Analysis: The simple bank that created a big problem

On 1 October 2008 HBOS was approaching a point at which it was no longer able to meet its liabilities and sought emergency liquidity assistance from the Bank of England.

Last week the Bank of England’s Prudential Regulatory Authority (PRA), together with the Financial Conduct Authority (FCA), published a comprehensive review into the failure of HBOS Group.

While the financial crisis did not affect Australia in the way it did Europe and the United States, HBOS Australia (HBOSA) nevertheless suffered significant losses.

The HBOS Review noted that Australian commercial property and house prices fell significantly in certain areas, in particular north and south east Queensland in Australia and also in New Zealand.

The review found that a loss of liquidity (as few potential investors were able to secure funding) and a glut of available property exacerbated the price falls.

“In Australia, a drive for market share, particularly in corporate lending, led HBOSA to support transactions with high inherent risks,” it said. “Therefore, while Australian banks generally suffered lower losses in the years subsequent to the review period, HBOSA’s loss record was significantly worse.”

The review noted that HBOSA had a lending portfolio that was markedly concentrated in commercial property.

“HBOSA also lent against high-risk real estate, such as land banks, or in poor quality locations. While other Australian banks had also lent in these areas, they had ensured this type of lending made up only a small part of their portfolio, whereas HBOSA had actively targeted these regions.”

In addition to making poor-quality loans in high-risk areas, the review found that HBOSA had regularly held the most junior debt tranches and sold higher-quality tranches on to other banks, thus increasing their risk of loss in the case of a default.

Interestingly, the review found that of HBOS’s total international business, the largest lending volumes were in Australia, where net lending grew 127 per cent from £14.6 billion in 2004 to £33.2 billion in 2007, “mainly in the corporate and residential mortgage sectors through the broker channel”.

In late 2008, as the group looked to reduce funding pressures on its balance sheet, BankWest, with £27 billion of loans, was sold at a loss to CBA, more than halving the size of the Australian business.

The review found that ultimate responsibility for the failure of HBOS rests with the board and senior management, who failed to set an appropriate strategy for the firm’s business and failed to challenge a flawed business model which placed inappropriate reliance on continuous growth without due regard to risks involved.

Interestingly, the review also found that the former UK regulator – the Financial Services Authority – had a flawed approach, which meant it did not appreciate the full extent of the risks HBOS was running and was not in a position to intervene before it was too late.

Andrew Bailey, deputy governor of the Bank of England, CEO of the PRA and accountable executive for the HBOS Review, said the story of the failure of HBOS is important both to provide a record of an event which required a major contribution by the public purse, and because it is a story of the failure of a bank that did not undertake complicated activity or so-called racy investment banking.

“HBOS was at root a simple bank that nonetheless managed to create a big problem,” he said.

The review into HBOS involved a dedicated team sourcing and considering around a quarter of a million documents and interviews with 80 key individuals.

As part of the review, Andrew Green QC was asked to provide an independent assessment of whether the decisions taken on enforcement by the former regulator, the FSA, were reasonable.

In his report, Mr Green recommends that the PRA and FCA should now consider whether any former senior managers of HBOS should be the subject of an enforcement investigation with a view to prohibition proceedings.

The PRA and FCA will conclude a review as to whether further enforcement action should be taken as early as possible next year.