Eric Daniels shouldered his way through the crowd outside the committee room
in Portcullis House, Westminster, on Wednesday afternoon, took a deep breath
and sat down, prepared for the worst.
His face, as always, was impassive. The chief executive of Lloyds Banking
Group, a 57-year-old American who speaks in a distinctive gravelly drawl, is
famed in the industry for his “Buddha-like” calm.
That was about to be tested. Daniels and his peers – Stephen Hester, chief
executive of RBS, John Varley, chief executive of Barclays, Antonio
Hor-ta-Osorio, chief executive of Abbey, and Paul Thurston, UK head of HSBC
– were the next set of witnesses in the Treasury committee’s inquiry into
the banking crisis.
The MPs – and the public – wanted blood for the collapse of the banking sector
and resulting recession. A hapless previous set of witnesses, including Sir
Fred “The Shred” Goodwin, formerly of RBS, had made grovelling public
apologies and were savaged by the press. The Sun branded them “Scumbag
Millionaires” on its front page.
This group had less to fear. They were meant to be the good guys of the
crisis, regarded as either having been prudent during the boom or competent
in clearing up the mess.
Daniels, however, had a guilty secret. He knew the Lloyds board was about to
sign off a disastrous set of annual results – results so bad it was forced
to put out a warning to the market last Friday.
The problems were at HBOS, the bank Daniels and his chairman Sir Victor Blank
had triumphantly swooped on in October when it came close to collapse.
The fruits of that victory were about to become ashes in their mouths. On
Friday Lloyds reported a £10 billion loss, £1.6 billion more than feared. It
blamed the figures partly on the fact it applied a “more conservative
provisioning methodology” than HBOS had done. Investors fled, with the
group’s shares falling by a third, prompting speculation Lloyds would have
to be nationalised.
Shortly before attending the committee Daniels had made an abrupt personal
about-turn. After insisting that he would not give up the £2m bonus payment
he was due for the year, he said he would not, after all, take it – a wise
decision in light of the storm to come.
Under MPs’ questioning, he trod a careful line. John McFall, chairman of the
committee, asked: “How can an acquisition be prudent if it pushes your
company towards nationalisation and the brink?”
Daniels said: “We thought that the HBOS acquisition, in the short term, would
be painful. It has turned out, given that the economy has turned down even
further, to be a very true statement, but we also believe it is
strategically a very good acquisition and will prove to be so in a couple of
years.”
Blank and Daniels can’t say they weren’t warned. The City first raised
concerns about HBOS’s exposures to corporate lending as far back as 2003.
The fears escalated as the bank became involved in ever more high-profile
deals, backing entrepreneurs such as Sir Philip Green, Sir Tom Hunter and
the Reuben brothers.
A Credit Suisse research note in July 2005 was one of the first to turn
bearish, warning that rising consumer debts would pose the bank problems,
and its corporate bank could not be relied on to bail it out. By early 2007
analysts were warning of problems. A UBS note said the bank’s
corporate-lending arm was “quite unlike any peer”.
It went on: “Our issues are that the corporate bank is becoming a real-estate
and private-equity focused conglomerate relatively late in the cycle. We
believe that the illiquid nature of these positions, their equity-like
volatility and the very low related costs make the earnings from HBOS’s
corporate bank uniquely cyclical.”
Under Peter Cummings, the head of corporate banking, the bank’s exposure to
property ballooned. It backed high-profile buyouts of housebuilders such as
Crest Nicholson and McCarthy & Stone and Wyevale garden centres. All
three deals have since hit the rocks. HBOS backed a slew of smaller
retailers that have gone into administration, such as shoe-shop chain Stead &
Simpson.
Daniels and Blank must have been aware of these concerns, but they charged on.
Daniels admitted to the MPs that they would normally have done much more due
diligence on such a deal.
“We probably would have put in somewhere around three to five times as much
time as we put in,” he said. IN August 2007, Andy Hornby, the chief
executive of HBOS, executed a sudden and unexpected boardroom clear-out.
Benny Higgins, a £1m-a-year retail banker hired from arch-rival RBS little
more than a year earlier, was ousted.
Officially, his departure followed a restructuring which split his job as head
of retail banking in two. However, his removal followed a sudden slowdown in
the bank’s mortgage business. It had sold only 8% of the mortgages loaned in
the UK in the first six months of 2007.
Higgins had slashed the commission HBOS paid to mortgage brokers and financial
advisers for selling HBOS products. As a result, sales had fallen through
the floor.
According to banking analysts, Higgins had argued at the time that he wanted
to make the HBOS loan book more conservative. Hornby took a different view.
HBOS returned to its former aggressive strategy. In the six months following
Higgins’s departure, the bank loaned 22% of all mortgages sold in Britain,
making up the ground lost earlier in the year. Hornby told his investors he
was pleased to have clawed back the bank’s share of the market.
HBOS’s gung-ho approach proved its undoing. Last week the emergence of a
whistleblower shed some light on what was going on, and how warnings were
ignored.
Paul Moore, the bank’s head of group regulatory risk between 2002 and 2005,
accused HBOS of being run by an “overeager sales culture”.
His claims forced Sir James Crosby, the bank’s former chief executive, to quit
as deputy chairman of the Financial Services Authority (FSA).
Hornby, meanwhile, has faced accusations that his testimony to the Treasury
committee was, in part, misleading.
Both Crosby and Hornby reject the whistleblower’s allegations. Many of the
mortgages that HBOS loaned after Higgins’s departure are likely to be part
of Lloyds’ current woes. According to the bank’s own Halifax house-price
index, the cost of homes fell more than 17% in the 12 months to January,
meaning that many of those with mortgages must be saddled with negative
equity.
The bank’s corporate-loan book – which included huge exposures to
housebuilders – has proved to be an even bigger problem, losing £7 billion.
Moore sent a file to the FSA in December 2004, outlining his complaints about
HBOS.
The FSA then ordered HBOS to commission a report into the allegations from
KPMG, the bank’s auditors.
“I cried when I read the report,” Moore told The Sunday Times last week. “I
was saddened that a firm I had worked for had not done its job properly.”
He added: “I complained to the chairman of the audit committee about the way
the investigation was handled.
“They started off with the answer they wanted to arrive at, and so there was
no need for them to go any further or question the information they were
given.”
Moore’s main complaints to the FSA related to the appointment of Jo Dawson, an
executive with a primarily sales-led background, as the bank’s new
group-risk director. Moore had wanted the job himself.
KPMG’s report was full of colourful claims about the tension between Moore and
Dawson. The firm interviewed 28 people at HBOS over 80 hours as part of a
four-month investigation. Moore’s behaviour was variously described as
“prickly” and “emotional”.
After his lawyer picked over the report, Moore was awarded a six-figure
pay-off from the bank and left in the middle of 2005. His claims about the
bank’s risk culture were kept quiet until an interview with the BBC’s Money
Programme last October – allegations he resuscitated as evidence to the
Treasury committee, prompting last week’s furore.
Moore’s claims relate to behaviour in HBOS’s retail bank, and the risks being
run on products such as mortgages, loans and credit cards. The average
mortgage lasts about three years, while debts rung up on credit cards tend
to become problematic even sooner.
Most of the business HBOS did while Moore was at the bank has already washed
through the books, and contributed to the bank’s large profits of recent
years.
Although the bank did suffer a jump in bad debts in late 2004 and 2005 – as
Moore was negotiating his exit – it didn’t bring HBOS down. The issues that
led to Friday’s huge losses were developing elsewhere.
Moore does not appear to have raised any concerns about the bank’s
overdependence on wholesale funding, or its overexposure to housebuilding.
Crosby remains defiant, in spite of his resignation and a noticeable lack of
support from Gordon Brown, who appointed him to both the FSA and to conduct
a review of the mortgage market.
“What is important is to focus on the facts and not the rhetoric; the issues
not the personalities,” Crosby told The Sunday Times. “I am confident that
the facts in this case will tell the story and I will make a complete
rebuttal in due course.” THE question now for Daniels and Blank is whether
they can survive the turmoil around Friday’s losses and reap what they
believe will be the long-term benefits of buying HBOS.
Senior shareholders contacted by The Sunday Times yesterday said they were
furious about Daniels’s admissions regarding the lack of due diligence. They
claimed they had supported the deal – attractive because it gives Lloyds a
dominant market share of UK retail banking – after receiving assurances from
senior Lloyds executives that they knew what they were getting into.
Some analysts are also now questioning whether the benefits of the deal will
be as great as first thought. “If Lloyds gets a monopoly or close to a
monopoly on retail banking, the government will act to break it up again. It
looked too good to be true, and it was,” one said.
For the moment, the Lloyds leadership must try to ride out the storm. There
may be some unexpected help on the way in the form of good trading results
from the first quarter of this year, as all UK banks have squeezed lending
and shut down unprofitable businesses.
While they wait hopefully for the furore to subside, Blank and Daniels must be
thinking that their haste in taking on HBOS could yet come back to haunt
them. Additional reporting: Claire Newell
