Material Adverse Change by Robert V. Stefanowski

Author:Robert V. Stefanowski
Language: eng
Format: epub
ISBN: 9781118236383
Publisher: Wiley
Published: 2018-04-24T00:00:00+00:00

HBOS History

HBOS was formed through the merger of Halifax and the Bank of Scotland in 2001, a diversified financial services group engaged in banking, insurance brokering, and financial services throughout the U.K. and internationally. Just prior to the start of the Great Recession, HBOS was the largest retail mortgage provider in the U.K. with a market share of 20 percent and balances of approximately $400 billion. HBOS was also the largest liquid savings provider in the U.K. with a market share of 15 percent. For the financial year ended December 31, 2007, HBOS reported revenues of $34 billion and generated profit before tax of $9.0 billion. A significant portion of HBOS's portfolio was comprised of commercial property lending.

Twenty-eight percent of HBOS's mortgage book was in the riskier, higher-margin specialist areas, principally buy-to-rent and self-certified loans. No background checks were performed in a self-certified loan; the information submitted by the applicant was taken at face value without being verified. In the United States, these loans were called “liar loans” because mortgage applicants frequently exaggerated their financial condition to obtain more financing than they could ultimately pay back. Nevertheless, HBOS continued to aggressively expand its mortgage book long after other players had stopped doing so. This was all fine until the housing market collapsed.

By the start of 2008, U.K. house prices had already fallen by 12 percent, the largest decline since 1983. Analysts were estimating a further drop of 15–20 percent in 2008–2009, but the house-price-to-income ratio, a key indicator of affordability, suggested that house prices would fall even more. This dramatic downturn in the housing market started to reveal broad issues with HBOS. HBOS was a sales-oriented bank with poor risk management at times. Paul Moore, head of regulatory risk at HBOS during 2002–2004, said, “I think a concern everybody had was whether or not the business was under control.”

The liability side of the HBOS balance sheet complicated things significantly. HBOS relied on wholesale financing to sustain operations. In other words, HBOS did not have significant customer deposits to fund its business. Rather it was dependent on raising money through loans from other banks or the capital markets via issuance of public debt or equity. When the capital markets dried up with the financial crisis, HBOS's access to financing dried up as well. A $315 billion mismatch between customer deposits the bank had on hand and the amount of money it had lent to others made the bank dangerously reliant on the capital markets (i.e., the company had issued $315mm of loans in excess to the level of deposits it maintained and could no longer borrow to make up the difference).

The combination of HBOS's exposure to $45 billion in toxic assets, very aggressive mortgage lending practices, and a reliance on wholesale funding put severe pressure on the bank's stock price. With the credit crisis unfolding, HBOS's share price slid further. The cost of HBOS's credit default spreads,1 an indication of the creditworthiness of the entity, continued to be higher than its peers, indicating that investors had lower faith in the company's viability as a going concern.

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