloyds TSB wanted acquire HBOS, the government would back the deal – waiving competition rules to create a super bank.


Female Newsreader:

We’re looking at this HBOS figure, we know it took a hit yesterday, it looks like its taking a hit again today, talk us through what we know?

(Aaron) It’s taken another big hit, I believe, currently, we’re trying to get the figures up at the moment. I believe, currently its down around 30, 35% the fact it had taken another hit.



When the markets opened on Tuesday morning HBOS was in a lot more trouble.


Now a major bank had failed the wholesale money markets the banks borrow from almost dried up. All banks were finding it far harder and more expensive to borrow money.


HBOS was highly reliant on the money markets to the finance its business. The share markets were now concerned that the bank could go bust.


JH: HBOS shares have been crashing, Adam what’s going on.


Well I don’t like to use words like crashing but it is hard to think of something else.


JH: Everybody whose got money in HBOS is going to be saying ‘is my money safe’ is it?


I don’t know John. And that is the problem I do not know.



All of a sudden about a quarter past eight in the morning, or something like that, shortly after the markets had opened, HBOS's shares just started to plummet. And at one stage they were down 50% on the day. The rest of the sector was actually up at the time but HBOS was down 50%, it was clear that there was a major problem. This was an issue where institutional investors suddenly got scared about HBOS’s ability to survive.



Wednesday the markets opened, suddenly the earth opened up and swallowed the share price. The market basically went completely off the rails. The share price collapsed in a way I have never seen before in a FTSE 100 company.

Every five minutes, auction, auction, auction, auction, auction, auction, auction, auction, auction, never seen the likes of it. This is a major institution tottering between bankruptcy and rescue.


BBC News Channel

Lets talk to our business editor Robert Peston because we’ve got some breaking news.


Robert Peston: Yes, I’ve got an extraordinary exclusive story ….I’ve actually learned that HBOS and Lloyds are in very advanced merger talks.



Once I had broadcast there was a rush on to conclude the deal, because given the volatility in the HBOS share price, given the concerns that depositors would withdraw money, they had to get it concluded, because not to conclude a deal in those circumstances would be extremely dangerous.



The merger talks went on through the day into the evening. At stake, the future of one of Britain most important financial institutions.


Here at the HQ of Lloyds TSB’s lawyers, the negotiations were intense.


Business that usually takes weeks had to be finalised in hours.


With HBOS struggling to finance its billions of pounds of loans, and its share price falling off a cliff, Lloyds had the whip hand.


In the early hours the terms were agreed – valuing HBOS at a mere twelve billion pounds – for a bank valued at over forty billion less than 2 years earlier.


The next morning, Sir Victor Blank, the Chairman of Lloyds TSB, arrived in the City for a news conference to officially announce the deal.


The new super bank would dominate the high street - with nearly thirty per cent of the mortgage market and billions in customer deposits. Lloyds were jubilant.



We just did an enormously good deal. This is fantastic. I rarely use superlatives but this really is a good deal. I think that we all live in turbulent times and I think no one can have turned on the television for the last two weeks and not seen what's going on in the financial markets so it gave us a unique opportunity, probably one that we won't see again. So the timing was good, we seized the opportunity.



That was the chairman of Lloyds, Sir Victor Blank and the CEO of HBOS Andy Hornby.

In the midst of a media frenzy, bankings’ new celebrities claimed the merger was an opportunity to rationalise resources – but the details were sketchy and many questions about the deal were left unanswered.


But all wheeling and dealing in the City was going to have a profound impact on the lives of ordinary people.


HBOS and Lloyds have branches in high streets up and down the country – and one in three of us bank with them.


HBOS has 1100 branches across the country - and in Scotland alone the bank employs 17,000 people.


When HBOS was created in 2001 – it brought together the traditional Bank of Scotland with the country’s biggest mortgage provider to produce a formidable rival to the big four high street banks.


HBOS was highly regarded in the City. In 2004 the bank made profits of four point six billion.



UK banks for many years were seen as very boring and very staid and something of an oligopoly as its know, big four banks, wide margins. Along comes HBOS, new kid on the block, aggressive in its pricing, winning new customers. It’s a genuine customer acquisition success story.



I think it was a major change – to change a bank from a fuddy-duddy, musty old place to a shopping centre, to a supermarket type culture. Inherently, that had a lot of good associated with it because it was bringing down prices and broadening access to the general population for financial services.



The bank grew its retail lending business aggressively.


Between 2001 and 2004 its lending rose by a third to £181 billion.



HBOS certainly had ambitious market share targets in certain areas, So they were selling they were making a lot of money through just the sheer volumes of credit cards, loans, mortgages that they were actually selling.



As in all banks, staff were incentivised to grow lending through a system of targets and bonuses.



Their sales staff received bonuses on the basis of how many mortgages they sold. One criticism one could make of that bonus structure is that it didn't reflect the arrears record or, the quality of the mortgages. It was solely about the number of mortgages sold.



The policy of rapidly growing lending created a number of potential risks - both for the bank’s finances and for its customers.


We’ve obtained this internal HBOS document from 2004, which suggests the Financial Services Authority was worried about the impact of the bank’s sales culture.


In 2003 the FSA wrote to HBOS as part of its ongoing review of banks, to express concern that aspects of the bank’s risk control mechanisms had “not kept pace with the increasingly sales driven operation.”


“There has been evidence that development of the control function in Retail Division has not kept pace with the increasingly sales driven operation.”


In response, HBOS conceded to the FSA that its risk management not kept pace with the focus on sales.


But it added that it had made “positive steps to address some of the issues raised” and said it had “no actual evidence of customer detriment.”


HBOS declined to be interviewed for this programme.

In a statement this week, HBOS told us the 2004 review “highlighted a number of actions to improve overall systems and controls. Those actions were accepted by the business………These reviews were shared with the FSA……And the matter was then closed.”


HBOS did indeed undertake a review of its Retail sales processes and controls in 2004 in conjunction with external advisers. The review highlighted a number of actions to improve overall systems and controls. Those actions were accepted by the business…. They were implemented with regular updates provided to the FSA throughout the process.


These reviews are very much part of the way that we do business. They are a common feature for other major banks as well. Their purpose is to deliberately challenge our working processes so as to make sure that they are truly fit for purpose. This review clearly demonstrates that HBOS has always sought to instil the highest standards of risk management in all its systems and processes.


Alongside implementing the main actions from this Retail report, a series of reviews were conducted by HBOS to confirm that we had a robust risk management framework in line with best practice. These reviews were shared with the FSA. The matter was then closed. There has been no need to revisit the issue since then given the very satisfactory manner in which the relevant actions were implemented."


Paul Moore was the most senior manager in charge of regulatory compliance at HBOS between 2002 and 2004 when he was made redundant.


It was his job to make sure the sales culture was balanced by internal risk management. He is speaking out for the first time.


We know the FSA had concerns about the sales culture, we’ve seen the report. What was the nature of the problem there?



Well, if you have the premier sales and marketing culture and that is your real focus, have you got sufficient controls risk management, compliance, credit risk management, etc. I think that’s a concern that everybody had as to whether or not the business was under control.



And if it wasn’t under control what were the consequences going to be?



Well, you can be forcing colleagues to sell things to customers that they don’t need - overselling loans, etc. So you have risks to customers. You also have risks to colleagues. And you have risk to the whole system because you’re obviously going to need more liquidity to cover the volume of business that you’re actually doing.



You were in charge of making sure that they did, in fact, cover those risks. And what was your conclusion?



That there was a long way to go from where they were from when I was made redundant.



Was HBOS an organisation where the control functions could raise the points that they needed going to raise in a culture that was conducive to those points being listened to?



The retail bank was going at breakneck speed and an internal risk and compliance function feels like a man in a rowing boat trying to slow down an oil tanker. I’m not suggesting that there were any bad intentions. But it was difficult to slow things down.



With hindsight, did these problems lay the seeds or give an early warning sign about what then happened with HBOS?



I wouldn’t just aim it at HBOS. I would aim it generally. If you have a substantial difference between your deposit base and your lending basis because you want to sell so much and you need to sell so much, well if liquidity dries up you’re clearly going to be in trouble aren’t you?



Of course it was not aggressive selling that broke the bank. It was the way it financed its borrowing and the risks associated with that.


In the thick of the housing boom, HBOS continued its sales drive and massively grew its retail and corporate lending.


To fund its growth it borrowed nearly two hundred billion pounds from the money markets.



HBOS was really a bank built for the good times, it was built around wholesale funding, it was built around higher risk, higher return type of lending which was great And so it worked very well in the good times.



Then everything changed. Last year the City was hit hard by billions of dollars of US loans that had gone bad in so-called sub prime lending – loans to people with poor credit histories.


August 2007 marked a turning point for the financial world. Facing huge losses from loans that couldn’t be paid back, almost overnight banks stopped lending to each other. This was the credit crunch and from now the question for HBOS was how would it survive?


In 2008, the housing bubble burst and the UK’s largest mortgage lender was in trouble.


And in February there was another nasty shock for HBOS shareholders when the bank revealed how exposed it was to problems in the US mortgage market.



Pension funds and fund managers lightened up their portfolios, now I don't think we want too much HBOS in the current climate, we'll sell a bit of that. The runes in the sand as the year progressed for HBOS were not good.



By June the bank admitted it was in difficulty. In Edinburgh HBOS defended itself at a meeting of shareholders.


Andy Hornby, the chief executive, explained the bank’s plan.


He outlined why HBOS needed to raise four billion pounds of new capital through a rights issue.


Shareholders were uneasy about the bank’s prospects.



We've taken decisive action on capital, and we will continue to take a prudent and cautious approach to running our business.



But not everyone was convinced by the sales pitch.



I walked into the auditorium – I could feel it, I could feel there was something wrong and that’s why I stood up and spoke. And he stood there and gave me a politicians answer



What back up plans and contingency plans …


There, there are always further contingency plans but you'd have to…



The people were being told by the chairman and the board that this is nothing to worry about. This is rock solid. A month later, they were telling people I’m sorry but its world affairs. This is nothing to do with us.



Shareholders were unimpressed. The rights issue was unpopular with investors – and Andy Hornby was under mounting pressure to find a solution.



Sentiment was so against him, the housing market, building market, retail, less disposable income, recession knocking at the door, how was he gonna be able to cope with this with the biggest mortgage book in the land, he couldn't do it.



Tonight at ten ….a giant merger is finally agreed between troubled HBOS and Lloyds TSB



In September, Andy Hornby found an answer to HBOS’s woes – to merge with Lloyds TSB. The government waived the competition rules in the midst of the financial turmoil and the deal was done.



In normal circumstances it this merger HBSO and Lloyds would never have made it through the competition laws and nor should it have. But these aren't normal times. So I don't think we can look at this deal and say it shouldn't be done because it needs to be done for the good of the high street, the good of the retail banking sector, and ultimately the good of the consumer.


The merger basically was a hit and hope tactic. HBOS needed capital, Lloyds TSB could provide it. All it needed was for the rest of the financial system to stabilise….



But it didn’t. The financial crisis spread to Iceland, to Russia, and to Asia. In Britain Bradford & Bingley collapsed, and was nationalised.

The government needed a far bigger plan - and fast.



This extraordinary shotgun marriage and suspension of the competition rules, began to make the markets worried about other banks, in particular Royal Bank of Scotland, to a lesser extent Barclays, there were real concerns that the run in the wholesale money markets was going to just lead to a flight to cash and probably the only bank that would-that would be left standing is HSBC.



In early October confidence drained from British banks and reports surfaced that depositors were pulling their money out. The whole system looked close to collapse.


Over the weekend of the 5th of October, journalists were briefed about the possibility of a radical government plan. The rumours spread across the City.


Days later the plan was put into action.



Good morning Wednesday 8th October you are listening to “Wake up to money”. The financial crisis doesn’t get any easier. This morning the Government will announce the part nationalisation of Britain’s crisis-stricken high street banks at a cost to the taxpayer of up to 50 billion pounds.



The banking bailout plan was breathtaking - 450 billion in loans – with three high street banks saying they required a state injection of capital.


The government spelt out to HBOS the terms of the bailout. The treasury would take a £17 billion stake in the merged bank – leaving nearly half of it in the hands of the taxpayer.


HBOS told us that the merger with Lloyds TSB was in the interests of its shareholders and all other stakeholders. That being part of a bigger group was good news in difficult economic times. And while it welcomed the stake taken by the government, it would not rely on continued state help. It added that it is a responsible lender.


The FSA, the regulator, told the banks to expect much tougher regulation - but it’s yet to be held to account for its own role in failing to ensure the banks were sound.


The FSA declined our request for an interview. But in a statement it said it does not comment on its regulation of specific firms.

Paul Moore, the former HBOS risk manager, is clear about the next step for British banking



The first thing that needs to happen is that there’s got to be a broad-ranging enquiry…that needs to investigate in some detail all of the things that happened. Because out of that will come lessons.



For the first time in our history the government has taken a major stake in our banking system. This is absolutely new ground. This is an opportunity to refashion and restructure the British banking industry.



The story of HBOS and the banking bailout marks a new age in finance. The way we bank, the way we save, the way businesses are financed and the way we buy homes has changed forever. And for the banks, the days of reckless expansion on borrowed money are over.

Next week on Credit Crash Britain, Max Flint investigates how the borrowing boom came to an end - and how we’re all now paying the price.


This episode of Credit Crash Britain was first broadcast on Thursday 30th October 2008 on BBC TWO.




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