Hubris: How HBOS Wrecked the Best Bank in Britain (20 page)

Brown became so well known that he was recognised in the street and the Bank sent him on a tour of branches so that customers could meet him face to face. He made guest appearances in television
shows but the novelty wore off and the over-exposure of Howard began to provide irritation rather than delight. The Bank withdrew him from public performances and for a while gave him a job in the
public relations department, but eventually he left banking and went back to his previous trade as a locksmith.

Meanwhile the bank was trying to boost its presence in the small- and medium-sized business market under a new department headed by Colin Matthew. This was a lucrative sector, with profit
margins more than twice those in personal banking. Bank of Scotland led this market in Scotland but without a branch presence in the south had found it difficult to break the stranglehold of the
London banks. The plan was to pilot new business banking services in 15 Halifax branches in England and then roll them out to 100 more. Matthew announced that he would recruit 1,500 experienced
staff – mostly
from other banks – and HBOS would match its offer to personal customers by paying interest on cash held in business accounts.

But the initiative got off to a disappointing start. Branches were geared towards personal customers and business people were not keen to discuss their company’s problems in busy, noisy
retail malls. Halifax branch staff were unused to dealing with commercial customers and did not understand their needs. They were also not equipped to handle large volumes of cash, particularly
coins. The campaign received a major setback when, after a training session in an open-plan branch in the Trafford shopping centre in Manchester, a flip-chart was left in full view of customers. It
listed all those businesses that Halifax did not want and that staff should discourage. They included new business start-ups, taxi drivers, window cleaners, market traders, shops and supermarkets.
The Sun
, the largest selling daily newspaper in Britain, got hold of a photograph of the chart and ran a story on its front page under the heading ‘Halifax couldn’t give a
XXXX’.
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It went on to quote affronted taxi drivers and window cleaners and carried a cartoon, which Bank of Scotland staff felt
‘captured all our frustrations’.
The Daily Mail
called HBOS ‘The bank that likes to say “no” to small business’.

The hapless Bank tried to explain that it was merely discouraging those businesses with cash-handling requirements which it could not yet meet, but the impression that it was rejecting a whole
class of basic small businesses proved hard to shake off. Other newspapers took up the story and small-business associations made loud complaints. James Crosby had to admit to a major embarrassment
over the gaffe but its campaign to break into the smaller end of the market received a blow from which it was hard to recover. Persuading small firm owners to change their bank had always been a
long job, involving them in considerable upheaval and disruption to their business. Now it looked even harder.

The flip-chart incident was bad enough, but there was a starker illustration of the change in culture to come. A cabbage was placed on the desk of a cashier who had not hit targets in a branch
in Glasgow, while in Paisley a cauliflower was the brassica which was chosen to represent under-achievement. The banking union was horrified and the incident provided another reason for the press
and broadcasters to criticise selling methods in financial services. The company’s apology looked lame.

Room at the top

With the embarrassment of the ‘no taxi drivers’ story still ringing in his ears, James Crosby delivered another bombshell when he went back to HBOS shareholders to
raise £1.37 billion in new capital. The market did not take it well and the share price, already trailing that of the Bank’s competitors, fell 8 per cent on the announcement. Officially
HBOS explained that it was having to put more money into its life assurance and pensions business because of changes in regulatory rules, but the feeling inside and outside the company was that it
was being driven too fast, particularly in selling new mortgages and corporate loans. Adding new business was sustainable if it could be done profitably so that some of the surplus generated could
provide extra capital. The worry was that new mortgages were being sold which were not profitable, or not profitable enough, and that the fast pace of growth Crosby was setting would lead HBOS
corporate banking into lowering its standards.

Newspapers voiced the fears of some City analysts:

Crosby also fuelled the fears himself when he admitted that HBOS could not fund its own expansion. ‘We are growing too fast to do that. Three years ago the bank had surplus capital and no
growth. Now we have got the strongest growth seen at a bank for years. I know it costs a lot to raise the money, but when you need money you have to ask for it.’
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Crosby had set demanding targets for the group and all its divisions. He wanted a return on equity of 20 per cent – a stretching goal at the best of times but
made more difficult by the decision to raise more equity. He also wanted each division to meet the return criteria and achieve a share of 15–20 per cent of its market. Retail could already
claim that in mortgages and deposit accounts but in other respects HBOS was still a small player. To ‘eat the lunch’ of the Big Four as Crosby promised, it would have to run very
hard.

The pace of growth was causing strains inside the company too. ‘The annual budgeting process was quite tense,’ remembers one senior manager. ‘The divisional chiefs would draw
up their budgets and send them up to Mike Ellis [finance director]. When they came back they had been pushed up, but were then carved in stone and you had to deliver. If you were to compete, you
just had to lend more.’ The feeling among former Bank of Scotland people was that HBOS was being pushed by men with little experience and no understanding of banking and the row boiled over
at a board meeting. ‘George Mitchell [head of corporate banking] lost his temper and shouted across the table, “We joined you on the basis that you had a lot of assets – but now
you are throwing those assets away.” ’

Peter Burt retired in January 2003 after 27 years with the Bank. He had been knighted in the New Year Honours List. His internal titles, now largely honorific, were passed on. George Mitchell
became Governor and got his name on Bank of Scotland banknotes, and Sir Ron Garrick stepped up as deputy chairman, although without executive responsibilities. The market had an inkling Burt was
about to announce his departure when he sold £2 million of HBOS shares. He had gone a year before his normal retirement age but still received a pension of £334,000 a year from a total
‘pot’ of £5.4 million.
The Daily Telegraph
reported that he also received a bonus of £347,000 in
his last year and retained 529,414 shares
– worth about £3.5 million.
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The annual report was careful to say that he had ‘elected to retire’ and that no
severance payment had been paid, but added: ‘Sir Peter Burt’s pension was based on his accrued benefit with no actuarial reduction for early payment. The cost of waiving the actuarial
reduction was £614,000.’ A pay-off of two-thirds of a million pounds is more than the vast majority of people can expect when they leave their jobs, but this was not an exceptional
amount in banking and, hidden away in the notes, provoked little attention.

Other salary increases were modest, except for Lord Stevenson, who saw his remuneration as part-time chairman rise by nearly a third to £472,500, partly paid to him directly and partly
through his company, Cloaca Maxima, named after the sewerage system of Ancient Rome.

Gordon McQueen, who had been running the treasury operation, left later the same year, again retiring early. His place was taken by Lindsay Mackay, a treasury veteran who had joined Bank of
Scotland in 1982. A big, quiet and serious man, he had a reputation for prudent management and calm judgement, but he was not given a place on the main board, where treasury was represented by
George Mitchell. The board also lost Sir Bob Reid, the former Shell executive who had served as a director of Bank of Scotland and had been senior non-executive director on the HBOS board. He had
long experience and had not been afraid to speak his mind.

There was still disquiet in Scotland that HBOS had been a takeover rather than a merger and the trigger which turned the concerns into public anger was the decision to refurbish the Bank’s
200-year-old headquarters on The Mound. To create a double-height central hall with views over Edinburgh which, it was unwisely announced, would be used for corporate entertaining, the working
branch was being closed and moved elsewhere. The public would no longer be admitted into the building, which still had in its foyer the 300-year-old iron-bound wooden chest which had served as the
Scottish Treasury. Not only that, but the gallery, a first-floor landing running around the foyer, was also removed. Off it had been the offices of the chief executive, treasurer and six other
general managers of the Old Bank. The traditional collegiate management structure had gone, to be replaced by ‘hot desking’.

For those who had opposed the merger, this was proof that the Scottish capital had lost an important head office, now being turned
from a working building into little
more than a dining room. A campaign was launched headed by Hugh Young, a former secretary of the Bank, and it gathered political and civic support, but it could not prevent the remodelling from
going ahead. Despite the assurances that the building now housed more working executives than it had done under the old Bank of Scotland regime, it was difficult to believe that the Bank was being
run from Scotland in anything but name.

Nevertheless, despite teething problems, the integration of the Bank and Halifax had gone well and the new group made good progress. For 2003 HBOS was able to report profits up 29 per cent, with
all divisions contributing. The retail business had been reined in slightly and grew by less than 20 per cent, but insurance and investment rose by over a half, business banking – having put
the ‘no taxi drivers’ row behind it – grew by a third and corporate banking by 21 per cent. It was a substantial result but there were still some doubts. The
Financial
Times
’ Lex column reported: ‘The real question remains bad debts: can HBOS conceivably have achieved this sort of loan growth without jeopardising credit quality? There are at
present few signs of serious trouble – non-performing loans remain at 1.75 per cent of advances. But until it is clear that all HBOS’s new loans do not carry the seeds of disaster, the
market will not give Mr Crosby the benefit of the doubt.’
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The following year the group was again able to report strong profit increases, with all divisions contributing. Crosby had to report that he had missed his 20 per cent return-on-equity target
– but only by a fraction. The City seemed generally pleased with the way things were going. In its three years of life, HBOS had outperformed other banks, without the feared dramatic rise in
bad debts, and had shown that when necessity demanded it was prepared to restrain its instinct to dash for growth.

Crosby dithered for several weeks over whether or not to make a counter bid for Abbey National, which was being bought by the Spanish bank Santander, but the City decided he had made the right
decision in sitting on his hands. Mike Ellis, the finance director, retired, to be replaced by Mark Tucker, who came from the insurance group Prudential. The board also lost another link with the
old Bank of Scotland with the retirement of John Maclean. Modern governance standards demanded that non-executive directors serve for limited fixed terms. If they stayed too long they were deemed
not
to be independent any more, but what it meant was that board members seldom stayed long enough to experience a whole business cycle, from boom to bust.

Tensions among the executive directors seemed to have cooled when, in March 2004, it was revealed that Andy Hornby had received an offer from a large retail company to join them as chief
executive, and to keep him, HBOS had given him a special incentive worth £2 million. The fact that the company was so keen to stop Hornby leaving clearly anointed him for higher things, but
there was no suggestion of any vacancy at the top of the business in the immediate future.

With better results generating more internal capital, HBOS now began to reverse the decision it had made two years before, using its cash to buy back shares from its investors. The effect was to
shrink its capital and to increase the share price. In two stages it first spent £750 million, then a further £250 million. Crosby said the policy was designed to make HBOS’s
assets ‘sweat more effectively’ on behalf of shareholders. ‘We have invested in capacity to self-fund our growth. Now we have got to that point and this allows us to convert that
growth into value for shareholders. We have got to make growth work harder for shareholder return.’
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Reducing the number of the
company’s shares would also have the effect of increasing its return on equity.