28 May 2009
Introductory note: An edited version of this article was published on the BBC News website under headline Why did HBOS make risky loans on May 27th, 2009. All the current and former HBOS insiders interviewed for this article did so on condition of anonymity.
Soon after it was formed from the merger of Halifax and Bank of Scotland in 2001, HBOS embarked on rapid growth strategy that included the adoption of a pile ‘em high and sell ‘em cheap approach to the banking market. The Edinburgh-based bank was so determined to win share from the ‘big four’ – Barclays, HSBC, Lloyds and NatWest/RBS – it threw caution to the wind. The Bank of Scotland was already considered to be an aggressive player in the corporate market, even before its merger with Halifax. It already had what was seen as an “atypical” approach to credit approvals, provisioning for bad debts and impaired assets.
Following the Halifax merger, salesmanship predominated and executives were incentivised to grow the loan book, with those responsible for activities including growing deposits and risk management being treated as second-class citizens. When expanding its corporate bank into the English market, HBOS even hired salespeople instead of bankers to help it grow its loan book. The merged bank’s risk-management and credit-checking processes, which had been both archaic and atypical under BoS, struggled to keep pace with its rapid growth. One former HBOS insider said: “They didn’t have their risk management infrastructure in place at all. They behaved in a very reckless fashion. Nothing was done properly.”
Some of the worst excesses, as exposed in a File on 4 program this week, occurred in the area of impaired and “high-risk” assets (loans where the customer is at risk of default or breaching covenants), bad debts (when a loan turns sour and has to be written off) and provisioning (the amount a bank sets aside on the assumption corporate customers will go bust). The former insider told me: “The bank had an “ad hoc” approach to this whole area.”
For example, Bank of Scotland Corporate, HBOS’s corporate lending arm, appears to have had a policy of continuing to lend to companies which other banks would have recognised as insolvent and put into administration.
The bank is thought to have done this so that it could book the customers’ interest payments as profit – and avoid having to declare the losses associated with writedowns and bad debts. That way it could flatter its own profitability, boosting the share price and directors’ bonuses. One turnaround consultant said,“HBOS was widely known in the market to be doing this. It was a very short-termist approach. They were showing no interest in the capital.”
A former senior Bank of Scotland Corporate insider said: “Sometimes the head of high risk would gamble on a loan coming good, and would continue to lend, when the prudent thing to have done would have been to have recognised the loss, and shut down the business so you had no more exposure”
On several occasions, the bank was told by its own appointed advisers that a corporate customer was technically bankrupt – and should therefore have been put into administration and the bad debt taken as a loss on the bank’s bottom line. But I understand the bank ignored the advice and kept the businesses afloat.
Such behaviour placed the directors of the companies concerned at risk, since trading whilst insolvent is illegal. However, the approach did have the advantage of enabling the bank’s former board of directors to artificially boost their pay packets – since higher profits translated into a stronger share price and bigger bonuses.
Another irregularity at HBOS was that it appears to have abused the government’s Small Firms’ Loan Guarantee Scheme (SFLGS) in order to whittle down its own exposure. On at least one occasion, and there may have been more, the bank used the SFLGS to pay off the unsecured borrowings of its business customers. One turnaround consultant said, “That’s illegal. Anyone who did that at [xxx bank] would have been immediately sacked – HBOS was effectively using government money to better their own position and reduce their exposure.” (For more on abuse of the SFLGS by banks, click here.)
Even though a system of credit committees — the detail of which is summarized in 21 pages of the bank’s latest report and accounts — was established within the bank’s corporate lending arm following the Halifax merger of September 2001, sources claim this was largely ineffectual due to the dominance of the bank’s former head of corporate, Peter Cummings.
Writing about Peter Cummings in a column titled “Get rid of this man who broke the bank” (published in the Times on December 13th 2008), Patrick Hoskings revealed the shocking legacy of the bank’s cavalier approach and reminded us who is picking up the tab.
Hoskings described the astonishing way in which Cummings used to run HBOS corporate and said that now, a few months after Cummings was forced out the door by Lloyds, his corporate loan book is “souring at the rate of £26 million a day”, while holdings in the HBOS’s disastrous equity portfolio are “depreciating at the rate of £11 million a day”. Hoskings continued: “Media-shy, prickly and defensive, his personal reputation soared on a personality cult puffed up by entrepreneurs who borrowed from him and could not believe their luck. Here was a man seemingly prepared to bankroll them on the sweetest of terms. No wonder they connived in glorifying Mr Cummings as the man with the golden touch.”
Because he struck lucky with a couple of lending decisions to the likes of retail billionaire Philip Green in the late 1990s, Cummings and his team were allowed to create a self-policing fiefdom under former HBOS chief executives Sir James Crosby and Andy Hornby. The HBOS board may have convinced itself Cummings was managing risks by syndicating and selling down debt.
Cummings is said to, invariably, have had the final say on major credit decisions. According to the bank’s former head of group regulatory risk, Paul Moore: “Cummings was chairman of the credit risk committee of corporate. This meant that he was essentially signing off his own loans.”
Sir Peter Burt, who stepped down as HBOS’s executive deputy chairman in early 2003, having previously been chief executive of Bank of Scotland, said: “If that’s true, then there was a complete failure of corporate governance. The chairman of a credit committee should never be the individual who is sponsoring the proposal. The danger is the chairman would be parti pris. Without proper checks and balances there can be no control over lending.”
Should HBOS’s corporate credit committee — which did sometimes convene without Cummings’s presence -– have vetoed a deal that he supported, former insiders tell me he invariably over-ruled these decisions. A former insider said: “Peter’s power base became stronger and stronger as the corporate division started to make more and more profit. As long as George Mitchell [HBOS’s head of corporate until December 2005] held the reins, Peter was kept in his box. But as corporate banking helped drive profits, Peter was given his head because he was viewed as a star.”
Other banks such as Barclays have a separate credit team which is not involved in either sales or relationships. However at BoS there was no such separation of the powers. The former insider said, “I think the reporting structure in HBOS – – and particularly its lack of a separate credit team — may have enabled its high-risk team to keep the corporate board in the dark about their exposure to individual companies. The reports that they provided would have been broad brush. The lack of a separate credit team meant the high-risk team did not take a properly objective look at the prospects of individual companies.”
In an environment of weak controls — in which risk managers who questioned the bank’s sales-focused approach tended to be fired, and pushers of loans reigned supreme — it was easier for the abuses exposed in the ‘File on 4′ programme to occur. The programme, which I helped to make, was first aired on May 26th, 2009. It tracked the activities of Lynden Scourfield, a director of high-risk within Bank of Scotland Corporate, and his relationship with a firm of self-styled “turnaround consultants” Quayside Corporate Services.
The debacle saw scores of millions in additional loans being lent to corporate borrowers that were for the most part already insolvent, and ended up costing the bank some £1bn. Astonishingly, no one at the bank seems to care.
To cap it all the whole imprudent edifice was built on shaky foundations. The bank’s short-term funding requirement was immense. Unlike the boards of better-managed banks like Santander and HSBC, HBOS’s board were fully paid up subscribers to the illusion of unlimited liquidity. When their illusion was shattered with the collapse of Bear Stearns in March 2008, they were effectively scuppered.
It is, of course, the UK taxpayer who is having to pick up the tab for the extraordinary mismanagement of BoS Corporate and the wider HBOS. Already £11.5 billion of taxpayers’ money has been injected into HBOS to shore up its capital position – without which the bank would have gone bust last October. Much more is likely to be needed as the bad debts come home to roost in coming months and years.
Apart from anything else, the whole sorry saga reveals that it is essential that those at the top of a bank should at least have some idea of what they’re doing. HBOS seemed to tick all the boxes for corporate governance. Crucially, however, neither its chairman or chief executive – respectively Lord Stevenson and Andy Hornby – were bankers.
- A edited version of this article , headlined “Why did HBOS make risky loans?” was published on the BBC News website on Wednesday May 27th, 2009