The Worst Bank in the World? HBOS’s Calamitous Seven Year Life

February 27th, 2010

HBOS’s entrance on The Mound; Image: The We

Lessons must be learnt from the short and calamitous history of HBOS, the bank which went effectively failed in September 2008, writes Ian Fraser (Note: This article was first posted under the headline “HBOS: When did the rot set in? And were shareholders asleep at the wheel?” on October 2nd, 2008 but has since been extensively updated to include more historical detail).

At best, there were some appalling corporate governance failures at the failed British bank HBOS, with an obsession with growth taking precedence over risk management and prudent banking practice soon after Sir James Crosby became chief executive and Lord Stevenson of Coddenham chairman of the merged HBOS group in September 2001.

At worst, the bank was dangerously out-of-control and probably also fraudulent, having been pump-primed by its management team to deliver maximum short-term profits growth (and maximum rewards for executives), irrespective of whether the bank had a chance of surviving long term — or whether customers were harmed.

Throughout the bank’s calamitous seven-year life, the Financial Services Authority (FSA) and other authorities for the most part turned a  blind eye to the bank’s blatant wrongdoing and recklessness. This applied in spades after chancellor Gordon Brown appointed James Crosby a director of the FSA while he remained chief executive of the bank, in January 2004. After that, any attempt to properly regulate HBOS seems to have been abandoned, with dire consequences for many of the bank’s customers, Lloyds shareholders, and the British taxpayer.

Feb 2001: Under the leadership of chief executive James Crosby, Halifax plc splashes out £1bn for the bulk of mutual insurer Equitable Life, an insurance brand so toxic that other potential bidders won’t dare touch it.

April 2001: On the rebound from his failure to acquire National Westminster Bank, Peter Burt, chief executive of Bank of Scotland, holds preliminary talks with Crosby about a merger with Halifax. The talks are held in Halifax’s notorious Mayfair company flat. A few days later, The (Glasgow) Herald breaks the story that the two banks are in merger talks.

May 2001:   Halifax and BoS formally announce their merger. Following Burt’s decision to step down,  Crosby will become chief executive and Halifax chairman Lord Stevenson will become chairman. The merged bank outlines plans to axe 2,000 jobs from a combined staff of 60,000 and cut annual costs by £305m a year. The banks make a “very strong commitment” to maintaining their headquarters in Edinburgh. Crosby claims the bank has a “war chest” to cause pain for the UK’s ‘big four’ banks – Barclays, HSBC/Midland, Lloyds TSB and RBS/NatWest

May 2001: Fraser Mackay, head of specialist mortgages in Bank of Scotland’s Manchester branch, allegedly started urging clients to take out equity-release term loans with BoS on condition that they “invest” the money in the Vavasseur Corporation ‘Ponzi’ scheme.  After the victims lose some $250m (because Vavasseur is a fraudulent scheme), the bank seeks to repossess their homes. Shin Gangar and Alan White of accountancy firm Dobb White & Co are later convicted and jailed for seven and a half years each for their role in the fraud. Despite its alleged complicity in peddling and/or legitimizing the fraud, BoS manages to evade prosecution (see The bank, the regulator and the Vavasseur fraud).

Aug 2001:   Peter Cummings (pictured left), managing director of corporate banking at Bank of Scotland, tells the Edinburgh Evening News he has been given practically an open chequebook by the bank’s board to invest in joint venture companies alongside customers of the bank. Targeted sectors include housebuilding and commercial property. The board’s decision to allow Cummings such autonomy followed successful deals Cummings had struck with the Topshop owner, Sir Philip Green.

Sept 2001:   The Bank of Scotland completes its nil-premium merger with Halifax, with Burt remaining as executive deputy chairman “to oversee integration”. According to the PR hype, the deal brings together some of the UK’s best-known financial services brands -– including Bank of Scotland, Birmingham Midshires, Clerical Medical, esure, Halifax and Intelligent Finance -– covering banking, insurance and asset management. The bank throws down the gauntlet to larger rivals, adopting the slogan “the new force in banking”. In the mortgage market the financial ombudsman rules that Halifax has mistreated borrowers by only allowing new customers access to its lowest rate.

Feb 2002:   City investors are non-plused when HBOS mounts a £1.37bn cash call, apparently to fund asset growth. The shares fall, despite maiden profits of £2.6bn.

Feb 2002:   A notorious flip-chart is found by The Sun in a disused Halifax branch in Manchester. A handwritten note on the flip-chart advises trainee business bankers to turn away business from “start-ups, taxi drivers, window cleaners, market traders, shops or supermarkets.” (see HBOS gaffe).

March 2002:   Widespread outrage as HBOS appears to lie when seeking to end a long-running dispute over Halifax’s two-tier mortgage rate. Halifax agrees to pay £7m in compensation to 30,000 customers but says customers who have not yet complained will be ineligible for compensation, implying they’d be unable to complain to the Financial Ombudsman. Halifax claimed the latter arrangement had been confirmed by the ombudsman. However the Ombudsman later says this is untrue. Yet Halifax refuses to take the misinformation off its website. “Shameful”, “Pitiful”, “Bizarre”, “Penny pinching, “Descended to the gutter”, are just some of the phrases used to describe HBOS’s bizarre behaviour (see Money Box Transcript).

May 2002:   Lord Simpson of Dunkeld, the man who destroyed Marconi, is jeered by shareholders at the bank’s Edinburgh annual general meeting as he is forced out  as a non-executive director. Shane O’Riordain, HBOS communications director, confirms a report that the bank’s director bonus schemes will allow Burt and  James Crosby to each earn bonuses of up to £10m on top of salary over the three-year term. Other directors could be in line for bonuses of between £6m and £7m over the same period.

July 2002:   As it rides the UK property boom, the bank pledges to beat all financial targets for the full year. Interim pretax profits climb 13% to £1.5bn, and the bank announces its share of net new mortgage lending has climbed to 31%, ahead of its target of 25%.

Sept 2002:   Launching an aggressive push to persuade current account holders to switch to HBOS, the bank’s chief spokesman Shane O’Riordain, says: “We do aim to be a member of the big four club, but we have no intention of being a well-behaved member.” (see HBOS taunts Big Four).

Late 2002:   The FSA conducts a full risk-assessment of HBOS, known as an Arrow assessment. It identifies the need to “strengthen the control infrastructure within the group”. It also commissions a report from PricewaterhouseCoopers on HBOS’s risk-management framework.

Jan 2003:   Burt steps down early as executive deputy chairman of HBOS, having overseen integration. He tells the Telegraph that the Bank of Scotland he joined is “like chalk and cheese” to the current HBOS. Burt is replaced as governor by the merged bank’s head of corporate banking, George Mitchell (see The Mound’s got a new Governor).

Feb 2003:   HBOS says annual profits rose 22% to £2.9bn for the year to December 2002. The bank is now selling three times more mortgages than its nearest rival, Abbey National. Crosby defends the bank’s push into corporate banking, including loans to entrepreneur Philip Green, even though other players are pulling back from that market for fear of stoking up bad debts.

Feb 2003:   The FSA fines Bank of Scotland £750,000 over administrative failures at its PEP/ISA division. The FSA says: “This put 30,000 PEP and ISA customers at risk of losing money and also exposed BoS to increased risks of fraud.”

March 2003:   Lord Stevenson first meets the retail tycoon Philip Green at a private Bank of Scotland dinner and is reportedly “blown away”. Stevenson suggests Green might want to consider bidding for Marks & Spencer with HBOS’s support (source Jeremy Warner in The Independent).

April 2003:   HBOS comes under fire for reckless lending into the UK mortgage market and for lending people six times their annual salaries to buy houses. O’Riordain seeks to downplay the story claiming: “There’s a theoretical possibility that customers could be offered six times their salary but there are stringent conditions attached. He stresses that Halifax’s lending is at “the prudent end of the spectrum”.

Oct 7, 2003:   At a Merrill Lynch banking conference, Crosby berates the government for over-regulating banking and financial services. He says: “In retail, we’ve had … numerous banking enquiries, most notably Cruickshank’s, and most recently unnecessary meddling in the SME banking sector.  None has either improved competition or access for customers. And Sandler looks like being no exception.”

Oct 3, 2003 HBOS says it’s on track to double its share of the UK business banking market from 3% to 6% by end 2004. The bank also says chief executive of business banking, Colin Matthew, is moving sideways into a newly created international and strategic role. HBOS says the business banking division will be subsumed into retail banking, under Andy Hornby. Larger SMEs will be shifted into corporate banking under George Mitchell, the bank’s head of corporate banking. The bank also announces that chief executive of treasury Gordon McQueen will retire in December, and is to be replaced by head of treasury Lindsay Mackay. Alan Weatherston, analyst at Collins Stewart, says McQueen’s early retirement came as “no surprise” and the bank’s treasury was ”fairly plain vanilla” with few risks attached.

Oct 2003:   HBOS subsidiary Birmingham Midshires suspends three mortgage advisers after investigating allegations that customers were encouraged to lie about their salaries on mortgage application forms. Birmingham Midshires also suspends sales of “self-certification” mortgages (or “liar loans”). Other HBOS subsidiaries allegedly implicated in mortgage fraud include Bank of Scotland and The Mortgage Business. The allegations were made on the BBC’s Money Programme following an investigation by reporter Michael Robinson.

Nov 2003:   The FSA fines HBOS’s majority-owned subsidiary St James Place £250,000 for serious inadequacies in monitoring and record-keeping. The FSA says it found: “Serious monitoring and record keeping inadequacies. These failings exposed investors to the risk of surrendering existing investment contracts and committing money to new investment contracts in circumstances where this may not have been in their interests.”

Nov 2003:   Bank of Scotland Corporate starts forcing many of its mid-sized corporate customers in South-east England to appoint known embezzlers Michael Bancroft and Tony Cartwright as “shadow directors”. Bancroft and Cartwright, who misappropriated £1.4m from Ritz Design Group PLC where they were respectively chairman/chief executive and finance director in 1991, had resurfaced as a self-styled  ‘turnaround consultantd’ with David Mills’s self-styled “turnaround consultancy” Quayside Corporate Services which the bank forced up to 200 of its corporate customers to use. Quayside was set up in 2002, apparently by HBOS, as a means of imposing shadow directors in customer firms.

Dec 2003:   In the calendar year 2003, Moody’s says that HBOS issued at least £13bn of residential mortgage-backed securities (RMBS) through Permanent Financing (Halifax), Mound Financing (BoS) and its covered bond programme. This is just under half the total value of RMBS issued in the UK that year.

Dec 2003:  The FSA fines HBOS £1.25m for lax money laundering controls. The regulator found unacceptably high levels of non-compliance with record-keeping procedures across BoS’s retail, corporate and business divisions. and an “absence of effective systems and controls in respect of its record-keeping policies and procedures”. Andrew Proctor, the FSA’s director of enforcement, says the failures were particularly serious as they undermined the bank’s ability to “comply with the requirements of orders served by law enforcement agencies under the Proceeds of Crime Act.”

Jan 2004:   Amid a furious row over the closure of the Head Office branch on the Mound and a spate of customer complaints about inadequate service arising from the botched integration of Halifax and BoS, Crosby issues a mea culpa to customers. He says: “We freely admit that we have had problems which have disrupted our service to customers … We would not hesitate to apologize to customers and colleagues who have suffered in the meantime.”

Jan 2004:   Crosby (pictured right) joins the FSA’s board of directors, after which the fines from the regulator mysteriously dry up. As a result of “regulatory capture” the FSA seems to have lost all appetite for investigating the bank’s misdemeanours.

Feb 2004:  Pre-tax profits soar by 29% to £3.77bn for the year to December 2003. Profits from retail banking increase 19% to £1.7bn, while business banking profits jump 32% to £404m. Share of net lending in UK mortgages reaches 25%, against a target of 23%. The bank claims: “After three years of a strong housing market, there’s no room for complacency. We have, and will continue, to tighten our lending criteria.”

Feb 2004:   The Stadia Group, founded by former Bank of Scotland treasurer and deputy general manager Gavin Masterton before his retirement from the bank in 2001, collapses into receivership owing the bank a reported £28m. Kevin McCabe’s Scarborough Development Group steps in to mop up the mess, prompting complaints to the FSA about the bank’s abuse of off-balance-sheet vehicles to massage its bad debt position (see Keane’s last stand).

Mar 2004:   HBOS issues a public apology and claims it will a review its lending policies after admitting to funding the acquisition of 45 pornographic magazines from the Daily Express owner Richard Desmond. Titles purchased include Asian Babes, Readers’ Wives, Mothers-in-Law and 60 Plus. But that bank refuses to follow the example of co-lender Bank of Ireland and withdraw its funding (see Bank apologises).

Mar 2004:   It emerges HBOS has offered head of retail Andy Hornby a £2m bung in share options to try to keep him at the bank. The “special incentive arrangement” is disclosed in HBOS’s annual report. O’Riordain says: “It is in the interests of our shareholders that [Andy] stays with us. He has transformed our retail banking operation.” (see Hornby gets £2m).

April 2004: Accountancy firm PricewaterhouseCoopers (PwC) completes a S166 inquiry into the “devolved model of risk management at HBOS. PWC concluded that the model used is “conceptually well designed” and “appropriate for HBOS” (see supplementary memorandum from Lord Stevenson). According to a detailed memorandum from Paul Moore, HBOS’s former group head of regulatory risk the S166 skilled person’s probe arose because the FSA was:-

“concerned about the level of oversight, challenge and functional leadership being carried out by group risk functions of the risk management in the operating divisions.”

May 30 2004 Eyebrows are raised in the City when it emerges retail tycoon Sir Philip Green has appointed HBOS chairman Lord Stevenson as non-executive director of the vehicle that Green is using to acquire Marks & Spencer. Lord Stevenson is to become senior independent director of M&S if the takeover succeeds, according to the Guardian. He would also be responsible for hiring the M&S chairman and other non-executive directors. HBOS had earlier bankrolled Green’s bids for Arcadia Group, BhS, Sears and Shoe Express and is one of the consortium of banks lending money for the M&S bid alongside Barclays, RBS, Merrill Lynch and Goldman Sachs. The Guardian reported that Lord Stevenson would not be HBOS’s representative on the board and the position has been approved by the bank (!!) “He is more than capable of managing any conflict of interest if one should arise,”  an HBOS source [perhaps Shane O'Riordain?] told the Guardian.

April 2004:   CEO James Crosby fails to appear at the HBOS’s annual meeting in Birmingham. His absence is blamed on viral conjunctivitis. An HBOS spokesman says it is Crosby’s first day off because of sickness in five years. Lord Stevenson tells the annual meeting that Crosby’s conjunctivitis is contagious and told sharehoders “not to read anything sinister into this”.

May 2004:  Shane O’Riordain is once again forced to apologise — this time over appalling standards of service and “contemptuous treatment” meted out by the 1,000 HBOS staff working in customer services for Equitable Life (see Morally, what you’re doing is theft).

July 2004:   At a meeting to discuss sales of a corporate bond fund, Paul Moore, group head of regulatory risk, is told not to make a “f***ing enemy of me” by the bank’s saleswoman extraordinaire Jo Dawson. Following an in-depth survey of the bank’s retail division, Moore has concluded that the bank has become so sales and growth-obsessed important functions like risk management are being side-lined. But his warning is ignored by the audit committee, chaired by Anthony Hobson, and board of directors.

Aug 2004:   The bank’s spokesman Shane O’Riordain talks up the possibility that HBOS will make a £10bn counter-bid for Abbey National, which is already the subject of a takeover bid from Spain’s Santander. HBOS appoints advisers including Lazard and Cazenove, as analysts and institutional investors urge it to proceed with a counter-bid. As part of the bank’s campaign,  O’Riordain seeks to blacken Santander’s name by alleging corporate governance abuses and highlighting fact that Santander chairman Emilio Botin is due to stand trial for misappropriating funds. “Kettle” and “black” spring to mind here.

Sept 2004 Sir James Crosby hires a crack team of 30 integration experts from KPMG’s transaction services arm to try to make the numbers for a potential £10bn bid for Abbey National stack up. The bank is reportedly targeting annual cost savings of £770m which would require 8,300 job losses, plus offloading Birmingham Midshires and Intelligent Finance to placate competition regulators. See: HBOS calls in KPMG integrators to make £10bn Abbey bid add up

Sept 15, 2004:  Crosby scraps plans to take over Abbey National after the UK authorities fail to deliver the “truncated” competition commission inquiry he was seeking. Crosby’s decision to withdraw at the eleventh hour is welcomed by bank analysts and interpreted by Standard Life Investments as “a statement of confidence in its own business prospects.” (see HBOS focuses on rebuilding)

Sept 2004:  A formal complaint is lodged with John Tiner, chief executive of the FSA, that HBOS is using a network of off-balance sheet vehicles part-owned by favoured corporate borrowers, including Scarborough Development Group owner Kevin McCabe, to disguise its true corporate bad debt position and mislead investors about its profitability. The FSA later dismisses the complaint.

Oct 2004:   A report by head of group regulatory risk Paul Moore (pictured left) warns that the bank’s sales-obsessed culture and inadequate internal controls mean it is headed for collapse. The report stated that HBOS is “going too fast” and had become “a serious risk to financial stability and consumer protection”. According to evidence later submitted to the Treasury Select Committee, the bank’s finance director Mike Ellis ensures that neither the audit committee nor the HBOS board has sight of Moore’s report. (See: The Moore Memo)

Nov 2004:   When Moore, who was only doing his job, complains about this, Crosby personally fires him. A business manager at Bank of Scotland, Alistair Wilson, is shot dead on the front doorstep of his home in Nairn. Despite suggestions that Wilson may have uncovered serious financial irregularities at the bank, his murder remains unsolved to this day.

Dec 2004:   The bank announces details of a share buyback of up to £750m and declares that its 2004 profit will beat forecasts. HBOS shares are on a roll…

Jan 2005:   After Crosby appoints saleswoman extraordinaire Jo Dawson to replace Moore as head of group regulatory risk, the risk management function is “dumbed down”, according to the whistleblower Anthony Smith. Crosby appointed Dawson even though she has limited experience, knowledge, or understanding of risk management or regulation, Moore later alleged.

Feb 2005:   HBOS reveals that profits soared by 22% to £4.6bn in the year ended December 2004. Crosby remains optimistic about the bank’s prospects, insisting its mortgage business will be “resilient”, even in a housing market slowdown. However bad debts rise slightly, which coupled with the prospect of further interest rate rises from the Bank of England and jitteriness about the UK housing market, spooks analysts.

Feb 2005:   Phil Flynn, a former Sinn Fein vice-president, steps down as Bank of Scotland (Ireland) chairman after his home and offices are raided by the Irish Garda in connection with an investigation into a £26.5 million Northern Bank raid in Belfast (see Peer challenges HBOS over Irish operations).

Feb 2005:   HBOS finance director Mark Tucker tenders his resignation to HBOS CEO James Crosby, having been offered the CEO role at Prudential.

April 27, 2005:   At a heated annual general meeting in Edinburgh, the bank’s board comes under fire for sacrificing customer service on the altar of “shareholder value”. One shareholder tells the board: “You keep talking about share value. Well I believe the order of priority should be customer, staff and then shareholder. If you don’t have customers you don’t have a bank.”

June 2005:  HBOS starts offering savings accounts that pay annual interest of 10%, more than double the Bank of England’s benchmark rate, in a desperate bid to boost deposits. HBOS says it will pay the rate, the highest among British banks, to adults who make regular deposits into a savings account in the name of a child.

July 2005:  In a bid to prevent him defecting to Boots, where he has been offered the chief executive’s role, Hornby is promoted to the role of HBOS’s chief operating officer. News of Hornby’s £2.2m bung first emerged in March 2004 (see above).

Aug 2005:  The bank buys back £1bn of its own shares, as it reveals that pretax profits have risen 15% to £2.26bn in the first half of the year, up from £1.97bn the previous year. The impaired loan charge rose 25% to £753m. Mortgages in arrears are up by one-third and impairments have climbed to 1.84% of loans, compared with 1.43% at the end of 2004. Telling the Independent newspaper about a tightening of lending criteria in retail markets Crosby says “As bankers, when we lend money it’s rather important for us to get it back.”

Aug 2005: Vegetables feature in the bizarre case of cabbages and cauliflowers. The vegetables are left on tellers’ desks in West of Scotland branches of Bank of Scotland to punish employees who miss sales targets. The scenario reinforces the impression that selling has become the bank’s top priority. See Cabbage lands bank in soup. Crosby implies that he has no intention of stepping down as CEO in an interview with Jason Nisse, published in the Independent on Sunday on Aug 7.

October 2005 The bank susoends Claire Bright, a senior executive in its Treasury division, from her posts two weeks after she made an internal complaint. She is fired by head of treasury Lindsay Mackay in January 2006, and later sues for unfair dismissal, sex discrimination and victimisation.

Dec 2005:  Perhaps dismayed at the bank’s recklessness, Bank of Scotland governor and HBOS head of corporate George Mitchell retires at the age of 55. Mitchell is replaced as head of corporate by Peter Cummings, who is given free rein to create a “bank within a bank” by HBOS’s board, who were impressed by some earlier deals he had done with retailer Sir Philip Green. Someone with knowledge of the situation later told the Financial Times: “As long as George Mitchell held the reins, Peter was kept in his box. But as corporate banking helped drive profits, Peter was seen as a star.”

Jan 2006: Four months after the Nisse interview Crosby, 49, announces he is resigning as chief executive with “wunderkind” Hornby, 38, poised to take over. Hornby tells the Telegraph that international acquisitions are not on the agenda “as our growth prospects in the UK are good.” Despite his lack of experience and self-confessed ignorance of banking fundamentals, Hornby gets lionised in much of the British press (see Hornby signals he’ll keep HBOS on track).

March 2006:  Pre-tax profits for 2005 soar by 17% to £4.8bn. The biggest contributor is a 27% rise in profits from corporate banking, presumably a consequence of the banks loose lending criteria and the inadequacy of its controls in this area. The bank has by now gained a reputation in the City for lending on deals at crazy multiples of Ebitda. Basically it has become known as a soft touch. Yet Crosby insists the bank is taking a “cautious” approach to corporate lending — and in the interview with the Independent on Sunday’s Jason Nisse, the previous summer Crosby had insisted:  ”As bankers, when we lend money it’s rather important for us to get it back.” Profits from retail grow by only 8%, partly as a consequence of sharply increased bad debts, which soar by 48% year-on-year to £991m.

May 2006:  Andy Hornby,  COO and head of retail banking, discreetly enters talks about a putative merger between HBOS and Lloyds TSB with the latter bank’s chairman Sir Victor Blank. The pair know each other as boardroom colleagues at the catalogue retailer GUS (which is demerged into Experian and Home Retail Group in October 2007). Had Hornby already recognised the game was up for HBOS?

May 10, 2006 Claire Bright, a senior executive in HBOS’s Treasury department launches a multi-million pound sex discrimination claim against the bank. Bright claimed she was unfairly dismissed, sexually discriminated against and victimised by HBOS, where she managed £140bn in assets. (see: Woman banker sues for £11m).

June 17, 2006:   Crosby is knighted in the Queen’s birthday honours “for services to the finance industry.”

June 29, 2006:   The FSA remains deeply concerned about the bank’s approach to risk management and writes to HBOS with a further interim ‘Arrow’ assessment. The regulator says there are “still control issues” at the bank and that it “will closely track progress in this area”. The regulator also says “the growth strategy of the group posed risks to the whole group and that these risks must be managed and mitigated.”

July 2006:  Hornby takes over the reins as HBOS chief executive.

Aug 2006:  Half-year pre-tax profits jump 17% to £2.65bn. The bank tells the City that it plans to increase its share buyback programme for the year from £750m to £1bn. 60,000 staff are handed a £670m windfall.

Sept 2006:   The bank continues to show limited awareness of economic cycles. BoS Corporate and Tom Hunter’s West Coast Capital massively overpay for the retirement homes builder McCarthy & Stone, trumping rival bidders Permira and Barclays Capital with a £1.1bn bid.

Oct 3, 2006:   HBOS says it has attained its market share ambitions in mortgages but still detects room for growth in current accounts, savings and general insurance. Just two months into the CEO job, Hornby says: “Given our customer base — no less than 22 million — and the natural strength of our distribution, we are being entirely realistic in aiming to push all of our core market shares into the 15%-20% range.” He says the bank is on track to return surplus capital (!!) to shareholders via a £1bn share buyback and that HBOS is targeting a cost-income ratio “into the mid 30s” by 2010.

Oct 2006:   The Farepak scandal, in which 150,000 savers from low-income families lose around £35m erupts. In some ways it is microcosm of what went wrong at the bank. HBOS had granted a £40 million overdraft facility to European Home Retail group, the parent of the fundamentally flawed Christmas hamper company. Yet as with other corporate customers, the bank allows the company to trade while technically insolvent, before finally putting it onto administration in on October 13th, 2006. The bank subsequently tries to profit from its demise (see We don’t need a court to tell us the Farepak scandal is reprehensible).

There are parallels with the bank’s abuse of other “impaired” assets around this time. Bizarrely since 2003, BoS Corporate has been allowing David Mills of ‘turnaround consultancy’ Quayside Corporate Services to take control of scores of its business customers, many of which were then pushed into administration and had their assets acquired at below market prices by the bank’s off-balance-sheet vehicle, The Sandstone Organisation, and by Mills and his associates though abuse of pre-packaged administrations. (see Examining HBOS and Banking’s Abu Ghraib).

Nov 2006:   UK politicians put forward parliamentary motions seeking to mount an inquiry into the bank’s role in the Farepak collapse. HBOS denies wrongdoing, but makes the PR gesture of contributing £2 million to a voluntary fund to help Farepak’s customers. Despite scores of complaints about the activities of Mills, Quayside and Scourfield, it persistently denies awareness of wrongdoing in the Reading scandal.

December 22, 2006:  Claire Bright drops her sex discrimination case against the bank Banker drops £11m HBOS sex bias case

Jan 2007:  A few bank analysts wake up to the risks inherent in HBOS’s out-of-control culture, reckless business model and propensity to deceive investors. On January 5, 2007, bank analysts at UBS publish a sceptical research note. Writing in the Sunday Times Iain Dey and Karl West later wrote: “At the time, it was almost sacrilegious to question anything the bank did. It was clocking up record profits year after year, while keeping its cost base under control.” The UBS analysts wrote:

“We believe that HBOS has not experienced any losses on its investment books in recent years. Nor are there any signs of stress. But we ask whether this is exactly the point in the cycle at which deals are done that later prove to have embedded unrealistic assumptions and become problematic. The nature of HBOS’s strategy means it will be holding the risk if and when that occurs.”

Analysts at Goldman Sachs also turn sceptical. On January 19th, they add the Edinburgh-based bank to their ‘conviction sell’ list, causing the shares to fall by 10 pence to £11.07.

Feb 2007:   A 19% hike in pre-tax profit to £5.7bn does little to allay City fears about HBOS. The bank is the biggest FTSE 100 faller at midday, as analysts complain about the lack of transparency from its board and the lack of future guidance. Stockbrokers Collins Stewart warn that the outlook for revenues for the full year of 2007 is “muted”.

March 2007:   It emerges that confidential information on 13,000 Halifax customers was stolen from one of its salespeople’s cars. A salesperson had left a briefcase containing paper files on the customers in their car, which was broken into (see Files on HBOS customers stolen).

March 2007:   BoS Corporate and private equity group West Coast Capital, owned by Ayrshire entrepreneur Sir Tom Hunter (pictured left), splash out £715m for housebuilder Crest Nicholson at the  peak of the property bubble. It was already well known in property circles that a major crash was imminent.

March 2007:   The corporate bank parts company with its director of mid-market high-risk  for England, Lynden Scourfield. He is understood to have cost the bank up to £1bn by extending loans to companies advised by David Mills’ self-styled ‘turnaround consultants’ Quayside Corporate Services. Scourfield is said to have been dismayed by the bank’s decision to ‘shut down’ the companies to which he had lent. The closures were orchestrated by BoS Corporate’s Tom Angus, Andrew Scott and Fraser Kelly. After a period of “sick leave” Scourfield resigns.

March 2007:   According to a Coroner’s report, the bank’s director of structured finance, Colin Swanson, commits suicide by hanging himself in a bathroom in the Millennium Hotel, Grosvenor Square. Former insiders say Swanson was “under massive stress because of unrealistic targets he had been given” and because “he had questioned the bank’s business model”.

March-April 2007:  Writing in an HBOS corporate publication, HBOS’s head of corporate lending Peter Cummings writes: “The job of banks is to assess risk but in the last 18-24 months that’s a job many banks seem to have forgotten and have taken huge hits on their balance sheet as a result. We never forgot. Our decisive strength is assessing credit risk and assessing people. We’re better at it.” (via the Financial Times)

April 16, 2007:   At a presentation to analysts/investors, Peter Cummings further reveals extent of his self-delusion:

“I continue to see sound economic fundamentals long term in the property lending sector and our largest partners as best-in-class property players. Real Estate continues to be, for us, one of the very best asset classes available.” [Ian's note - the economics are by this stage totally unsound and Bank of Scotland's partners are for the most part a long way from being best-in-class; many are property wannabees and chancers who cannot quite believe what a soft touch Cummings is]

“The diversity in our asset-class portfolio and the variety in our product range provide us with a portfolio of strategies for organic growth through-the-cycle.”

“Our asset class model is capable of either holding assets on balance sheet, or distributing them using methods such as secondary trading, securitisation, conduits, warehousing or syndication.”

May 2007:   HBOS shares climb to an apogee of 1153p. But the first rumblings of the credit crisis and market suspicions that something is seriously awry at HBOS cause the bank’s share price to enter a period of decline. The bank takes a 50% stake in over-stretched property developer Kilmartin Holdings, even though its assets are known to be of poor quality and  the commercial property bubble is known to have burst. Ian Robertson, managing director of corporate banking at BoS, “retires” after 36 years with the bank. Internally, nobody wants to take on responsibility for the opaque and perilous structure known as “Robbo’s Bank”.

July 31, 2007:   The credit crisis formally starts. Two Bear Stearns hedge funds — Bear Stearns High-Grade Structured Credit Strategies Master Fund and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund — both of which were massively exposed to subprime loans seek bankruptcy protection in the Cayman Islands grand court.

Aug 2, 2007: Jochen Sanio, director of German banking supervisory body, Bafin, warns of a systemic financial crisis. “This could lead to the worst crisis since 1931,” he said.

August 9, 2007: The global financial sector recognizes it is living on borrowed time after two BNP Paribas freezes three funds exposed to the stumbling US subprime mortgage market. The French bank blames “complete evaporation of liquidity in certain market segments of the US securitisation market” for its decision to stop redemptions from the three funds, and further investments.

August 21, 2007: In a further tipping point for the markets, Paul McCulley an official at the world’s largest bond investors Pimco, gives a speech to economists at Jackson Hole Wyoming. He warns of the beginnings of a run on the world of  “shadow banks” which he defines as “the whole alphabet soup of levered-up non-bank investment conduits, vehicles and structures”. HBOS has scores of these.

Aug 2007:   A crucial month for HBOS. At the half-year results, Hornby blames a crash in the bank’s share of new residential mortgage lending (which has slumped to just 8% of the UK market) on a “largely unsuccessful” pricing strategy, which is in turn blamed on head of retail Benny Higgins. Hornby adds: “Having taken corrective action to our pricing strategy, the strength of the HBOS franchise has been demonstrated by the speed with which we have returned to our 15 to 20 per cent net lending range in May and June.” To become aggressive again in the UK residential mortgage market this late in the cycle was clearly lunacy for the bank.

Aug 2007:   Higgins, architect of the bank’s more cautious approach to the UK mortgage market, leaves. He had slashed the commission HBOS paid to intermediaries for selling HBOS products, which had the desired effect of causing sales to slow. HBOS has by now probably become a hostage to fortune: its earnings expectations are inextricably linked to its share of the UK housing market. Commentators suggest that Higgins, who has since re-surfaced at Tesco Bank, timed his departure well (see HBOS pays price for short-term thinking).

Aug 22, 2007:  Lindsay Mackay, chief executive of HBOS Treasury Services, admits that Grampian Funding, an off-balance-sheet “conduit” of the bank’s, cannot find investors willing to lend to it for more than one day. Grampian Funding has $36.1bn of debt outstanding and invests mainly in ‘triple-A’ rated securities, with a focus on toxic waste including MBSs and CDOs. The conduit was not mentioned in HBOS’s 2006 annual report and accounts. HBOS shores up the shadowy and perilously exposed vehicle, paying off outstanding commercial paper from its own balance sheet. Mackay insists this will have “no material adverse impact” on HBOS’s fortunes but Standard & Poor’s disagrees saying it will add nearly £14bn of risk-weighted assets. Five-year credit default swaps on HBOS rise 4.5 basis points to 48.5 basis points after the news emerges (see Faith in Grampian hastens fall of Bent). Also in August the bank resists the urge to make a £1.2bn plus takeover of property developer Quintain Estates.

Sept-Oct 2007:  The collapse of Northern Rock, the start of the UK housing market downturn, the intensification of the credit crunch and mounting fears over the sustainability of the bank’s model cause falls in the HBOS share price to accelerate. It is increasingly apparent that reckless lending to housebuilders and property developers (as well as the purchase of equity stakes in such players at ridiculously over-generous prices, and the conflicts of interest inherent in a “pig on pork” model) coupled with poor collateralization and virtually non-existent risk-management, coupled with the bank’s dominant share the UK mortgage market and, of course, its dependence on wholesale funding and a flawed approach to treasury, have left HBOS perilously exposed.

Oct 24, 2007:   In a surprisingly frank interview with Melanie Reid of The Times, HBOS chairman Lord Stevenson admits he has for the past 12 years suffered bouts of clinical depression. Speaking ahead of a mental health conference in Glasgow. Stevenson said: “It is a nasty truth in life that a nasty bastard with no humanity can be successful in business, but not for any length of time. Type A males who are competitive and insensitive to other people’s feelings have to change if they are going to build something that’s sustainable and will continue long after they are gone.” It is unclear if this was a reference to Peter Cummings or any other individuals at HBOS.

Nov 2007:   Crosby becomes deputy chairman of the FSA. Sir Clive Thompson, former chairman of EHR, parent of Farepak, said that HBOS had “hung [Farepak's management] out to dry.” Thompson added: “I have sat on the board of six FTSE 100 companies, but never have I seen behaviour such as this. If this is typical of the way HBOS treats small companies I am disgusted.”

Dec 2007:   Halifax chief economist Martin Ellis rubbishes talk from the IMF and HSBC that UK house prices are 30% to 40% overvalued. He tells MoneyMarketing: ”A robust UK economy and the accompanying sound health of the labour market continue to provide strong underpinnings for the housing market … there is a fundamental supply and demand imbalance in the UK that simply does not exist in the US.” HBOS calculates that the UK government’s target of building three million new homes by 2020 is more than 500,000 short of what will be required based on official household projections.

Jan 1, 2008:   Astonishingly, the FSA decides to grant HBOS “advanced internal ratings-based” (AIRB) approach. A sign that the FSA has absolute trust in the bank’s management, this is effectively a waiver pemitting the bank to do its own risk modelling and “stress testing”, without any need for FSA inspection. The decision is later described as “an extraordinary lapse of judgement by the regulator“.

Feb 27, 2008:   HBOS’s profits are flat at £5.71bn. Hornby seems unsure about the future saying: “The current turmoil in global financial markets introduces considerable uncertainty into the plans of all financial institutions. We are planning on the assumptions that market conditions will remain uncertain throughout 2008.” Hornby admits margins from UK mortgages are being squeezed and corporate lending is likely to slow. The bank tells journalists that it has decided that what it describes as “maximum disclosure” about state of its treasury book is the best policy, making oblique references to the comparative lack of transparency at RBS. But the move backfires. Analysts latch onto the fact HBOS owns £7.1bn of “Alt A” assets, the US equivalent of self-certified mortgages. After analysts mark down their profit forecasts the bank’s shares collapse, ending the week at 603.50p. And still the group’s 65,000 UK staff share a £280m bonus. Investors are further infuriated when HBOS drops the targets under which directors receive payouts on its executive incentive schemes. Given that HBOS and other UK banks have been pleading subsidized liquidity, the Bank of England governor Mervyn King is furious at HBOS’s decision to hike its dividend by 18% to 48.9p. King is said to be enraged that a bank should seek to enrich its shareholders, directors and staff whilst seeking to socialize likely losses (see Banks warned to curb payouts).

Feb 2008:   Peter Cummings, HBOS’s head of corporate banking, defends the bank’s decision to continue lending to the UK’s bombed out commercial property sector at an awards ceremony. In remarks that will come back to haunt him, Cummings says: “Some people look as though they are losing their nerve — beginning to panic, even — in today’s testing property environment. Not us.”

March 19, 2008:   HBOS shares slump by 17% in what the bank characterizes as a “bear raid” on itself by short sellers. The bank seeks to divert attention away from the perilousness of its position by lashing out at “white collar criminals”. Hornby vehemently denies rumours that HBOS is struggling to fund itself and that it has had to seek emergency funding from the Bank of England — even though the rumours were almost certainly true — and pins the blame on short-sellers spreading false rumours. The bank demands, and gets, an FSA inquiry. In a statement the FSA that “HBOS is a strong financial institution”. But if this was true, why did the bank raised £750m at 9.5% earlier in March. Credit default swaps on HBOS’s debt soar to 237 basis points. (see Worst CDS ratings).

April 2008:  Despite his role as the architect of HBOS’s collapse, Sir James Crosby is appointed, by his close friend prime minister Gordon Brown, to chair a working group examining how to boost confidence in the UK’s rapidly shrinking mortgage market. The bank again ignores investor concerns about its massive exposure to the crumbling property market and buys a significant equity stake in Edinburgh-based housebuilder Miller Group, to which it is already a significant lender. Peter Cummings allegedly over-rules advice from bank officials who, given the market turmoil, had strongly advised against buying the stake at the pre-crisis share price. One ex-insider said this was “the final straw for [BoS Corporate head of credit risk] Hugh McMillan. It was pushed through credit and I wouldn’t be surprised if that sparked Hugh’s departure.” McMillan left the bank on April 30th, 2008.

April 2008:  After Sir Fred Goodwin, chief executive of RBS, unveils plans for a £12bn rights issue to shore up his own bank’s shot-to-pieces capital base, there is an expectation that HBOS will follow suit. HBOS spin doctor Shane O’Riordain suggests a rights issue might be on the cards, but denies that any asset sales are planned or required. (see The bankers’ new clothes)

April 2008:   At a crowded AGM in Glasgow, which isn’t even attended by Hornby, the bank unveils plans for a deeply-discounted £4bn rights issue, a dividend cut and fresh write-downs on its sub-prime assets. Hornby, whose image is beamed up from London, asserts that the rights issue will bring about a “step change in our capital strength” enabling HBOS to “consolidate leadership in residential mortgages and savings”. But investors and analysts are wholly unconvinced by such mendacious rhetoric. The bank also reveals it is more heavily exposed to US toxic debt than it previously divulged, admitting to ownership of a £7.1bn tranche of Alt-A mortgages on its books (a.k.a. “liar loans”). See Not simply a preparation for tough times ahead

June 26, 2008:  At a general meeting in Edinburgh’s EICC, shareholders are persuaded to vote in favour of a £4bn rights issue underwritten by Morgan Stanley and Dresdner Kleinwort. They are reassured by a bullish trading update and statements from HBOS. At the meeting HBOS chairman Lord Stevenson says: “The rights issue will put us in a competitive position … Armageddon may happen, and we should be prepared for it, and we are.” Hornby says the cash call is “about making sure we’ve got real capital strength for whatever macroeconomic environment comes our way”. A string of complaints are later made to the Treasury and the FSA about the veracity of these and other statements made by the bank. [Note: On November 4th, 2009 Lloyds confirmed that the FSA is formally investigating whether investors were conned (See HBOS misled investors, The unanswered questions around the HBOS cash call and Probing HBOS).

July 2008:  Following further sharp falls in the HBOS share price, the rights issue is shunned by 92% of the bank’s shareholders, and underwriters Morgan Stanley and Dresdner Kleinwort end up with a £3.8bn “stick” of unwanted HBOS stock. In a clear case of conflict of interest, Morgan Stanley later discloses it has also shorted 2.3% of HBOS’s stock.

July 31, 2008:  The unsustainability of HBOS’s model becomes even clearer after it reveals first-half profits have plunged 72% to £848m. The bank blames this collapse in profitability on ‘a rise in bad debts’ and ‘further write-downs’ on its portfolio of cavalier loans and toxic assets. The bank slashes its dividend, telling investors they will be paid in shares not cash. Hornby confirms that the bank is considering selling off non-core assets including insurer Clerical Medical, fund manager Insight Investment and Australian bank BankWest.

Aug 2008:  HBOS says it is axing 400 jobs, as part of a shake-up that includes the closure of its specialist lending arm The Mortgage Business, the closure of a mortgage processing facility in Cardiff, and the scaling back of online brand Intelligent Finance. It also announces it will close 53 of its 204 estate agency branches by the year end. Some 40,000 job cuts will later follow.

Aug 15, 2008:   HBOS chief executive Andy Hornby has a “quiet drink” with Lloyds TSB chief executive Eric Daniels with a view to selling him the Edinburgh-based bank. “They came to the conclusion that there was a lot to be said for a deal and that maybe we should push it along,” Lloyds chairman Sir Victor Blank later tells the Guardian’s Jill Treanor (see  City grandee who could soon be heading a bank of Britain).

Sept 11, 2008:   The Bank of England governor Mervyn King weakens the bank’s position when he says the Special Liquidity Scheme (SLS) will cease. King says mortgage lenders should not treat central banks as a “magical piggy bank” and that guaranteeing the mortgage market, as happens in the US via Fannie Mae and Freddie Mac, would have profound economic and fiscal consequences for decades. Willem Buiter, chairman of European political economy at the London School of Economics, later says King signed HBOS’s death warrant with these remarks.

Sept 15, 2008:  Markets open on Monday morning following the bankruptcy of New York-based investment bank Lehman Brothers, wholesale funding markets are wholly paralysed and HBOS’s share price immediately collapse by 18% as investors recognize that HBOS is a dead man walking.

Sept 16, 2008: With a £198bn gap between its lending and its deposits and the wholesale markets frozen, HBOS is effectively bust. S&P downgrades the counterparty ratings on the holding company to A+ from AA-. Credit default swaps on HBOS’s senior debt soar to 512.5 basis points (while CDS on its subordinated debt climb to 750 basis points) as depositors commence a £30bn plus “run” on HBOS. Its online service HOBS goes down. The FSA issues a statement saying: “We can confirm that, as HBOS already stated, HBOS has a strong capital base and continues to fund satisfactorily.” The bank’s spin-doctor, Shane O’Riordain, says: “HBOS notes the current volatility in bank share prices following developments in the US. HBOS has a strong capital base and continues to fund very satisfactorily.” And yes, pigs have been know to fly. Investors are unconvinced by the spin. The bank’s share price tumbles a further 22%. Hornby and Eric Daniels, CEO of Lloyds, plus Morgan Stanley’s Simon Robey  (adviser to HBOS) and Merrill Lynch’s Matthew Greenburgh (adviser to Lloyds), enter secret, emergency talks about a rescue takeover of HBOS in Halifax’s notorious Mayfair flat. According to the Telegraph, a desperate, stressed out Hornby is pinning his hopes on a takeover by Lloyds (see Disastrous deal)

Sept 17, 2008: At 3am, after hours of intensive talks, Hornby/Robey and Daniels/Greenburgh reach a deal of sorts. Lloyds will pay an “indicative” price of 285p per HBOS share. In a clear breach of FSA rules, the news is leaked to the BBC’s business editor Robert Peston, who publishes it on his blog at 9am. Apparently the leak was driven by very real fears that HBOS had insufficient liquidity to meet counter-party demands and was at risk of collapsing withi hours. The news, confirmed by both banks later that day, briefly reverses the collapse in HBOS’s share price. However Daniels is furious about the price mentioned by Peston (‘nearly 300p a share’) . The 285p was always meant to be have been only an indicative price. The American threatens to pull out of the deal.  Hornby is again reduced to a state of “high anxiety” and Daniels/Greenburgh successfully get the price knocked down to 235p later that day. Law firm Linklaters works through the night on the deal. Stock market observers are very surprised by the leak and the two banks’ failures to suspend their shares (see Sir George on Robert Peston).

Sept 18, 2008: Lloyds TSB and HBOS formally announce the £12.2bn rescue takeover of the latter, and confirm that prime minister Gordon Brown has eased the path to the deal by agreeing to waive UK competition law. It later emerges that conversations between Brown and Lloyds chairman Sir Victor Blank (pictured left) about a tie-up had taken place at a Citigroup dinner held in Spencer House in St James, London the previous Monday and in mid-August on a flight back from Tel Aviv (see City grandee who could soon be heading a bank of Britain &  Merger Press Conference Video).

Sept 19, 2008:  In a desperate bid to prevent the shares of UK banks from flooring, the FSA imposes a short-selling ban. However a backlash soon erupts against the Lloyds deal, with many shareholders and analysts decidedly unenthusiastic. A group of patriotic Scots hatch a plan to extricate the old Bank of Scotland from the Lloyds / Halifax combine if a deal ever completes (see HBOS: The crash landing … and Scores of people).

Sept 29, 2008:   HBOS spin doctor Shane O’Riordain, despite (or perhaps because of?) the unreliability of many of his statements, is named as the best-regarded communications professional at a British bank. One financial journalist told CorpComms magazine: ”‘Shane is the best PR guy in Britain. HBOS are brilliant at communications but there are some fundamental problems at that company that not even brilliant communications can overcome.”

Sept 30, 2008:  As HBOS shares close at 122p, well below the price offered by Lloyds, analysts conclude the deal is off.

Oct 1, 2008:  Margo Macdonald MSP asks Lothian and Borders Police to investigate the bank after reading the Lloyds TSB and HBOS chairmen’s “joyous comments” following a takeover which she pointed out were “unimpeded by the usual rules governing such big business deals”. She said Gordon Brown and Alistair Darling were wrong to waive the normal referral to the Competition Commission, and that the FSA had been “curiously quiet”.

Oct 1, 2008:  Brown reiterates his support for the deal, which reassures some that the “merger” might happen. Backing from Standard Life Investments and other institutional investors — apparently orchestrated by Gordon Brown and chancellor Alistair Darling — pushes HBOS shares up 21% to 148p, while Lloyds TSB ends 10% higher at 280p. The Bank of England also provides HBOS with a clandestine £25.4 billion emergency loan, which remains a closely guarded secret until November 2009. This is added to up to a secret $18bn loan from the US Federal Reserve. Had Lloyds shareholders been aware that the bank they were buying was effectively bust and has only been kept afloat by these clandestine emergency loans, they would never have agreed to take HBOS off the government’s hands (see: HBOS and RBS received secret loans).

© Copyright Ian Fraser 2008-2010

To read a selection of further coverage of chicanery, shenanigans, malfeasance and alleged fraud at HBOS, Halifax, Bank of Scotland and Lloyds Banking Group click here . If you have suggestions for episodes that are missing from this catalogue of abuse please email me at ian@ianfraser.org or call me on 07803 970393 

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