Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  The Bank was never comfortable with this position and looked for opportunities to sell its shareholding as soon as possible. During his period as chief executive, Bruce Pattullo had maintained a rigid policy of refusing to take equity stakes in companies to which the Bank was also a lender, seeing it as a conflict of interest. If a company got into difficulties, the priority for the Bank was to get its money back and that might mean going over the heads of shareholders to call in a receiver while there was still a chance of recovering the loan. That could leave the shareholders with nothing.

  When it began to finance MBOs, younger managers started to question that policy. As the example I gave at the beginning of this chapter shows, equity holders stood to make the biggest gains in leveraged deals. In theory they were taking the most risk, but in practice if a company went down the Bank also stood to lose. Why not get some of the icing as well as the cake? After Pattullo retired, the ban on equity began to be relaxed.

  Bank of Scotland Corporate began to offer a ‘one-stop shop’ to people wanting to do big transactions. Alongside senior debt, it would offer mezzanine and equity finance, earning itself more interest and fees for arranging and structuring the deal. It began to promote itself as the bank which could put together the essential elements of making a transaction happen and it published a regular magazine, Deal Leader. Its pages profiled the entrepreneurs it was backing, describing their companies and how Bank of Scotland’s cash had helped them grow. It carried a regular feature promoting a member of the Bank’s corporate team under the heading ‘The Loan Arranger’. A regular section called ‘Deals Done Differently’ also listed the transactions the Bank had recently completed.

  Over the six or seven years following the merger, equity stakes became a major profit source for HBOS. A series of subsidiary companies was set up, all bearing a name derived from the old Bank of Scotland Latin motto ‘Tanto Uberior’ (which approximately translates as ‘so much the more plentiful’). Uberior Ventures, Uberior Investments, Uberior Equity, Uberior Property and others similarly named held stakes in 70 companies such as health and fitness group David Lloyd Leisure, builder Keepmoat, newsagent group Martin McColl and dozens of property companies including a 22.5 per cent stake in Chelsfield Partners, a 50 per cent stake in a luxury hotel venture with Sir Rocco Forte, a shopping centre joint venture with Warner Estate, a retail joint venture with the Reuben brothers and a petrol station joint venture.

  At its height the combined value of these shareholdings was said to top £5.5 billion and the portfolio generated hundreds of millions of pounds of annual income in dividends or the proceeds of sales. Besides providing equity funding, HBOS also lent £4.5 billion to these companies to fund expansion or new developments.

  As you might guess from the parties he throws, the retail businessman Sir Philip Green has a liking for the dramatic. He is also a good storyteller. Recalling one of the early deals in which he had been involved – the purchase of the Olympus Sports chain of clothing shops from the British retail group Sears in 1995 – he told the journalist Robert Peston that the message telling him the company was for sale came while he was undergoing a heart operation:

  The only reason I didn’t do it myself was that I was in Wellington Hospital in the intensive care unit when I got the call. When I was offered it, I was in the hospital. So I said: ‘Can’t do it this week, can we do it next week?’ I had other things on. Couldn’t do it. But it worked out well. Tom did it. Worked well. Everybody won.1

  Like every good story, it contains some truth, but the actual circumstances of the purchase may be more prosaic. The Tom in question was the Scottish entrepreneur Tom Hunter. When he left university in 1984 Hunter had borrowed £10,000 from his father and the Royal Bank of Scotland and started selling trainers from the back of a van. By 1995 he had built the business into a chain of shops named Sports Division and was making £4 million a year in profit. He was looking for ways to expand when one of his suppliers tipped him off that Sears wanted to sell Olympus. A purchase would more than double Sports Division’s number of outlets, but Olympus was losing money. Hunter, then 34, went to see Philip Strong, Sears’ chief executive, but was shown the door. Strong did not believe Hunter could come up with the money and would not negotiate with him.

  Hunter and Green had met when Green had bought the Glasgow budget retailer What Everyone Wants, so Hunter called him and asked him to front the deal. Green went to Sears and secured an option to buy Olympus. (The call telling him he had the option may have come while he was in hospital.) Hunter received the call from Green saying the deal was on while he was holidaying in Barbados with his family, but now his problems started. To buy the company he needed to borrow £20 million, but the Royal Bank turned him down. Racking his brains, Hunter remembered meeting someone from Bank of Scotland while on a trip to Turin organised by David Murray, then owner of Glasgow Rangers, to see his team play Juventus. He called Murray to be told that the man he had spoken to was Gavin Masterton, the Bank’s Treasurer. On his return from holiday, Hunter called Masterton, who sent one of his corporate managers to see him – Peter Cummings.

  Hunter and Cummings had a lot in common. Coming from modest beginnings, both had done well in their chosen careers, but had remained rooted in the communities from which they came. Cummings still lived in Dumbarton, Hunter in the South Ayrshire community of New Cumnock. Hunter knew exactly what he had to do to turn Olympus around and took Cummings through his figures in detail. If he could make the new stores perform even half as well as his existing shops he would be able to repay the loan with ease. Cummings had been told by Masterton: ‘Be hard, but don’t lose the deal.’ He fulfilled both parts of his brief. The Bank agreed to lend the £20 million but Cummings demanded security over Hunter’s business and his house. Philip Green also extracted a high price for his part – £1 million in cash and 12.5 per cent of the equity – but he was right. It did work out well and everybody did win. Hunter more than met his promise to Cummings and repaid the loan within six months. Three years later he sold Sports Division for £295 million.

  The connection between Green, Hunter and Cummings was to be crucial to Green’s next big deal in 1999 when he bought the remainder of Sears. Green and Hunter were putting money into the purchase, together with the Barclay twins Sir David and Sir Frederick, who had built up substantial businesses ranging from hotels to shipping. Cummings was handling the transaction for the Bank, but chief executive Peter Burt was taking a close interest, partly because of the importance of the Barclay brothers, whose account he oversaw personally and partly because there was a potential embarrassment for the Bank: its Deputy Governor, Sir Bob Reid, was chairman of Sears. Green, again, told Peston the story:

  It was the night of the deal, Sears. The Barclays were funding. I put in X, they put in Y, we borrowed Z. At five o’clock the night before £150 million of the funding falls out of bed. Bank finance. They couldn’t get it done. I called Peter Cummings. I had a relationship with him from Sports Division. I said: ‘Peter, I need a favour.’

  ‘What do you need?’

  I said: ‘I need one hundred and fifty million quid.’

  ‘When?’

  I said: ‘tonight.’

  He said: ‘Is it for what I think it’s for?’

  I said: ‘yes.’

  He said: ‘Bit tricky, give me 20 minutes.’

  Called back. He said: ‘All right, I’m on, on the following basis: boom, boom, boom.’

  I said: ‘Right, let’s go. We did it through the night. So I bought more than my Y. To get it over the line, I got it over the line myself. But it was on a handshake.2

  You might get the impression that Cummings agreed to lend £150 million to Green on the strength of a telephone call but, again, the truth is less colourful. The banker used that 20 minutes to call his boss, Peter Burt. Bank of Scotland was lending to its long-standing good customers the Barclays, not to Green, and Burt agreed to lend more to get the deal done, but to the Barclays, who had agreed to p
ut in more money. Speed was of the essence, but Burt also called his boss, the then Bank Governor Sir Alistair Grant, to make sure that everyone understood what was being agreed and on what terms.

  Like the Olympus deal, the purchase of Sears turned out better than anyone had expected. Green was an extraordinarily talented businessman as well as a retailer. He had paid £549 million, but broke up the group, selling off parts of it which he did not want and recouped the purchase price within three months. Again, the cash the Bank had lent was repaid in quick time and the deal cemented the relationship between Philip Green and Peter Cummings. Green also liked to make a splash at London casinos and from the press reports it could appear that both he and Cummings were gamblers, prepared to take big business risks to win big rewards, but in reality both were detail men. Green had long experience in turning around retail brands and before he made purchases he worked hard to understand every aspect of the business.

  Green and Hunter went on to purchase the store group Bhs in 2000 for £200 million, where Green tripled the profits, but it was his acquisition of Arcadia, the Top Shop and Dorothy Perkins company, in 2002 which was his most spectacular. The deal had been planned in partnership with the Icelandic Baugur group, which was going to take some of the high-street brands owned by Arcadia. But in the final stages they ran into trouble and their offices were raided by the Icelandic police.

  To get the deal done Green and his family put in £120 million. ‘The fundamental difference between me and those tossers running public companies,’ Green told the Financial Times, ‘is that I invest my own money.’ Bank of Scotland, by this time part of HBOS, provided the rest – £808 million. The bank also paid £6 million for an 8 per cent stake in the business, effectively acting as a private equity house as well as lending.3 The deal graphically illustrated Green’s maverick approach to business. Arcadia was a public company, quoted on the Stock Exchange, and normal City protocol would have demanded a series of quiet, nuanced conversations between advisory firms before any direct approach was made. Green dispensed with all that and called Stuart Rose, Arcadia’s chief executive, himself. ‘Why should anyone pay £10–15 million in fees just to find out whether the other person wants to do business?’ It was an unorthodox attitude, but the Takeover Panel accepted it.

  Green may have been investing his own money but HBOS would be hazarding its depositors’ funds. Cummings was closely identified with the deal and was criticised in the press for the scale of the risk he was allegedly running on behalf of the Bank. In fact most of the work was done by a team working under him led by one of his deputies, Graeme Shankland, and the transaction was signed off by George Mitchell, the director then responsible for corporate banking.

  But yet again Green proved that he was a master retailer and as good as his word to Cummings. Within a year he had boosted sales in the group and repaid £500 million of the cash he had borrowed. A year after that he had paid off the whole lot. The night before he announced doubled profits, Green hosted a dinner for George Mitchell and Peter Cummings at Les Ambassadeurs, his favourite Mayfair club and casino. The following morning Cummings drank champagne with Green at the Arcadia offices at Oxford Circus, before both of them addressed the staff. It appears to have been a very emotional occasion for them all. As Green spoke, his wife Tina, a tear in her eye, according to the Financial Times, held Cummings’ hand. But it was Cummings’ speech which was most extraordinary and illustrates the very close relationship he had formed with Green.

  ‘As shareholders, stakeholders and bankers, we can only thank you from the bottom of our hearts for delivering a first class set of results. It is outstanding. When you decide to lend money you assess the skill-set of the people in the business: what I see now in this room, is not just a skill-set and competence, but capability to compete with the best.’ He went on to describe Philip Green as ‘the most conservative and prudent finance manager I have met’, and praised his ‘integrity by the barrel-load’.4 His words may have been justified, but his willingness to say them in public was hardly in keeping with the traditional image of the typical Scottish bank manager.

  Green had already paid a dividend but as the group rode the consumer boom, there was much more to come. He lived during the week in a London hotel, but had his private jet ferry him back to Monaco at the weekends, where Tina Green was a resident tax-exile. Although Green ran the group, Tina was technically the owner and when Arcadia paid out £1.2 billion in dividend in 2005 – the biggest personal dividend in British history – most of it went to Tina free of tax. HBOS, as the only other shareholder, received £100 million as its reward. To fund the payout Green again borrowed, much of it from Bank of Scotland, which then syndicated the loan to other banks – so the Bank was effectively lending to pay its own share of the dividend.

  Cummings was not Green’s only supporter in HBOS. In 2004 Green bid an eye-watering £9.5 billion for Marks & Spencer, the UK’s biggest clothing retailer, but walked away when the price got too high. Green was prepared to put in £1.6 billion of his family’s money and HBOS were to fund the rest alongside other banks. Had the deal succeeded Green had invited Lord Stevenson to become senior non-executive director on the board, an appointment which the Bank claimed would not lead to a conflict of interest because as yet he held no position in M & S and had received no money from the company. The move led to one of the few clashes on the HBOS board when some non-executives objected to the chairman approving the Bank’s involvement in the M & S bid. The tense atmosphere was defused by Sir Ron Garrick, who offered to read the papers and make the decision in Stevenson’s place.

  The Green-Cummings connection was to be a source of opportunities for HBOS which only a select handful of other bankers could access. ‘FOPs’ – the Friends of Philip – were a small group of high-rolling individuals who were transforming the British corporate landscape with a series of audacious debt-funded deals. The FOPs included Tom Hunter, but also the Reuben brothers, David and Simon, who had made their fortunes in metals, trading and property, the property developers Robert and Vincent Tchenguiz, Nick Leslau, another property entrepreneur, Alan Leighton the retailer and Bernie Ecclestone, the owner of Formula One motor racing. They worked hard and played hard, often meeting at parties on each other’s Mediterranean yachts, in Riviera mansions or London apartments. Green was a spectacular party-giver, but the soirees at Robert Tchenguiz’s London home could rival them. Housed in the former Royal College of Organists premises close to the Royal Albert Hall, it boasted two swimming pools, one on the roof terrace, the other in the basement.

  The group shared many things in common. They came from modest beginnings. The Tchenguiz family had twice lost everything in Iraq and Iran, before the sons re-established the family fortune in Britain, Leslau had started on a milk round and traded umbrellas on a market stall and Ecclestone had begun his working life dealing in motorcycle spares. They worked outside the establishment. Not for them the tedious formality of normal City convention. They worked directly, took big risks with their own money and understood the power of leverage.

  Few bankers were privileged to drink vintage champagne from the bottle in Monaco clubs with this crowd, but among them were Mike ‘Woody’ Sherwood, of Goldman Sachs, Bob Wigley, of Merrill Lynch, the only woman of the group the American Robin Saunders, and Peter Cummings.

  Cummings’ appeal came from the impression that he could commit large sums of HBOS money on his own say-so – an idea that Green did little to dispel:

  Goldman Sachs said there’s no relationship on the planet that anybody’s got [like the one between Green and Cummings]. What flipped Goldman Sachs’ lid was that in the middle of the night – in the middle of the night – we were 900 million quid short [on the bid for M & S]. They thought we could not do it. I said: ‘why not?’ They said: ‘Look, we’ll do half.’ I said: ‘Okay, I’ll do the other half. Give me ten minutes.’ I called him [Cummings] up. He said: ‘Right, let’s go.’ We got a fax inside seven minutes, while they were having
meetings, conference calls, meetings of compliance committees.’5

  HBOS insiders are adamant that Cummings could not and did not authorise big loans on his own. HBOS corporate had a system of credit committees for each part of the business, each chaired by a managing director. Above these was a credit committee for corporate as a whole chaired by the director, although after 2005 this was Cummings himself. This arrangement might have provided a review and checking mechanism while there was a separation between the deal originator and the chair of the committee, but Cummings continued to be personally involved in deal-making while he was in overall charge of the corporate division. If there was no time to put a deal through the committee system, Cummings had to seek authorisation from two other directors and for very big deals from the chief executive. His ability to act fast and make decisions even at night, insiders insist, was because of the short lines of communication within the Bank.

  ‘Peter’s clients, without exception, loved him, but he never bypassed the credit committee and when he said “We’ll do that” it was always subject to the Bank’s safeguards, or he would say, “I’m not going to be able to back that up, we are not going to do it.” They knew exactly where they stood,’ a board director remembers.

  The deals came thick and fast, in retail, properties, leisure and hotels. Then there were the ones that got away. Green tried for Safeway and M&S, Hunter for Alders and House of Fraser, Hunter and Leslau for Selfridges. Sometimes members of the group acted together, sometimes alone and occasionally they were competing against each other. Each time there was ‘leverage’ – huge amounts of debt, often provided solely or in part by HBOS.

  By 2003 Cummings was estimated to have lent £2.3 billion to the retail sector,6 much of it to men who had become his personal friends. The Bank supported the Barclay brothers in their £750 million purchase of Littlewoods, the stores and pools group, and Tom Hunter’s £310 million takeover of Wyevale Garden Centres, with HBOS providing lending and Uberior Investments, one of the group’s subsidiaries, buying 20 per cent. As the economic good times continued the deals got bigger. In 2004 Hunter appointed the merchant bank Rothschilds to find him deals at over £1 billion. There would be no problem in raising finance, he said, to which Cummings commented: ‘If the deal was right, that would be correct.’7