Hubris: How HBOS Wrecked the Best Bank in Britain (28 page)

On 15 September, a day the newspapers called ‘Black Monday’, ‘Meltdown Monday’ or ‘Panic Monday’, the FTSE 100 share index tumbled 200
points and HBOS shares went into freefall. The
Financial Times
described a macabre prediction game in progress: who will be next? The market had already decided: it would be HBOS.

The plight of the Bank had been watched closely by the UK Government throughout the summer. The company’s half-year results, revealed at the end of July, showed profits halved after a loss
of £1 billion on its investments, a further £2 billion write-off to its reserves and bad debts up again. To save liquidity the dividend was being cut and would be paid by issuing new
shares, rather than in cash. Andy Hornby also announced that the Bank was putting some of its best subsidiaries up for sale: Bankwest in Australia, the insurance company Clerical Medical and the
fund manager Insight Investment. Alistair Darling was sceptical about its future: ‘There was a whiff of death surrounding the whole operation. Two once solid institutions, the Halifax
Building Society and the Bank of Scotland, were heading for the rocks.’
¹
HBOS posed a massive problem for the Government. They had
not yet found a permanent solution to Northern Rock’s difficulties, but HBOS was much bigger – any collapse would destroy the savings of 20 million people and create havoc in the
banking system. The FSA was already searching for options and the Treasury began to work on a contingency plan.

Worries focused on HBOS’ capital and liquidity. A further big fall in the value of its reserves following a massive write-off in 2007 suggested that its capital was progressively crumbling
away and with it the bank’s capacity to absorb losses. It was also running short of cash. Hornby had tried to play down suggestions that HBOS was having problems raising money on the
inter-bank market, but to add to its woes the credit rating agency Standard & Poors downgraded HBOS one notch from AA- to A+, increasing the costs it had to pay to borrow.

It was about this time that I attended the dinner where my neighbour gave me the shocking news that he had withdrawn £20 million to put it in a safer place.
³

In fact a massive run on the Bank was in full swing, but it was practically unseen by the general public. Unlike Northern Rock a
year earlier, there were no queues
outside branches and no television pictures to alarm bankers and politicians, but by electronic transfer, telephoned instructions and face-to-face withdrawals HBOS was haemorrhaging cash as its
depositors lost faith. An estimated £30 billion was withdrawn by individuals and companies within a few weeks – a death blow.

On the other side of the balance sheet money was not coming back as quickly as it had done. As the economy turned down, householders could not sell their homes, so they were not moving and
paying off their mortgages. Credit card debt was not being paid off as quickly. Companies were taking longer to reduce their borrowings and were unable to refinance deals with other banks. Many of
those firms which had over-borrowed in the days of low interest rates and high economic growth were now in trouble. HBOS corporate teams were fighting fires all over the country. McCarthy &
Stone, bought by HBOS and Tom Hunter in 2006 for £1.2 billion, was struggling to refinance its £800 million debt. Crest Nicholson was trying to get banks to exchange half of the
£1 billion they were owed for shares in the company. Retail chain JJB Sports and property groups Kandahar and Kenmore had breached their lending covenants. The secondary market was also
drying up. Recent deals were remaining on the books of HBOS as other British and foreign banks which once would have snapped up portions of HBOS Corporate’s loans withdrew from the market,
meaning that the whole debt remained with HBOS.

In Bank of Scotland’s LIBOR
⁴
department staff were trying to complete a routine transaction: ‘We were trying to transfer
£100 million to another syndicate bank. It was the sort of thing we liked to get done at the start of the morning, but at the end of the day we got a call asking “Where’s the
money?” We checked everything over and couldn’t find anything wrong – the money had left us. The following day it still hadn’t arrived – I thought to myself:
“Someone in treasury hasn’t pressed the right button; they’re going to get in trouble for this.” But that wasn’t the problem; the money never arrived, we just
didn’t have the funds.’

To keep the bank afloat, Alistair Darling had to authorise the Bank of England to make exceptional loans to HBOS and other troubled
banks, including the Royal Bank and
Bradford & Bingley. In view of the severe fall in the HBOS share price caused by the false rumour six months before, the arrangement had to be kept secret from the market, but in confidence
Darling told John McFall MP, chairman of the House of Commons Treasury Select Committee. The full extent of the loans did not become known for a year, when Mervyn King told MPs that, acting in its
capacity as lender of last resort, the Bank of England had lent £62 billion to the troubled banks
²
. Over a third went to HBOS, which,
with Darling’s approval, was also borrowing $18 billion from the US Federal Reserve through Bank of Scotland’s American branch.
³

Darling estimated that HBOS was having to borrow £16 billion overnight, every night, just to keep going.
⁴
The figure may have been
an over-estimate, but the timescale was not. The market had become very short-term. After the collapse of Lehman every bank wanted to conserve as much cash as possible, so lending for 24 hours was
as long as they were prepared to let it out of their sight. HBOS had borrowed £278 billion on the wholesale money markets, 60 per cent of this for periods of less than a year. In the next 12
months it would have to refinance £164 billion as its loans fell due and had to be repaid, yet it was living from day to day. The strain on the treasury department was immense, but it
remained calm and professional and took each day as it came.

The atmosphere was much more tense in the group’s City executive suite. Andy Hornby was feeling the stress of the constant pressure and uncertainty. Until then, in the words of one of his
close colleagues, he had led a charmed life. Whatever he had done at school, at Oxford, at Harvard, in his first jobs in Blue Circle, Asda and Halifax, he had excelled. He had been the youngest,
the cleverest, the highest achiever. Any setbacks he had encountered had been minor and, with his willingness to listen, learn and work hard, he had won people over and put any difficulties behind
him. But this time his problems were of a different order of magnitude. He was having to react hourly to events that he not only could not control, but that he could not understand. His easy
likeability was being replaced by irritability, and the lack of sleep and continual worry were showing on his face.

HBOS could not survive on its own. After Northern Rock, Brown and Darling were reluctant to nationalise another bank, so a private-sector
solution seemed the neatest
answer. Of the possible candidates as acquirer, LloydsTSB was the obvious first choice. It was conservatively run, with a strong balance sheet (dependent on the wholesale markets for only 25 per
cent of its funding) and had come through the sub-prime crisis largely unscathed. It also had the most to gain. A takeover of HBOS would give it coverage in the North of England and Scotland, where
it was weak, and provide scope to make massive cost reductions by cutting out duplication in back office functions and the branch networks. The HBOS board had often considered a merger between the
two banks at strategy planning sessions, but the obstacle in the way had always been the Competition Commission. A combined bank would have a dominant market share in mortgages, personal savings
and current accounts that would never be allowed in normal times. But these were not normal times.

Hornby knew the LloydsTSB chairman, Sir Victor Blank, well because they both served on the board of Home Retail Group, the Argos and Homebase retailer. He had also encountered Eric Daniels,
Lloyds’ chief executive, many times at bank meetings. Daniels, known as the ‘Quiet American’ in the City because of his unAmerican love of understatement, was a career banker. He
had served with Citibank in Latin America and met his wife in Panama, where they still had a house with views from the Atlantic to the Pacific. He spent three years in London in the late 1980s
running Citi’s private bank during a previous property crash. He joined Lloyds in 2001 as head of retail and moved into the top job two years later. According to
The Guardian
:
‘With his slow American drawl, Daniels is the perfect foil to the bank’s go-getting chairman, Sir Victor Blank. Although he admits to a love of “over-wrought” Italian opera,
Daniels is not a man given to histrionics. He even smokes with an air of quiet contemplation – leading journalists to describe him as the Marlboro man . . . When asked last month [August
2008] whether he would do any more deals he replied: “Don’t hold your breath. I don’t buy a pair of shoes just because they are cheap.” ’
⁵

Hornby and Daniels had held tentative discussions over the summer, now they began urgent negotiations.

There was a symmetry to the beginning and end of the life of HBOS. On 16 September Hornby, his finance director, Mike Ellis, and main adviser Simon Robey of Morgan Stanley, met Daniels, Tim
Tookey, Lloyds’ finance director, and their adviser Matthew
Greenburgh from Merrill Lynch, in the HBOS corporate flat in St James’s. Seven years before it had
been the venue for the meeting between Peter Burt and James Crosby when the merger between Halifax and Bank of Scotland had been hammered out. Then the air had been light with optimism and
excitement. Now it was heavy with dejection and resignation.

Daniels knew he had the upper hand and Hornby knew he could not leave the room without a deal. According to the
The Daily Telegraph
: ‘ “Andy was in a state of panic,”
one person at the meeting said. There was a lot of aggression between the two teams. You always get that in a bid but this was compressed into a few moments and the stakes were enormous. Obviously,
it got heated.’
⁶
The talks dragged on into the early hours of the following morning before the outline of a deal was agreed. HBOS
would be bought by LloydsTSB at ‘around’ £2.85 a share, a much higher level than the current share price on the Stock Exchange, but less than half of the value at the time the
company had started life in 2002. The two sides broke up expecting to meet later that morning, but someone at HBOS leaked the news to Robert Peston at the BBC who wrote on his blog at 9 a.m. that a
deal was close at near to £3 a share. Daniels was furious and an hour and a half later Peston blogged: ‘Maybe I’ve slightly over-egged the price that Lloyds TSB will pay for HBOS.
Perhaps it will be nearer £2 than £3.’

News of the deal did nothing to steady the HBOS share price and the value of LloydsTSB’s shares also dropped as investors worried about what the bank was taking on. All bank shares were
tumbling and in a desperate attempt to steady the market the FSA imposed a three-month ban on short selling and the Bank of England announced an extension of its special liquidity scheme, which was
keeping several banks afloat.

There was still the competition issue to overcome and later that day Daniels met Darling to ask the Government to suspend competition law to allow a takeover to go ahead. Darling agreed to
discuss it with Gordon Brown, but he was still not convinced that Lloyds knew what it was getting into or that a deal was possible at all. He instructed his officials to prepare two alternative
statements, one welcoming a takeover by LloydsTSB, the other explaining the nationalisation of HBOS. Victor Blank had already raised the competition issue with the Prime Minister while they were
flying back from a trade mission to Israel and Palestine, but had not got a final answer.

The collapse of HBOS, with 30 million customers, was unthinkable, but neither of the alternatives was appealing for the Government either. It had taken nearly six months
to decide to take Northern Rock into public ownership, and apart from the political opposition and practical problems it was also threatened with legal action by some shareholders for expropriating
their investments. It did not want to go through that again on a much larger scale with HBOS if an alternative could be found. But allowing Lloyds to acquire HBOS had the potential to create a
fearsome monopoly. The combination would give Lloyds market leadership in seven key product areas: in current accounts and mortgages it would have over 30 per cent of the market; in savings, credit
cards and small businesses it would have over 20 per cent and it would also lead the personal lending and home insurance markets too.
⁷

The Prime Minister’s final consent to suspend competition law was signalled to Blank during cocktails before a dinner both men were attending during the week of the final negotiations, but
a picture of the two in deep conversation published in the
Financial Times
on the day the deal was finally announced gave the impression that it was a political stitch-up.

Later that day, 17 September, Daniels agreed to an offer at £2.32, some 20 per cent less than his sighting shot a few hours earlier. Hornby had little option but to accept. Now began a
second sleepless night as teams from both banks worked through the dark at the City offices of Linklaters, Lloyds’ lawyers, to complete the paperwork. Tookey left the meeting at 4.15 a.m.,
only to find that his hotel room had been given to someone else. He slept for an hour on a colleague’s couch in the Lloyds’ City office before meeting Hornby at 7 a.m. in Daniels’
office for the Stock Exchange announcement and the press calls.

By the time of the press conference on 19 September Hornby had recovered his composure and Daniels had forgotten his anger. The two men shook hands, watched over by Sir Victor Blank. Both sides
thought they had got the best from the negotiation. Daniels had acquired a bank bigger than his own, giving him a commanding position in the retail market without spending cash and giving his own
shareholders a majority of the equity. He could hardly contain his enthusiasm: ‘We just did an enormously good deal. This is fantastic. I rarely use superlatives, but this is really a good
deal.’ Hornby was
congratulated by members of his board for pulling off ‘an unbelieveably good deal’. The price may have been half what could have been
achieved six months before, but it was well above the market price of the shares and he had secured the future of his bank.