Last Thursday, seven years after the event, the British bank regulators, now under the firm aegis of the Bank of England, finally published their long-awaited report into the failure of HBOS, the UK’s fourth-largest bank.
It came with a strongly worded criticism of the three top managers, Lord Stevenson, the chairman, and the two successive chief executives, James Crosby and Andy Hornby.
There is not much in it that we don’t know already, so much time has passed and so much blood has been spilt all of the executives and directors involved were either forced to step down or have long departed – that it is too late to have any real impact on events.
Nonetheless, it serves as an invaluable document in highlighting how an institution can go so awry when it gets into the wrong hands. It also serves as a salutary lesson into the inadequacies of the due diligence process if the underlying assumptions are wrong – as they were in this case.
The story is well enough known – when Lehman Brothers filed for bankruptcy in September 2008, it triggered a worldwide banking crisis which HBOS, already in trouble, could not survive. It had to be rescued by Lloyds TSB with the UK prime minister Gordon Brown personally paving the way to facilitate the takeover. The government pumped £20 billion (Dh111.33bn) of new capital into the two banks simply to keep them alive (it has since got it all back and more).
The deal turned out badly for Lloyds, which had hugely underestimated both the scale of the recession the British economy was entering and the impact it would have on HBOS’s shaky loans to high-risk borrowers. Despite about 5,400 man hours of due diligence, it failed to spot the dark holes in the HBOS corporate loan book and in its international interests in Ireland and Australia, where it had been particularly reckless. In Ireland alone it took £10.5bn of losses and another £3.5bn in Australia.
In September 2008, as Lloyds began its due diligence, its economists – in line with the UK treasury and Bank of England – were forecasting a relatively benign one-in-15-years recession, roughly a 2 per cent fall in GDP, whereas in the six-month period to March 2009 the economy fell by 6.5 per cent and by 7.5 per cent in total, the biggest recession in almost 100 years. The impact of that on risky and geared property companies was devastating – many of HBOS’s bigger bets were completely wiped out.
Lloyds can be blamed for its naivety and poor judgment in not perceiving that. But in the autumn of 2008 it seemed to make a lot of sense. Lloyds, which would vault from fifth to second place in the British banking hierarchy, reckoned it could take £2.5bn to £3bn out of costs, which has since been achieved, and would gain a 30 per cent market share of mortgages, personal accounts and small business lending. The synergies of cross-selling its Scottish Widows insurance and other products across the HBOS network were also considerable.
Right up to the moment the deal was finally consummated in January 2009, it still believed the advantages comfortably outweighed the disadvantages. The recession had provided the only chance it would ever get of landing what it called “the big prize”.
No takeover in British corporate history had ever received so much support. It was blessed by the highest authorities in the land, unlimited liquidity was provided by the Bank of England, and at the prime minister’s personal request, the business secretary Peter Mandelson introduced an emergency order permitting the merger on the grounds of “the stability of the UK financial system”.
In the City the analysts positively gushed: “The deal is an absolute steal,” said one. The financial press portrayed Sir Victor Blank, the chairman, and Eric Daniels, the chief executive, as the “saviours” of HBOS and maybe even the banking system. Within months it all changed as the economy crashed and the bad news began pouring in.
Up to the time the deal was agreed, HBOS had reported comparatively minor impairments to the market. Its 2008 interim results, announced in September, disclosed only £1.3bn of impairments, and were the latest available public statement which Lloyds had to rely on. In fact the HBOS impairments for 2008 turned out to be £13.5bn with another £21.1bn to follow in 2009. Between 2008 and 2011, Lloyds had to take impairment charges of £52.6bn on HBOS’s lending portfolios, 10 per cent of its banking assets, a massive figure compared to the £10bn it had allowed for in its calculations. About £21.9bn of that was on the corporate book run by Peter Cummings, the only person so far to suffer public censure and a hefty fine of £500,000. Very little of this had been identified in the due diligence process.
If Lloyds had known all that, it would never have gone ahead with the bid, Yet it survived and today is a £60bn group making £8bn a year, the second-biggest bank in Europe and Britain’s eighth-biggest company. So it could be said that all’s well that ends well – unless you happen to be a Lloyds shareholder (although even their fortunes have recovered). Even the government came out ahead.
Ivan Fallon is the author of Black Horse Ride: The Inside Story of Lloyds and the Banking Crisis (Robson Press).
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