‘I am very disappointed. I am numbed by it. I am also galvanised by it.’ Fred Goodwin, August 2008 as RBS unveils historic pre-tax loss of £691m
The summer of 2008 was marked out by atrocious weather, Chris Hoy’s three gold medals at the Beijing Olympics, Amy Winehouse singing ‘Love Is a Losing Game’ at pop festivals around the UK, Russia’s war in Ossetia . . . and a calm before the storm for the bankers.
Shutting the stable door five years after the horse had bolted, Chancellor Alistair Darling unveiled a few legislative changes in his speech at the Mansion House on 18 June. Darling said that responsibility for financial stability would be restored to the Bank of England, which would also take charge of a new ‘resolution regime’ for failing banks. Darling also said that a new Financial Stability Committee (FSC) would be set up within the Bank, drawing on independent City expertise. It also emerged that Sir John Gieve – who had taken a lot of flak over the authorities’ cack-handed response to the crisis – would step down as deputy governor in early 2009.
On 8 August 2008, the day the Olympics opened, RBS unveiled a pre-tax loss of £691 million for the first half of the year, the second-biggest loss in British banking history. Goodwin told the assembled analysts: ‘I am very disappointed. I am numbed by it. I am also galvanised by it.’ One of the few straws Goodwin could cling to was that the analysts’ consensus had been for even worse losses. The bank said it was pulling in its horns in the UK market through removing facilities and weaning clients off credit by tightening up terms and conditions on loans etc. – a tightening of the screw that was already causing pain for a great many corporate and commercial borrowers. Goodwin seemed blasé about the harm this might cause, saying,
After initial squeals of pain from the customer-facing colleagues as we start down this path, actually we are managing this now [sic] in a less painful manner and will see these gains and improvements continuing into the second half as we further de-leverage the balance sheet.
That was banker-speak for ‘We don’t care if customers are made to suffer, as long as we save our skins.’
Exploiting business customers’ trust in the bank
At the presentation on 8 August, Goodwin boasted to analysts that sales of interest-rate swaps had soared 59 per cent in the first half of 2008 vis-à-vis the first half of 2007. The bank embarked on a concerted push to sell these complex over-the-counter derivatives to its existing SME customers in 2005. It did this by exploiting business customers’ trust in the bank and lack of financial acumen. Interest-rate swaps were highly attractive products from the bank’s perspective since the economy was slowing and each product’s lifetime profits could be booked on day one, boosting short-term profitability and bonuses. However, many of the SME customers who bought them ended up being ruined when interest rates fell (as I explain in Chapter 33).
At the time, the Libor rate [The interest rate at which banks offer to lend to one another in the international interbank market] was already well known to be unreliable and ‘dishonest’ – suggestions banks were lying about the rate had been aired by the Wall Street Journal, the Financial Times, Bloomberg News and Bloomberg Television. The suspicion was that Libor panel banks, which included RBS, were submitting false Libor numbers either to cheat derivatives counterparties or reduce their own borrowing costs.
Officials at the Bank of England and the Treasury were relaxed, aware that downward pressure on Libor would give banks some breathing space as the crisis intensified, as it gave the impression they were able to borrow money at lower interest rates than they were actually borrowing at, and made them seem stronger than they were, in the hope that it would reduce the need for state aid. Libor got only a cursory mention at RBS’s session with analysts in Bishopsgate on 8 August, when (Johnny) Cameron (head of investment banking) acknowledged it was getting a bit squiffy. He said, ‘There are a lot of strange things going on in the money markets, as you know, in the Libor and the Libor fixings and so on . . .’
Pulling levers to minimise bad debts
At the same session, Goodwin boasted about putting greater numbers of business borrowers into the bank’s specialised lending services (SLS) unit, a centralised repository for borrowers considered to be delinquent or in default. He told the analysts that, in terms of the ‘levers’ that RBS was able to pull in order to minimise bad debts, the bank was now ‘incentivising’ its relationship managers to transfer corporate borrowers into SLS by giving them an ‘amnesty’ if they did so. Goodwin said, ‘They get immunised from it if it goes into the centre.’
James Alexander, an analyst with M&G Investments, asked why, in view of RBS’s ‘well-known appetite for risky leveraged property transactions around Europe’, its provisions for bad debts were not higher. He said, ‘A German bank did announce a rather large provision a couple of days ago for, I think, a transaction that you were co-leading with them in. They announced €250 million and you don’t seem to have announced anything of that size.’
Cameron, wearing a rather natty pair of reading glasses with yellow stems, said:
Well, the answer to the first part is, first of all, I don’t accept the premise about we are only doing all the risky lending in Europe, if I can just park that point! Secondly, the definition of non-performing loans and potential problem loans is run by risk they bring forward, and that’s the number and that is the trend. Again, it might reflect the de-risking point. I don’t know whether that is why it hasn’t gone up as much as you would expect, but that is the number produced by the independent risk department. And thirdly Spanish property: yes, a difficult market. We are working with some of our customers there; we are appropriately provisioned today and very comfortable with that, but who knows looking forward!
Cameron’s final sentence, a rare expression of candour from a leading UK banker, was hardly reassuring.
However, Goodwin was adamant the bank would be profitable in the full year to December 2008, claiming it had more than replaced the £5.9 billion lost in credit market write-downs. Horribly mangling the pronunciation of the word masochist, (Tom) McKillop (RBS chairman) said, ‘Maybe you have to be a bit of a masochist [Gordon Pell (CEO retail banking) turned away, with a pained look on his face at this point] but it’s when things are tough that you really, really do see organisations perform . . . I’m a great believer in adversity sorting out who the long-term winners are going to be.’ Little did McKillop realise how wrong he was at this point.
Goodwin gets galvanised
At a press conference that day, Schadenfreude at RBS’s misfortune was palpable. Andrew Johnson, deputy City editor of the Daily Express, asked Goodwin why, after the string of failures on his watch, he still considered himself to be the right person to lead the bank. Goodwin said, ‘It’s not me solely that runs the bank. There are a team of people.’ Goodwin also said, ‘I won’t do this job forever but, right now, you find me extremely galvanised to the task at hand.’ It was in the wake of this that Pell who had long harboured dreams of succeeding Goodwin, said to one RBS employee in a corridor of the Bishopsgate office, ‘At this rate, there’s going to be one of two Gordons running the bank – it’s either going to be me or Gordon Brown.’
Having reluctantly nationalised Northern Rock, Brown’s government was loath to nationalise any other banks. Rather than tackling the disease – the banks’ rotten cultures, precarious business models, capital and liquidity shortfalls – he preferred to try to address the symptoms. In particular he wanted to find ways of ‘unblocking the mortgage market’. He asked his friend, the former HBOS chief executive Sir James Crosby, to lead a review of the mortgage market in April 2008. But Crosby, who is today seen as one of the most incompetent bank chief executives of his generation, came back with a proposal (a state guarantee for mortgage-backed securities) that the Treasury saw as woefully inadequate.
At the time, the Treasury, the FSA and the Bank of England were much more concerned about the difficulties being faced by mortgage banks like HBOS, Bradford & Bingley and Alliance & Leicester than they were about Royal Bank of Scotland. The Treasury put HBOS on its ‘watch list’ after September 2007 and Darling says ‘alarm bells’ started to ring about the other Edinburgh-based bank in July 2008. Darling said, ‘HBOS was becoming increasingly desperate. There was whiff of death surrounding the whole operation.’
Under its flibbertigibbet of a chairman, Lord Dennis Stevenson, HBOS had driven itself into the ground largely as a result of astonishingly reckless lending in the UK, Ireland and Australasia. In its half-year results at the end of July, the bank said profits for the first half had collapsed by 72 per cent to £848 million. It slashed its dividend and told investors they would be paid in shares not cash. Just like RBS, the bank was punishing once-loyal customers in a desperate bid to stay afloat.
Are you thinking what I’m thinking?
HBOS’s chief executive Andy Hornby, who was becoming increasingly stressed out by summer of 2008, sidled up to a stronger partner in the shape of Lloyds TSB in the hope that it might rescue HBOS from the consequences of its own folly. On 15 August 2008, the 41-year-old Bristolian had ‘a quiet drink’ with Lloyds TSB chief executive Eric Daniels with a view to selling the bank to Lloyds. A deal would be cemented the following month, after Gordon Brown ‘got into a huddle’ with Blank at a Citigroup event in Spencer House in St James and agreed to waive competition law if Lloyds would rescue HBOS.
Brown was becoming increasingly anxious about the state of the banking sector. He asked his protégé, Shriti Vadera, a former UBS Warburg investment banker, to find ways of resolving the crisis. Vadera had come to Britain aged fifteen, five years after her family was expelled from Uganda by the country’s dictator Idi Amin, and had been a minister in the Department for Business, Enterprise and Regulatory Reform since January 2008. She cancelled her summer holiday and, working alongside Treasury official Tom Scholar, set about finding ways of unblocking the plumbing of the UK financial system.
Talking as they strode across Trafalgar Square one August afternoon, Vadera and Scholar concluded that a complete recapitalisation of the British banking system was the only answer. As they passed beneath Nelson’s Column, Vadera turned to Scholar and asked, ‘Are you thinking what I’m thinking?’
Scholar was. In view of the three abortive bank rights issues of spring 2008, it seemed there was only one source of capital left – the government. In a series of email exchanges under the title ‘Is it capital? they fine-tuned their thinking. Brown and Darling agreed with the approach. The Bank of England – whose special liquidity scheme was due to expire on 11 September – had independently reached a similar conclusion.
To be continued…
This is the first extract from The Crash, Chapter 28 of Ian Fraser’s best selling book Shredded: Inside RBS, the Bank that Broke Britain
Follow Ian Fraser on Twitter @Ian_Fraser
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