Is Hornby’s fund-raising simply preparation for tough times ahead?

By Ian Fraser

Sunday Herald

May 4th, 2008

ANDY Hornby may have come top of his class at Harvard Business School but this does not seem to have made him an especially good banker. Before becoming HBOS chief executive in July 2006, Hornby – who once ran the cheap-and-cheerful George clothing brand at Asda – vowed to pursue pretty much the same strategy as his predecessor James Crosby.

Call it unimaginative, but Hornby outlined his goals as being: to expand the business; to make further share buybacks; to pursue fiscal discipline and target international expansion. Nearly two years on, Hornby is badly off track.

The bank’s shares have plunged by 59% from their peak of 1153p in February 2007 – a bigger slump than at any other UK bank over the period (RBS is down 51%). And to rub salt into investors’ wounds, Hornby last week said he would tap investors for £4 billion with a five-for-two rights issue, with the new shares priced at 275p each.

Admittedly, the small matter of the credit crunch has intervened to complicate matters for the super-smart 41-year-old Bristolian. But arguably he should have seen this coming – there are plenty outside banking who did – and irrespective of the macroeconomic backdrop he has singularly failed to achieve his goals.

On fiscal discipline, Hornby’s HBOS may be less dependent than was Northern Rock on the wholesale capital markets, but it still depends on them to fund 51% of its loan book. Furthermore the bank’s penchant for “exotic” debt-related instruments has led it to retain £9.1bn worth of US mortgage-backed securities, of which £6.9bn are “Alt-A” on its books. Given that it wrote down the value of these by £2.9bn last week, this does not smack of fiscal rectitude.

But what about growth? Well, organic growth seems to be pretty much off the agenda for the time being. Hornby last week admitted as much saying he does not believe that expansion can restart in earnest until the securitisation markets re-open, which he does not believe will happen until mid-2009.

In any case Neptune Investment Management’s Chris Taylor cannot see where future growth will come from for UK’s beleaguered banks. He says: “Structurally, whole areas of the banks’ business have been washed away … You can have a bounce on the back of things not getting worse, but what has come out in the US has still to come out of the woodwork in the UK.”

On international expansion, the scope for organic growth in HBOS’s chosen territories of Ireland and Australia remains limited, largely because of slowing economic growth in both these markets. Enlarging HBOS’s global footprint through acquisitions seems very unlikely, at least for the time being.

Last but not least, what about those promised share buybacks? HBOS effectively went into reverse gear on this score last week with its decision to raise £4 billion through a rights issue. What rankles with investors is that neither Hornby nor his boardroom chums were able to come up with convincing reasons for wanting to hold a rights issue.

Indeed Hornby and his colleagues have sought to position the fund-raising as a sign of strength, rather than weakness. Hornby described the fund-raising as a “step change” that would allow HBOS to consolidate its “competitive position in our core markets” and enable it to gain share from “fair weather competitors.”

The bank also sought to justify its decision by saying it now takes a more negative view of the outlook for the UK economy. It now claims to take a gloomier view than it did two months ago. Instead of thinking that UK house prices will remain flat this year, it now accepts they could tumble by 5-10% in both 2008 and in 2009.

The danger facing Hornby is that he risks emulating the even more hapless Jonathan Bloomer. The former Prudential boss severely irritated his shareholders in 2004 when he tapped them for a rights issue without having much of a clue what he wanted the money for. Bloomer was dumped by Pru’s board.

The suspicion among investors and analysts is that Hornby is quietly plumping up a cushion to insulate the bank from what are almost certain to be the tougher times ahead. The bank remains more exposed than its peers to UK mortgages and has backed highly-leveraged deals in commercial property. It continues to acquire stakes in housebuilders despite the gloom. Were mortgage defaults to rise, there’s a view in the City last week’s rights issue will be the first of several from HBOS.

Bank of England governor Mervyn King, who is getting more outspoken by the day, last week suggested that Britain’s banks have been the authors of their own troubles because of their use of remuneration structures that egg on executives to take reckless lending and investment decisions. He believes the whole bonus and incentive culture needs to be revised.

On the strength of his performance at the annual general meeting last week (when he was beamed in from a London studio (dubbed “Gherkin-land” by one of the shareholders in Glasgow’s SECC), it’s possible that the highly personable Bristol City fanatic will escape Jonathan Bloomer’s fate. However, given the sorry state in which HBOS now finds itself, the bank’s remuneration committee might take a hint from Mr King and punish Mr Hornby with a cut in his £1.9 million pay packet. At least…

This article was the main business comment in the Sunday Herald on May 4th 2008

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