Page last updated at 11:27 GMT, Thursday, 30 October 2008

HBOS: Breaking the bank

By Jacqui Farnham
BBC Money Programme

HBOS sign
HBOS has had a dramatic fall from grace in the past year

The takeover of HBOS by Lloyds TSB will create the biggest ever British bank with more accounts and mortgages than any of its high street rivals.

Only a year ago a merger on this scale would have been unthinkable, but a year is a long time in banking.

The now infamous credit crunch first hit the headlines in the summer of 2007.

On 9 August, banks that had previously greased the wheels of the economy by lending money to each other, suddenly stopped lending amidst fears of exposure to high-risk US mortgages.

All the High Street banks make money by borrowing from "wholesale banks" at one rate and then lending it to us in the form of mortgages at a higher rate.

Once that stream of money stopped, they were in trouble.

The crisis hit a new level when it was announced in September that Northern Rock, once the darling of the city, was fighting for survival.

When the Treasury stepped in on 17 September 2007 to guarantee all deposits in Northern Rock, it seemed as if stability had returned to Britain's banking system.

In fact was just the calm before the storm.

A perfect financial storm

Almost exactly a year later, on Monday 15t September 2008, a crisis engulfed Wall Street.

The bank will be a colossus in the retail financial market with 142,000 employees and a 28% market share

Lehman Brothers, the world's fourth biggest investment bank, filed for bankruptcy.

The problem? US mortgages gone bad.

Merrill Lynch, another US behemoth was swallowed by Bank of America and on Monday afternoon rumours began to circulate that colossal insurance company AIG was on the brink of going bust.

As stock markets plunged around the world, eyes turned to the British banks to see who would be next.

Amid the tumbling share prices one name stood out - HBOS, owner of Halifax.

"Movements in HBOS were spectacular," says Howard Wheeldon of BCG Traders.

"The screens were all red on that day and the graph of HBOS just went down and down."

Like it's smaller rival Northern Rock, HBOS had also made money by borrowing from the wholesale markets.

Since the credit crunch it had struggled on, financing its debts with shorter term loans at higher interest rates.

When Lehman Brothers collapsed, the wholesale banks battened down the hatches.

HBOS chief executive Andy Hornby
HBOS chief Andy Hornby has had a rough year

As Monday turned into Tuesday, investors began to believe that soon HBOS might not be able to pay back its loans.

Leigh Goodwin, banks analyst at Fox-Pitt Kelton Investment Bank, believes big shareholders were getting out fast.

"This was an issue where institutional investors suddenly got scared about HBOS's ability to survive," he says.

"They were basically selling the shares very heavily."

When the UK markets closed at 4.30 on Tuesday, HBOS share price had hit a low of 177p, almost 90% lower than it had been at its height in February 2007.

A lifeline from Lloyds TSB

On Wednesday, as the share price again tumbled, it suddenly became clear that HBOS had been thrown a lifeline.

The collapse of Lehman Brothers was contagious

In a live broadcast, the BBC's business editor, Robert Peston, announced that HBOS were in emergency talks with Lloyds TSB.

Once he had broadcast, there was a rush on to complete the deal.

"Given the concerns that depositors would withdraw money, they couldn't afford to delay the deal," says Mr Peston. "They had to get it concluded."

That conclusion came in an announcement at the close of trading on Thursday.

Lloyds TSB would purchase HBOS for the rock bottom price of 12bn.

But this was not the first time Lloyds TSB had made overtures to a big mortgage lender.

In 2001, it had been banned from purchasing an ailing Abbey because the resulting bank would have been so big it would have contravened competition law.

This time, Prime Minister, Gordon Brown personally reassured Lloyds chairman, Victor Blank that competition rules could be bypassed in the national interest.


And that should have been the end of it. HBOS had been saved and the markets ought to have stabilised.

The world of finance is being restructured

Instead, the crisis deepened - and it spread around the World. Soon Iceland, Russia and to Asia were facing their own financial storms. In Britain, an embattled Bradford & Bingley was nationalised.

On October 8th the government stepped in, in an effort to prop up Britain's economy. The treasury announced a massive government bail out worth nearly half a trillion pounds in loans and guarantees.

As part of the plan, the new HBOS Lloyds TSB merged bank would get a 17 billion cash injection and in return tax payers would own 43% of the bank.

Scottish impact

The City may be temporarily satisfied by the merger, but 400 miles away in Scotland; the takeover has big implications for the country's future as a financial centre.

When HBOS formed in 2001 it was itself the result of a merger between the Bank of Scotland and Halifax.

The BOS in HBOS is a vital Scottish institution dating back 300 years. It even prints the country's banknotes.

And HBOS is a big employer employing 1,700 people.

When the merger goes through, Lloyds TSB has pledged to make savings of 1bn and there are widespread fears in Scotland that they will be hit hard.

For former chairman of Bank of Scotland, Sir Peter Burt, the merger appears to be a mixed blessing.

"I was relieved because it stopped the meltdown, but saddened because it's going to be so damaging to Scotland," he says.

"In every High Street there's probably a branch of Lloyds TSB and a branch of Halifax or the Bank of Scotland and sadly I'm afraid that thousands of jobs will go."

Who is to blame

Inevitably, investors, customers and employees are all looking around to see where the burden of blame lies.

Some blame the FSA, the financial regulator that is supposed to exercise controls over the banks.

Others point the finger at the US government for allowing the sub-prime mortgage problems to begin.

But HBOS itself is also firmly in the frame.

In 2001, when HBOS was created, they swept into the UK banking market with a totally new kind of strategy.

They offered good value products with top end customer service in an effort to capture banking market share.

The strategy allowed the bank to grow quickly, but in order to finance its lending it came to rely more heavily than other banks on the wholesale markets.

By June this year, HBOS had borrowed a net amount of 198bn.

RBS trailed behind with 170bn and Lloyds TSB was borrowing 68bn.

HSBC was in the comfortable position of having no wholesale market funding requirement at all.

The FSA itself is to bring stronger regulation to the banks to prevent this kind of crash from ever happening again.

And with the part nationalisation of the banking system, it would seem that our banks are now in safer hands.

According to Will Hutton of the Work Foundation, it's a new era for British banking.

"This is absolutely new ground," he says.

"This is an opportunity to refashion and restructure the British banking industry."

Credit Crash Britain - HBOS: Breaking the Bank, BBC 2, Thursday 30th October at 1930.

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