Hubris: How HBOS Wrecked the Best Bank in Britain (7 page)

Oil field financing was far outside the Bank’s experience, but it began to get calls asking if it was participating in this or that and younger executives began to press the senior
management to take action. In 1972 the Bank recruited its first expert from the oil industry and in the same year, Bruce Pattullo, a 34-year-old manager, persuaded the Treasurer (as the Chief
Executive was still called) to allow him to organise an oil conference in London. The event,
‘Scottish North Sea Oil’, held at the Savoy, branded Bank of Scotland
as the ‘oil bank’ and led to it being invited to participate in the financing of BP’s Forties oil field.

By the standards of the time, the total sum to be raised was massive at £360 million, to be split between a consortium of banks. The deal tested the Bank in a number of ways: the structure
was complicated, the margin was finer than the Bank had been used to on industrial lending, but also it challenged one of the fundamental lending principles. The lenders would have no recourse to
BP, despite its huge assets and strong cash flows from elsewhere in the world. They were to be repaid from the profits of the field and so had to make their own assessment of how much oil it held,
how much of it was recoverable and at what price it could be sold. They were being asked to lend against the asset, not the ability of the borrower to repay. Despite its inexperience and
misgivings, the Bank was the first to sign up, a move which cemented its reputation in the industry. Forties turned out to be one of the largest, longest-lasting and most profitable of the North
Sea fields.

The Bank went on to part-fund a number of other oil developments, to open an office in Houston, Texas, the US oil capital, and to look at financing elsewhere in the world. At home North Sea
business was also boosting its industrial customers in engineering, shipping and construction and providing opportunities for its clients in the investment sector. But in taking up the chances
offered, the Bank also crossed another line – it took equity stakes (that is, it owned shares) in some ventures as well as providing loans. The Bank had previously maintained that providing
both debt and equity opened it to the risk of conflict of interest. As a pure lender a bank had only one concern – to get its money back – but when it also became a part-owner its
loyalties could become divided. It comforted itself by saying that these were exceptional circumstances, that its participation was small and that none of its customers objected; it overturned
centuries of practice, but the Bank took the risk nevertheless and mostly did very well out of it.

The Oil Shock had other repercussions for the banks years later. Higher oil prices meant that the governments of oil-producing countries, companies and individuals, particularly in the Middle
East, accumulated huge financial surpluses and began to deposit them with banks in the US and Europe. The question for the banks
was where to lend this money profitably. The
economies of the developed world were still suffering the effects of the oil price rises and the demand for borrowing was weak, so they turned instead to the developing world, and especially Latin
America. Governments there were desperate to borrow and willing to pay high rates of interest. These were not the sort of customers Western banks would normally consider taking on. Their
governments tended to be unstable and short-lived, their economies were erratic and corruption and inflation were endemic. But the banks’ executives clung to a belief that countries, unlike
companies, could not go bust – the IMF would step in to prevent a default. Third World lending therefore looked like a one-way bet; your money was guaranteed and margins were much higher than
you could get anywhere else. Loan officers from US and European banks began touring Central and South America pressing cash on willing borrowers.

This proposed a dilemma for Bank of Scotland. Lending on the large scale required by governments was done by consortia of banks. The Bank was too small to be part of the leadership of any of
these groups, it had no international network of branches and offices and its experience of currency lending was confined to meeting the export needs of its domestic customers. Nevertheless some of
the Bank’s executives in the newly formed international division wanted to be part of the action – the margins on offer, even for those lower down the food chain as the Bank would be,
were too fat to ignore. Barclays, which had a big shareholding in Bank of Scotland, was also pressing the Bank to take part in consortia which it was leading. The board was cautious about
‘taking crumbs from other men’s tables’, as one board paper put it,
⁸
but nevertheless, the Bank did lend.

The total debt of Latin American governments quadrupled over eight years while at the same time economic recovery meant that interest rates rose. Inevitably some countries could not meet their
interest charges and repayments and panic ensued when first Mexico, then Argentina and Brazil teetered on the edge of default. The consequences for the banks were dire. The total capital of some US
and London banks would have been wiped out had they been forced to write off all their lending to the region. The IMF did have to step in, but the sums were so large that all it could do was extend
debt terms to allow banks time to write off their loans. Bank of Scotland had the least exposure of any UK clearing bank, but had it had to
write off the lot in one go, it
would have lost more than a quarter of its capital.

The international rescue bought time and although the Bank wrote off some debts, it adopted an innovative solution to others. David Jenkins, the Bank’s Economist, was pressed into a new
role, travelling South America to negotiate debt-for-equity swaps which saw the Bank acquire, among other things, a hotel on Copacabana Beach in Rio de Janeiro, a tomato-paste factory in north-east
Brazil, and a stake in the country’s third-largest paper producer.
⁹
Jenkins, short, bald, dapper, with a wry wit and ready smile, must
have cut an unlikely figure touring some of the more remote areas of Brazil and Chile. He turned his adventures into a series of humorous articles for
The Scottish Banker
magazine.

Cometh the hour, cometh the man

At the end of the 1970s a quiet revolution occurred at the top of Bank of Scotland. The appropriately named Tom Risk was appointed one of two deputy Governors.
¹

Risk was a corporate lawyer who had been a director of the Bank for some time. Importantly, he had chaired its corporate banking subsidiary, initially named Bank of Scotland Finance Company, but
later relaunched with the old British Linen Bank name. His chief executive there had been Bruce Pattullo, the manager who had led the Bank to raise its profile in the oil industry. Risk was a
strategist and a shrewd judge of character. Along with some of the other board members he was concerned that the Bank’s lacklustre performance over the previous decade made it vulnerable to a
takeover. With the retirement of the Treasurer (Chief Executive) looming, he persuaded his fellow directors to leap a generation, ignore the potential candidates among the general managers and
promote Pattullo, who was made Deputy Treasurer and Chief General Manager in 1979 and promoted to the top post the following year at the age of 41.

It was not only Pattullo’s youth which was unusual. His background made him a very strange animal in clearing banking on either side of the border. Whereas most recruits had joined the
Bank from state schools, Pattullo had been educated at prep school, Rugby and Hertford College, Oxford. There he had developed an interest in economics and fancied a career in finance, but while
his university contemporaries might have gone into stockbroking or one of the blue-blooded London merchant banks, he opted to join Bank of Scotland as one of the first of a handful of candidates on
its new graduate programme. Recruiting from university was a radical departure for
the Bank, but any difference to its usual method of training stopped there. Pattullo was
still required to work in a branch ‘passing money over the counter’ and to study for the Institute exams, although having acquired the habit of studying on his own at Oxford, he opted
for correspondence, rather than night classes. He won the Institute’s first prize in his exam year. As with other recruits, the Bank moved him around, so that by the time he reached the top
nearly 20 years later he had acquired a broad experience of practical banking.

Pattullo was intelligent, rather than clever, thoughtful rather than impulsive. By temperament he was a quiet, cautious man, not given to overstatement. I had known him for a couple of years by
the time he was appointed to the Treasurer’s position and I interviewed him for the
Financial Times
. I asked him his ambition and was surprised by the answer:

‘To make this the best-performing bank.’

‘The best-performing bank in Scotland?’ I asked.

‘The best-performing bank anywhere,’ he said.

His leadership marked a radical change in character and culture. Previously the Bank had been constrained by its hierarchy. Information had a long way to climb to get from the customer to top
management and decisions wound their way down through many layers before being implemented. Pattullo was open and approachable and, in some ways despite his middle-class upbringing, unconventional,
prepared to consider new ways of doing things and to listen to his subordinates as well as to his peers. For the senior executives who wanted to get the new chief’s ear there was another
marked change. Unlike previous generations of top Scottish bankers, Pattullo was not a golfer. He played tennis and had a court built in the garden of his Edinburgh home. Several of his senior
lieutenants started to work on their serves.

By the time he became Treasurer, he had had two decades to observe how the Bank’s management structure inhibited innovation and made decision-making cumbersome. He introduced a Management
Board
¹
, consisting of the top half-dozen or so senior executives who met regularly to discuss the progress of the Bank in their various
fields. Everyone, whether they were in International, Treasury, managing the East of Scotland business, the West or London, got an overview of what was happening, where problems might occur and
where opportunities were being presented. This group became
the engine of change within the Bank, reinforced by the fact that most of its members had offices on the first
floor of the headquarters building on The Mound. If they were in the office they took coffee together and often lunched together.

Risk and Pattullo redesigned the governance of the Bank. They created a clear separation of the functions of the main board – now focused on strategy and a role as trustees of the
proprietors’ (shareholders’) funds – and the Management Board, which ran the Bank day to day. To link the two, the Treasurer sat on the main board as a full member, and the
Governor attended the Management Board. The minutes of Management Board meetings were made available to directors, and executives attended the main board meetings, sitting at the back and silent
unless asked to speak.

Pattullo also ended the stranglehold the Inspectors’ Department had over innovation and promotions and focused it on internal audit. He promoted younger, able managers and he changed the
culture, abolishing the Business Development Unit, a head office team supposedly responsible for finding new opportunities, and sent a circular to all managers telling them they were all
responsible for growing the business. No more would initiative be slapped down: ‘The Treasurer has let it be known that he is open to ideas from anywhere,’ one young manager told me
with enthusiasm at the time.

Tom Risk was appointed Governor in 1981 and the two men formed a formidable partnership at the top of the Bank, each passionately committed to its independence and to making it a force to be
reckoned with. When the chairman of the Distillers’ Company, Scotland’s biggest whisky producer and by common consent a poorly managed dozy giant, came to suggest that it might buy Bank
of Scotland, Risk politely but promptly walked him to the door and closed it behind him. A more credible threat was posed when Barclays, which had owned 36 per cent of Bank of Scotland since its
acquisition of British Linen Bank, decided it wanted either to acquire the remainder of the Bank or to sell its stock. There was no appetite on The Mound for becoming a subsidiary of Barclays,
which had its own problems and was still in the grip of the founding families. Instead Risk arranged to have Standard Life, Scotland’s largest life assurance company, buy the holding, rather
than have it acquired by a possible predator. ‘It was a squalid Scottish stitch-up,’ remarked one Bank executive. Standard Life was criticised for the deal on the
grounds that such a big stake, representing over 7 per cent of its equity holdings, would unbalance its portfolio, but it held the shares for ten years and sold them for four times
what it had initially paid.

Pattullo turned conventional thinking in the Bank on its head. Whereas the previous generation of managers had seen the ending of the Gentleman’s Agreement as a threat that the English
banks would come into Scotland, he saw it as an opportunity. With an English market ten times the size of Scotland to go after, Pattullo saw that he had the best of the deal. Whereas others saw
Bank of Scotland’s tiny percentage of the UK banking market as a weakness, he regarded it as a strength. He could realistically aim to double his share, whereas any of the ‘Big
Four’ English banks, each with about a fifth or more of the market would struggle to gain any increase.

His strategy was to move into England with a series of carefully positioned branches in fast-growing English regions. Birmingham was the first, quickly followed by other major cities. He
recognised that in a new market it would be impossible to make enough profit from retail business to justify the property and manpower costs of opening a large branch network, so the new offices
were to concentrate on corporate business, lending and, crucially, taking deposits. That would mean a fewer number of bigger and more profitable deals.