Hubris: How HBOS Wrecked the Best Bank in Britain (22 page)

Controversially, Bank of Scotland Corporate (as it branded itself) began routinely taking equity stakes in companies to which it was also a lender. For decades Bank of Scotland had acquired
warrants or options in companies, but received shares only through special circumstances. In the oil industry it had been established practice that banks providing debt for oilfield financings
might also get a tiny percentage of the ownership. In other industries some shareholdings had been acquired by default: the borrower had run into trouble, usually because of an economic downturn,
could not repay the loan and the Bank, rather than write off everything, had accepted ownership of all or part of the venture in exchange for cancelling the debt. It had done this a number of times
in South America during the Latin American debt crisis and at home had become the reluctant owner of hotels and golf courses in the same way.

The Bank was never comfortable with this position and looked for opportunities to sell its shareholding as soon as possible. During his period as chief executive, Bruce Pattullo had maintained a
rigid policy of refusing to take equity stakes in companies to which the Bank was also a lender, seeing it as a conflict of interest. If a company got into difficulties, the priority for the Bank
was to get its money back and that might mean going over the heads of shareholders to call in a receiver while there was still a chance of recovering the loan. That could leave the shareholders
with nothing.

When it began to finance MBOs, younger managers started to
question that policy. As the example I gave at the beginning of this chapter shows, equity holders stood to
make the biggest gains in leveraged deals. In theory they were taking the most risk, but in practice if a company went down the Bank also stood to lose. Why not get some of the icing as well as the
cake? After Pattullo retired, the ban on equity began to be relaxed.

Bank of Scotland Corporate began to offer a ‘one-stop shop’ to people wanting to do big transactions. Alongside senior debt, it would offer mezzanine and equity finance, earning
itself more interest and fees for arranging and structuring the deal. It began to promote itself as the bank which could put together the essential elements of making a transaction happen and it
published a regular magazine,
Deal Leader
. Its pages profiled the entrepreneurs it was backing, describing their companies and how Bank of Scotland’s cash had helped them grow. It
carried a regular feature promoting a member of the Bank’s corporate team under the heading ‘The Loan Arranger’. A regular section called ‘Deals Done Differently’ also
listed the transactions the Bank had recently completed.

Over the six or seven years following the merger, equity stakes became a major profit source for HBOS. A series of subsidiary companies was set up, all bearing a name derived from the old Bank
of Scotland Latin motto
‘Tanto Uberior’
(which approximately translates as ‘so much the more plentiful’). Uberior Ventures, Uberior Investments, Uberior Equity,
Uberior Property and others similarly named held stakes in 70 companies such as health and fitness group David Lloyd Leisure, builder Keepmoat, newsagent group Martin McColl and dozens of property
companies including a 22.5 per cent stake in Chelsfield Partners, a 50 per cent stake in a luxury hotel venture with Sir Rocco Forte, a shopping centre joint venture with Warner Estate, a retail
joint venture with the Reuben brothers and a petrol station joint venture.

At its height the combined value of these shareholdings was said to top £5.5 billion and the portfolio generated hundreds of millions of pounds of annual income in dividends or the
proceeds of sales. Besides providing equity funding, HBOS also lent £4.5 billion to these companies to fund expansion or new developments.

As you might guess from the parties he throws, the retail businessman Sir Philip Green has a liking for the dramatic. He is also a good storyteller. Recalling one of the early deals in which he
had been
involved – the purchase of the Olympus Sports chain of clothing shops from the British retail group Sears in 1995 – he told the journalist Robert Peston
that the message telling him the company was for sale came while he was undergoing a heart operation:

Like every good story, it contains some truth, but the actual circumstances of the purchase may be more prosaic. The Tom in question was the Scottish entrepreneur Tom Hunter. When he left
university in 1984 Hunter had borrowed £10,000 from his father and the Royal Bank of Scotland and started selling trainers from the back of a van. By 1995 he had built the business into a
chain of shops named Sports Division and was making £4 million a year in profit. He was looking for ways to expand when one of his suppliers tipped him off that Sears wanted to sell Olympus.
A purchase would more than double Sports Division’s number of outlets, but Olympus was losing money. Hunter, then 34, went to see Philip Strong, Sears’ chief executive, but was shown
the door. Strong did not believe Hunter could come up with the money and would not negotiate with him.

Hunter and Green had met when Green had bought the Glasgow budget retailer What Everyone Wants, so Hunter called him and asked him to front the deal. Green went to Sears and secured an option to
buy Olympus. (The call telling him he had the option may have come while he was in hospital.) Hunter received the call from Green saying the deal was on while he was holidaying in Barbados with his
family, but now his problems started. To buy the company he needed to borrow £20 million, but the Royal Bank turned him down. Racking his brains, Hunter remembered meeting someone from Bank
of Scotland while on a trip to Turin organised by David Murray, then owner of Glasgow Rangers, to see his team play Juventus. He called Murray to be told that the man he had spoken to was Gavin
Masterton, the Bank’s Treasurer. On his return from holiday, Hunter called Masterton, who sent one of his corporate managers to see him – Peter Cummings.

Hunter and Cummings had a lot in common. Coming from modest beginnings, both had done well in their chosen careers, but had remained rooted in the communities from which
they came. Cummings still lived in Dumbarton, Hunter in the South Ayrshire community of New Cumnock. Hunter knew exactly what he had to do to turn Olympus around and took Cummings through his
figures in detail. If he could make the new stores perform even half as well as his existing shops he would be able to repay the loan with ease. Cummings had been told by Masterton: ‘Be hard,
but don’t lose the deal.’ He fulfilled both parts of his brief. The Bank agreed to lend the £20 million but Cummings demanded security over Hunter’s business and his house.
Philip Green also extracted a high price for his part – £1 million in cash and 12.5 per cent of the equity – but he was right. It did work out well and everybody did win. Hunter
more than met his promise to Cummings and repaid the loan within six months. Three years later he sold Sports Division for £295 million.

The connection between Green, Hunter and Cummings was to be crucial to Green’s next big deal in 1999 when he bought the remainder of Sears. Green and Hunter were putting money into the
purchase, together with the Barclay twins Sir David and Sir Frederick, who had built up substantial businesses ranging from hotels to shipping. Cummings was handling the transaction for the Bank,
but chief executive Peter Burt was taking a close interest, partly because of the importance of the Barclay brothers, whose account he oversaw personally and partly because there was a potential
embarrassment for the Bank: its Deputy Governor, Sir Bob Reid, was chairman of Sears. Green, again, told Peston the story:

You might get the impression that Cummings agreed to lend £150 million to Green on the strength of a telephone call but, again, the truth is less colourful. The banker used that 20 minutes
to call his boss, Peter Burt. Bank of Scotland was lending to its long-standing good customers the Barclays, not to Green, and Burt agreed to lend more to get the deal done, but to the Barclays,
who had agreed to put in more money. Speed was of the essence, but Burt also called his boss, the then Bank Governor Sir Alistair Grant, to make sure that everyone understood what was being agreed
and on what terms.

Like the Olympus deal, the purchase of Sears turned out better than anyone had expected. Green was an extraordinarily talented businessman as well as a retailer. He had paid £549 million,
but broke up the group, selling off parts of it which he did not want and recouped the purchase price within three months. Again, the cash the Bank had lent was repaid in quick time and the deal
cemented the relationship between Philip Green and Peter Cummings. Green also liked to make a splash at London casinos and from the press reports it could appear that both he and Cummings were
gamblers, prepared to take big business risks to win big rewards, but in reality both were detail men. Green had long experience in turning around retail brands and before he made purchases he
worked hard to understand every aspect of the business.

Green and Hunter went on to purchase the store group Bhs in 2000 for £200 million, where Green tripled the profits, but it was his acquisition of Arcadia, the Top Shop and Dorothy Perkins
company, in 2002 which was his most spectacular. The deal had been planned in partnership with the Icelandic Baugur group, which was going to take some of the high-street brands owned by Arcadia.
But in the final stages they ran into trouble and their offices were raided by the Icelandic police.

To get the deal done Green and his family put in £120 million. ‘The fundamental difference between me and those tossers running
public companies,’ Green
told the
Financial Times
, ‘is that I invest my own money.’ Bank of Scotland, by this time part of HBOS, provided the rest – £808 million. The bank also paid
£6 million for an 8 per cent stake in the business, effectively acting as a private equity house as well as lending.
³
The deal
graphically illustrated Green’s maverick approach to business. Arcadia was a public company, quoted on the Stock Exchange, and normal City protocol would have demanded a series of quiet,
nuanced conversations between advisory firms before any direct approach was made. Green dispensed with all that and called Stuart Rose, Arcadia’s chief executive, himself. ‘Why should
anyone pay £10–15 million in fees just to find out whether the other person wants to do business?’ It was an unorthodox attitude, but the Takeover Panel accepted it.

Green may have been investing his own money but HBOS would be hazarding its depositors’ funds. Cummings was closely identified with the deal and was criticised in the press for the scale
of the risk he was allegedly running on behalf of the Bank. In fact most of the work was done by a team working under him led by one of his deputies, Graeme Shankland, and the transaction was
signed off by George Mitchell, the director then responsible for corporate banking.

But yet again Green proved that he was a master retailer and as good as his word to Cummings. Within a year he had boosted sales in the group and repaid £500 million of the cash he had
borrowed. A year after that he had paid off the whole lot. The night before he announced doubled profits, Green hosted a dinner for George Mitchell and Peter Cummings at Les Ambassadeurs, his
favourite Mayfair club and casino. The following morning Cummings drank champagne with Green at the Arcadia offices at Oxford Circus, before both of them addressed the staff. It appears to have
been a very emotional occasion for them all. As Green spoke, his wife Tina, a tear in her eye, according to the
Financial Times
, held Cummings’ hand. But it was Cummings’
speech which was most extraordinary and illustrates the very close relationship he had formed with Green.

‘As shareholders, stakeholders and bankers, we can only thank you from the bottom of our hearts for delivering a first class set of results. It is outstanding. When you decide to lend
money you assess the skill-set of the people in the business: what I see now in this room, is not just a skill-set and competence, but capability to compete with the best.’ He went on to
describe Philip Green as ‘the most conservative
and prudent finance manager I have met’, and praised his ‘integrity by the barrel-load’.
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His words may have been justified, but his willingness to say them in public was hardly in keeping with the traditional image of the typical Scottish
bank manager.

Green had already paid a dividend but as the group rode the consumer boom, there was much more to come. He lived during the week in a London hotel, but had his private jet ferry him back to
Monaco at the weekends, where Tina Green was a resident tax-exile. Although Green ran the group, Tina was technically the owner and when Arcadia paid out £1.2 billion in dividend in 2005
– the biggest personal dividend in British history – most of it went to Tina free of tax. HBOS, as the only other shareholder, received £100 million as its reward. To fund the
payout Green again borrowed, much of it from Bank of Scotland, which then syndicated the loan to other banks – so the Bank was effectively lending to pay its own share of the dividend.