Page last updated at 10:24 GMT, Saturday, 8 November 2008

Full text: Letter to Lord Stevenson

Here is the letter sent by the former chief executives of Bank of Scotland and Royal Bank of Scotland, Sir Peter Burt and Sir George Mathewson, calling for HBOS's chairman and chief executive to resign:

Dear Dennis

1. Following your conversation with Peter Burt we (George Mathewson and Peter Burt), are writing to outline our thoughts in relation to the proposed takeover of HBOS PLC by Lloyds TSB Group PLC. We are sure that you recognise the need for the HBOS Board to be seeking the best option for its shareholders and indeed, for all stakeholders as required by the recent companies legislation. We also recognise that you and your colleagues have endured a traumatic year and are doubtlessly suffering from the inevitable fatigue that the situation has created.

2. Nevertheless you appear determined to continue with the takeover by Lloyds on terms which perversely were made worse for the HBOS shareholders following the comprehensive actions implemented by the Government to allay the systemic crisis and to restore financial stability to the UK banking sector.

3. In the words of Tom Scholar, Managing Director, International & Finance HMT, HMG have put a floor under the banking crisis and have thereby provided the HBOS Board and the HBOS shareholders with an opportunity that, we believe, is likely to be of far greater value than simply subscribing to a deal put together in haste, a deal that should have been obsolete within days of being announced due to the Government's positive recapitalisation actions. In short, the terms of the takeover are unfair to HBOS shareholders and we believe there are better options available, which the Board should be exploring. The failure to do so is to sacrifice the opportunity for shareholders to recover substantial lost value.

4. When you spoke to me, I requested that you and Andy Hornby resign and that you appoint me and George Mathewson to the Board of Directors of HBOS PLC as Chairman and Chief Executive respectively. We repeat that request here. It is our intention to create a detailed alternative plan that we believe will represent better value for both the HBOS shareholders and stakeholders by keeping HBOS as an independent bank. The Board can accept the Government's offer of financing, return HBOS to its core business using prudent underwriting practices for existing and new customers alike, establish relations with new investors globally and carry out a full strategic review of HBOS' assets and non-core businesses with fresh sets of eyes to maximise shareholder value.

5. In the absence of your support for this, we intend to canvass shareholder support with a view to requisitioning an EGM to seek your and Andy Hornby's removal from the Board and the appointment of George and myself.

Peter Burt
Sir Peter Burt was one of the letter-writers

6. The HBOS shareholders then can be assured that every possible option will have been explored and that their interests have been fully considered.

7. For the avoidance of doubt, we firmly believe that a standalone recapitalised HBOS, which has had a strategic plan agreed and new management teams put into place will represent far greater upside and stability than the Lloyds takeover. If, however, Lloyds makes a more appropriate commercial offer for HBOS that too will be given full consideration.

8. Although you signed a non-solicitation clause on September 18th, it is hard to see what the reason for renewing this agreement was on October 13th after the sector-wide recapitalisation by HMG, particularly when Lloyds TSB unilaterally changed the terms to the further detriment of the HBOS shareholders. (The non-solicitation clause does not appear in the Lloyds Circular to its shareholders). In any event, as drafted, neither the Implementation Agreement nor a non-solicitation clause preclude the HBOS Board from putting together a plan themselves to preserve an independent HBOS on a basis which is better for the HBOS shareholders than a sale to Lloyds. Instead of exploiting this opportunity once the recapitalisation plan was confirmed by HMG, you have supported what is increasingly looking like a one-sided deal.

9. On September 18th, the proposed takeover by Lloyds appeared to be a case of a strong well-managed bank riding to the rescue of a bank in dire straights. As the Chancellor pointed out in his evidence to the Commons Select Committee on the day of the takeover being announced HBOS was not a '…perfectly happy, functioning bank [without HMG's intervention] ….HBOS would have been in an extraordinarily difficult situation'. It is now clear that it was not just HBOS that was in an extraordinarily difficult position - a number of banks were, including Lloyds. That information in itself should have prompted the Board of HBOS to urgently consider alternative plans. We can see how the option of keeping HBOS independent without immediate changes in management would have been unrealistic, hence the implementation of our own plans for those changes. RBS has successfully changed management and remained independent and it has required more financial assistance than HBOS and Lloyds TSB combined.

10. Relative to their respective sizes, Lloyds now appears to require greater support than HBOS. Lloyds has announced that if the takeover does not proceed, a stand-alone Lloyds will be required by the FSA to raise further new capital above and beyond the £5.5bn currently required and a figure of an additional £1.5bn (a 27% increase) has been indicated. This means that the stand-alone Lloyds would require £7bn of new capital equal to 63% of its existing equity capital (£11.1bn) at their Interim results date. The £11.5bn that HBOS needs is 54% of the £21.1bn capital at their Interim results. These figures perhaps suggest that it is Lloyds and not HBOS that is being bailed out by the takeover, at the expense of HBOS shareholders.

11. HBOS is larger than Lloyds (£681bn of total assets against £368bn of total assets), has more equity capital than Lloyds (£21.1bn against £11.1bn), historically has been much more profitable than Lloyds (in 2007 HBOS earned £5.47bn before tax against Lloyds' £4.0bn), and more efficient (in 2007 HBOS' cost to income ratio was 41% against Lloyds' 49%). With HMG providing all the new capital, HMG will have 43.5% of the enlarged group, Lloyds shareholders 36.5% and HBOS shareholders just 20%. Under normal circumstances, HBOS shareholders should be receiving two-thirds of the 56.5% that private shareholders are retaining if HMG provides all the funds required, not the one-third or so the current offer implies. In other words, the HBOS shareholders should be receiving more than 1 Lloyds share for every HBOS share rather than the 0.605 to which Lloyds has reduced their offer. In light of HBOS' established ability to recapitalise, the terms greatly undervalue HBOS shares, even at the original 0.833 ratio. For more than two million smaller HBOS shareholders this ratio is extremely important.

12. On September 18th the HBOS Board may have had little choice but to accede - the Lloyds solution was the only one available. But the Lloyds takeover was the last of the case-by-case solutions put into place to deal with the financial crisis and as previously mentioned there is now a sector wide, generalised response designed to put stability back into the UK banking system - an action you have chosen not to use for the benefit of HBOS shareholders. Recently and repeatedly the Chancellor and HMT has made it clear that HMG's offer to provide new capital and funding support is available to any bank, although obviously the amounts required will depend upon each bank's circumstances.

13. The Chancellor repeated his assurance that assistance is available to any eligible bank in a recent letter.

Lord Stevenson
The letter was sent to Lord Stevenson

14. Although the £11.5bn recapitalisation figure is specific to the Lloyds takeover of HBOS, HMT indicated that there is no reason why HBOS could not ask for recapitalisation as a stand-alone bank. In which case, HBOS would seem unlikely to need substantially more capital than the £11.5bn. Hector Sants, CEO of the FSA, was reported as saying that the £11.5bn was sufficient to recapitalise HBOS. Lloyds confirmed in the Notes to its Circular issued this week that based on its work to date and on non-public HBOS information, it expects HBOS to have negative net capital adjustments of no more than £10 billion after tax, reduced by the amount of the HBOS Available-For-Sale reserve which at 30 September 2008 amounted to approximately £4 billion.

15. With HMG having made the position crystal clear that there is now a level playing field, that there is capital available as required and, given the disproportionate share of total assets, net assets, historic profits and sustainable earnings that HBOS shareholders are contributing in the takeover, it is surprising that the HBOS Board has not sought new management, to maintain an independent bank and to begin to rebuild shareholder value. The original necessity for the Lloyds takeover of HBOS was to ensure the survival of the Bank to gain financial stability. In light of the availability of new capital from HMG for HBOS, the takeover is no longer necessary to ensure financial stability. It is an extraordinary price for HBOS shareholders to pay for seemingly expediting your wish for a swift change in management.

16. Nor has there been much focus on the risks and problems involved in integrating the two banks, a matter directly relevant to the creation of greater shareholder value. The task of implementing the takeover and integrating the two businesses is enormous and Lloyds is taking on a massive challenge. It is a challenge, which would strain the resources of any company, and one taken on at a time when management of banks should never be more focussed on continuing to service their loyal, larger, retail, SME and wholesale customer base in UK during challenging economic times. This may have particular resonance, as now it is clear Lloyds has its own problems with which it has to deal. As it has been established that they too need substantial Government assistance, how does that need reflect on the Lloyds management performance, abilities and resources?

HBOS headquarters
The HBOS headquarters in Halifax

17. The merger does not recover the shareholder value lost in the financial crisis. The funding problems which have brought the sector to this position and which will be faced by the combined entity will not go away. Credit lines available to a single, combined group from other banks are likely to be less than the sum available to the two individual banks. The enlarged group would have c.£230bn of wholesale funding to refinance over the next 12 months. HBOS' reliance on short term wholesale funding relative to total wholesale funding is actually lower than Lloyds' - the enlarged group would have around 63% of its wholesale funding in short term instruments compared to HBOS' 59%.

18. HBOS Board's initial recommendation to shareholders to accept the offer from Lloyds was made in entirely different circumstances from those at the time of the subsequent recommendation for the diminished price proposed by Lloyds. That was at a time when the HBOS Board was and remains in a stronger position either to negotiate a fair price from Lloyds or to maintain the independence of HBOS and bring in new management with the experience to create a plan that will begin to rebuild shareholder value and restore stakeholder confidence.

19. We believe this opportunity may be lost to the detriment of HBOS shareholders who have found themselves being sold to a smaller competitor bank whose management has fared little better during this crisis, whose own financial requirements from the FSA appear to be comparatively larger than HBOS' and who have managed to extract a recommendation from the HBOS Board on arbitrarily reduced terms. It is unclear why the HBOS Board accepted the new terms without ensuring that all opportunities to restore shareholder value, including as a stand-alone bank, were fully explored. HBOS could continue as a stand-alone bank certainly no weaker than Lloyds and one with a better chance of securing the crucial necessary liquidity, to service its existing and new customer base than the proposed enlarged group.

20. Given the importance of HBOS to all the various stakeholders, and the time constraint to articulate our position we feel it is appropriate to release a copy of this letter to the public.

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