Hubris: How HBOS Wrecked the Best Bank in Britain (18 page)

The merger was mostly well received inside the two companies. Only 2,000 jobs would be lost through reducing duplication, a fraction of those already lost in the Royal’s takeover of
NatWest, and these were to be achieved by natural wastage rather than compulsory redundancy. Yorkshire would retain the headquarters of the retail bank, but the corporate head office was to be in
Edinburgh and Burt had secured a safeguard – more than half of the board would have to vote in favour before the HQ could be moved. Since the board was to be made up equally of directors from
each side, it looked like an effective Scottish veto.

There was a north-south divide in the way the merger was viewed from the outside. Crosby stressed to
The Herald
, Glasgow’s daily newspaper, his love of the city, in which he had
lived for many years and where his wife had been born. To the
Yorkshire Post
he emphasised his Yorkshire birth and his family home at Ilkley. There was scepticism about the company’s
assurances on the headquarters. Nationalist and Conservative politicians in Scotland sought assurances that The Mound would be the head office in more than just name, while the Halifax
Courier
ran a banner headline: ‘Betrayed’.

Bank of Scotland published its results on the same day, revealing that profits were up 12 per cent and had topped £1 billion for the first time. The share price of both companies rose,
taking their combined worth over £30 billion, but the argument that the new bank would succeed by boosting sales rather than cutting costs did not please everyone in the City. One analyst was
doubtful that the strategy could
succeed: ‘We like slash-and-burn deals. The more people who get fired the better.’
¹

A few weeks later the Office of Fair Trading cleared the merger on competition grounds. HBOS would have a market-leading share of 20 per cent in mortgages and not far short of that in savings
accounts, but its position in other markets such as current accounts, business and corporate accounts was tiny compared to the Big Four – underlining the fact that there was a lot to go for.
As far as the balance of power in the new organisation was concerned, it was fairly clear where the weight lay. Not only were Halifax providing the chairman, chief executive and finance director,
but nearly half the profit would be generated by the retail business controlled by Andy Hornby and a further quarter by the insurance activities run by Phil Hodkinson, who was brought in from
Zurich Financial Services at the time of the merger. Taken together these five top executives had no banking qualifications and only a few years of banking experience between them. Little more than
a year earlier, Peter Burt had criticised the top management of NatWest for the same failing. Now he had handed over his Bank to them.

It was announced that James Crosby and Mike Ellis would have offices in The Mound and both men rented flats in Edinburgh. Ellis worked out of his office except when group business took him
elsewhere and quickly won respect from the Bank of Scotland management for his professionalism, experience and the hard work he put into mastering the new business. Crosby was seen in his office
much less often. He admitted to the
Independent
that he would only visit once a week and was immediately branded the ‘once-a-week Scot’. He would continue to live in Yorkshire,
where three of his four children were at school. He was recognised as very intelligent, but not an easy man to talk to or to read. With Hornby based in Halifax, the days of the close corporate
collaboration of the Bank of Scotland general managers with offices grouped together on the same floor of The Mound were gone. It was much more difficult to get an overview of the business or a
sense of shared values and mission.

Non-executive directors for the combined board were chosen by the executives – who issued invitations to five from each side. The Bank provided Deputy Governor and former Shell executive
Sir Bob Reid, Sir Ron Garrick, former chief executive of the engineering group Weir, John Maclean, an accountant who had been in shipping,
Brian Ivory, who had run a whisky
company, and Lord Simpson of Dunkeld, whose stewardship of the electronics group Marconi, which was facing collapse, was coming under sustained attack by workers and investors alike. He lasted less
than a year before resigning under shareholder pressure. Notable among those not asked to serve as an HBOS director was Lesley Knox, who had a reputation for asking pointed and difficult questions
on the Bank board. She also had experience in corporate finance and asset management, working for an investment bank. In the years to come her expertise would be missed.

There was also a lack of banking experience among the former Halifax directors. They were Charles Dunstone, the founder of Carphone Warehouse, Tony Hobson, who had been finance director of the
life assurance company Legal & General, Coline McConville, who was in advertising, Louis Sherwood, whose background was television and retail, and Philip Yea from the drinks industry.

Bank of Scotland had got by without ex-bankers among its non-executives, but the process of ‘homologation’ – the cross-examination of executives on specific initiatives,
including major lending decisions – meant that they had built up a detailed picture of how the Bank ran and where the pitfalls might be hidden. Those directors who moved to HBOS found that
the board was expected to operate in a very different way. ‘Stevenson didn’t see the point of close questioning the executives,’ one director recalls, ‘but there was a
point. Over time you could see a growing over-confidence: we lent money and we were never wrong. The board lost the habit of challenge.’ HBOS was on a different scale to Bank of Scotland and
a much more complex organisation. The formal governance demands on boards had also grown, with new regulations and new City codes. ‘Board papers were inches thick and if you asked a question
at a board meeting an executive could always point to a report of 156 pages and tell you that your question was answered on page 144. You had never got to it – there just wasn’t time to
read it all.’

Another director recalls: ‘The HBOS governance structure was well thought through, they had taken external advice and on paper it looked very strong. In practice Dennis, James and Andy
were a very tight team and they ran the company. We thought Peter would be part of it, but he wasn’t.’

Yet despite the misgivings there was a feeling that the Bank had
found a way out of its long-standing funding dilemma. But had it? Despite the fabled strength of its
balance sheet, Halifax had not completely eliminated the reliance on wholesale funding markets. In its last year as an independent company, Bank of Scotland had lent £66 billion and been able
to cover 54 per cent from customer deposits. Although HBOS could cover 66 per cent of its lending from deposits, it was still reliant on the wholesale market for a third of its advances and,
worryingly, there was no significant business area where deposit growth was keeping up with the rise in lending.

Responsibility for keeping the group funded fell to Gordon McQueen, who had merged the two treasury operations. Bank of Scotland had always been conservatively run, never venturing into
proprietary trading, but seeing itself only as a service department for the Bank and its customers. Since demutualisation Halifax had started a small trading business, which, although it involved
some risk, was well run and profitable, but McQueen closed it. Treasury was expected at least to cover its costs from the prices it charged corporate customers and the lending businesses within the
group for the capital they needed, but McQueen wanted to go further and use higher internal pricing to force the retail, business and corporate banking operations to target deposit growth as well
as lending increases. The proposal was vetoed by Crosby. To do so would hold the whole business back, he said.

However, there was nothing to fear on the wholesale funding market. The combined group had a strong balance sheet and was viewed as low-risk by those who lent to it. The rating agencies graded
99 per cent of its investment portfolio as A or better, and 86 per cent was graded AAA – the highest level. For Bank of Scotland’s continued growth in corporate lending the outlook was
good: following the merger its senior debt had been upgraded from A+ to AA by Standard & Poors, one of the leading ratings agencies.
²
This was a mark of approval and meant that the Bank would be able to borrow at lower rates, making it more competitive in its drive to take business from its London rivals.

A clash of cultures

HBOS shares made their debut on the London Stock Exchange the day before the attack on the Twin Towers in New York in September 2001. The market was already in a grim mood
fearing a recession and the FTSE index suffered a major fall, but the new bank’s shares bucked the trend and rose more than three per cent on the day, a good omen. The previous few months had
seen the deal approved by both sets of shareholders in ballots and at special meetings. Sir Jack Shaw and other Bank of Scotland directors who were not joining the HBOS board bowed out and more
than three centuries of independence for Britain’s oldest commercial bank had come to an end.

The vote of Bank shareholders had produced a final example of the personal attention to detail for which chief executives of the Bank had been known. A small shareholder, Dr George Fieldman,
complained that because of an administrative error he and others like him who held their shares in a tax-free savings plan had been denied a vote. After complaining, getting no satisfaction and
threatening to take it further, he was surprised to receive a telephone call from Peter Burt.

‘He seemed a very polite and thoughtful individual and said he had heard that there was a problem. I explained how I and many other customers holding BoS shares in a BoS Personal Equity
Plan had been disenfranchised and that the Bank had actually profited by failing to meet its obligations. I outlined how they must have saved money by not having to pay for the necessary paper,
printing, postage and processing for the vote which failed to take place. Mr Burt said: “All true but what can we do about it?” I suggested he should add up the total amount that the
Bank had saved by dint of its mistake and give the equivalent sum to charity. He asked, “Which charity?” I said, “You choose.” He suggested “Save the Children”,
and I agreed. Shortly afterwards I received a letter, dated 3 September 2001, from Peter Burt informing me that he had sent a cheque for £4,000 to the
Save the
Children Fund, and so a degree of satisfaction was obtained.’
¹

A few weeks later Bank of Scotland reported half-year results – its last as a separate company. Profits rose by 7 per cent on lending, up by nearly a quarter, but HBOS shares fell on the
revelation that bad debt provisions had risen by 27 per cent – a portent of the harsher economic times which were coming.

HBOS’s first annual report laid heavy stress on partnership. The cover, with the caption ‘The New Force’, showed two shirt-sleeved arms with hands clasped in friendship. One
set of cufflinks bore the cross of St George, the other the saltire of St Andrew. In his chairman’s introduction Lord Stevenson promised ‘shared values, shared vision and an ambition to
seek out new opportunities’. The speed at which the merger had been agreed and concluded was testimony to the closeness of view of the two sides. ‘This was a merger of equals where
relative size was always secondary to the shareholder value that teams with a shared vision can create.’

The overview of the group’s activities highlighted its strength in various areas through a very selective use of the numbers. Retail banking was number one in mortgages and savings, the
report trumpeted. There was no claim for market position for insurance, merely that it had £1.1 billion of life, pension and investment premium income. Similarly the document reported
£19 billion of business lending (a figure which would have put it fairly low down the list of lenders to small and medium firms) but claimed HBOS was market leader in the UK in management
buyouts, bank finance for social housing and public-to-private financing. To round it off it was also a ‘major sterling money market presence’.

In his narrative, James Crosby emphasised the bank’s solidity and its intention to be a consumer champion. For personal customers he promised realistic pricing and transparent charging
coupled with ‘pro-consumer PR work’. For corporate banking he described the ‘old world’ character of the lending book – and indeed the Bank of Scotland portfolio was
old world. It had avoided the excesses of the new economy’s ‘dot.com’ boom and bust and preferred to lend to traditional industries like engineering, manufacturing, construction
and property and have its loans backed by real-world assets like land, bricks and mortar. In an echo of the traditional Bank philosophy of ‘staying at the table’, he promised, ‘We
also pride ourselves on having
the flexibility, whenever realistic, to see customers through the bad times as well as the good. After all a bank that pulls back at the first
whiff of trouble does not deserve the partnership we seek with each of our corporate customers.’

You had to look deeper into the accounts to spot some of the less satisfactory aspects of the group’s performance. In retail, the area run by Andy Hornby which made up half the total group
business, profits had declined despite increased lending. Costs and provisions against bad debts were up and interest margins were lower. It was insurance, which was benefiting from the acquisition
of the Equitable Life salesforce a year earlier, and corporate banking, which saw lending increase by a third and profits by even more, that provided the group’s growth.

Deep inside the report, it was revealed that the merger had been the occasion for substantial increases in salaries for the top management. James Crosby saw his total remuneration (salary plus
bonus) leap from £690,000 to over £1 million, a rise of 56 per cent and a sum which made him better paid than the chief executive of LloydsTSB. Peter Burt was not far behind, seeing a
rise from £682,000 to £994,000. Mike Ellis received 55 per cent more, Andy Hornby 64 per cent more and the three former Bank executives, Gordon McQueen, Colin Matthew and George
Mitchell more than doubled their total takings. Even the part-time chairman, Lord Stevenson, saw his remuneration jump from £265,000 to £363,000.