Annex 2: The International
1. The International Division was formed
in 2004, comprising the Group's activities outside the UK, with
the objective of accelerating their growth and increasing the
proportion of group profit derived from non-UK businesses. After
the formation of the International Division, the bank expanded
its activities relatively rapidly. Colin Matthew, CEO of the International
Division, said that although the Division existed to expand in
markets outside the UK, the strategy was to grow "products
and sectors where we had real expertise in the UK". The Division
contained three principal units: activities in Australia and Ireland,
the two largest businesses in terms of loans, and Europe and North
America (ENA), containing its other non-UK businesses.
The expansion strategy was particularly concentrated in Ireland
and Australia, where BoS already had presences and where the intention
was to grow both the corporate and retail activities.
This annex therefore particularly analyses the Division's growth
strategy in these two countries.
HBOS's activities in Australia
2. Colin Matthew presented his strategy
for Australia to the Board in June 2004. His plan was for HBOS
Australia to double its national market share.
Four local banks dominated the Australian market, but due to "significant
customer dissatisfaction" and "relatively low levels
of customer commitment",
there was "the opportunity for HBOS Australia to pursue a
differentiated 'customer champion' proposition."
The strategy planned growth in Corporate and Business Banking,
Retail Banking and bancassurance, including in the East coast
markets, where the Group's shares were smaller. He presented the
growth strategy in Australia as "credible, manageable and
By June 2006 Colin Matthew told the Board that the longer term
aim for the Australian business "was to become a major Australian
Financial services company with market shares in the 15-20 per
cent range in chosen segments."
HBOS's activities in Ireland
3. In Ireland HBOS inherited ICC Bank,
a small corporate banking business. The Group also grew a retail
presence, including acquiring some branches from the Electricity
Supply Board, planning to convert them into banking outlets. The
local management in Ireland claimed that "the business was
on target to become Ireland's second largest business bank during
2004, with the clear aim of becoming the No 1 business bank during
retail products initiative was aimed to "secure 15 per cent
market share in residential mortgages; 5 per cent of the credit
card market; 5 per cent of household savings."
4. In 2006, HBOS's Irish business made
EUR 213m profit before tax
and had EUR 27 billion of assets.
In May 2007 the Irish management was targeting "in excess
of EUR 500m, with over EUR 50 billion of assets"
within five years. Furthermore, this rapid growth was described
as "only the start of a journey towards the overall strategic
goal of becoming the fourth largest full service Irish bank by
retail markets in Ireland BoS,
had already captured an 8 per cent
share of outstanding mortgage debt from a standing start and would
aim to grow share by 1 per cent per annum in future. The target
was to grow Retail share to 13 per cent by 2011.
HBOS also aimed to develop an enhanced
Corporate proposition in Ireland, where the Division saw significant
potential for growth.
HBOS's activities in ENA
5. In 2005, HBOS's ENA businesses made
£283m profit before tax. In July 2006 their aim was to "build
a business capable of delivering sustainable profit growth and
£1 billion in earnings by 2011,"
to be achieved by growth in all the principal businesses.
The Division's growth
6. The Division grew rapidly from its
formation 2004 to 2008. The following table summarises the growth
of the International businesses in aggregate, and broken down
between the individual units, from 2004 and 2008.
The table illustrates the rapid pace
of business growth generated by the Division during the period.
Customer loans grew at an underlying compound rate of 31 per cent
over the four years.
There was an increasing concentration in property and construction,
which was 48 per cent of International corporate loans in 2008,
compared with 34 per cent in 2004.
7. The International Division's growth
was heavily lending led. Underlying compound deposit growth was
25 per cent a year over the period. Although this growth rate
is high in absolute terms, it was slower than the Division's loan
growth. Furthermore, as the starting figure for customer deposits
was relatively small, at £10 billion, the absolute growth
in deposit volumes was smaller than the growth rate might imply.
Andy Hornby explained that it proved easier to expand quickly
in both economies in corporate banking than in retail banking,
which is natural as retail franchises take longer to build.
Colin Matthew said that lending growth in both Ireland and Australia
particularly specialised in "asset specific transactions",
which led to above average concentration in CRE and related sectors
in the Corporate loan books.
8. Loan growth in Ireland and Australia
continued after the onset of the financial crisis. In 2008, organic,
constant currency loan growth was 3 per cent in Australia and
8 per cent in Ireland. Colin Matthew considered that this growth
reflected increased draw downs of existing facilities, the inability
to sell down and the residential mortgage pipeline.
9. The expansion of HBOS's international
businesses was asset led, with growth in new lending exceeding
growth in retail customer deposits throughout the 2004-08 period.
Andy Hornby and Colin Matthew both explained that it proved relatively
more difficult to grow local customer deposits than loans. Colin
Matthew indicated that the plan was for the growth of the International
Division initially to be funded by the Group, and, as they became
more established, the international businesses were expected to
grow customer deposits. However, achieving this ambition proved
to be "slower than planned."
The International Division's loans/deposits ratio remained relatively
stable on an underlying basis, but the quantum of the customer
funding gap grew materially in absolute terms. As a result of
business growth over the period, the customer funding gap increased
from £22.4 billion in 2004 to £55.5 billion at the end
of 2008. This funding gap was not directly responsible for the
Division's losses, but it was a significant factor in the overall
group funding gap and materially increased the Group's wholesale
funding requirement. Furthermore, the International Division was
a significant factor in the Group's use of wholesale funding to
support relatively illiquid customer loans. Lindsay Mackay agreed
that this was a policy that would no longer be adopted.
10. The strategy and performance of
the International businesses were regularly reviewed by the relevant
group functions, including the Group's Board, ExCo and other group
committees and supervisory and control functions, as for all the
main divisions. HBOS recruited local management to run its businesses
in Australia and Ireland and had local boards, which had independent
chairmen and both local and UK representatives. The Division's
internal risk management function had both local and UK elements.
11. The Group's reporting, management
and control procedures imply that International's strategy was
communicated internally. No witness has indicated insufficient
information was available. Andy Hornby said that he considered
International risks particularly carefully, because that was the
area where the bank was "growing most strongly."
However, Sir Charles Dunstone commented that less time was spent
on International than Corporate or Retail.
Nor has any witness indicated that there were fundamental objections
at any of the various levels to the International Division's strategy
or exposures, though several referred to appropriate levels of
consideration and debate. However, the procedures failed
to prevent and indeed sanctioned, the growth of the Division.
Colin Matthew suggested that "the issue of distance
was a consideration."
The Division's impairments
12. Significant impairments were charged
in Ireland and Australia by HBOS in 2008 and LBG in 2009-11, as
illustrated in the following table:
LBG charged a further £897m of
impairments against Ireland and £203m against Australia in
the first half of 2012.
Impairments against HBOS's business
13. The estimated impairments against
Ireland totalled £10.9 billion between 2008 and 2011, which
is equivalent to 36 per cent of the Division's loan book at the
end of 2008. The sterling figures actually benefit from the deprecation
in the EURO over the period and would be some 5 per cent worse
in local currency terms. CRE was the principal factor in the impairments;
60 per cent of impaired loans in Ireland at the end of 2011 related
to CRE exposures.
14. All leading Irish banks incurred
significant impairments, as a result of the Irish recession. However,
the losses at HBOS were relatively greater than those of the other
major Irish banking groups, as the following table shows:
15. HBOS's impairments as a proportion
of loans were the second highest of the major banking groups in
Ireland. There is also a very significant gap between the HBOS
proportion and the next highest figure.
Impairments against HBOS's business
16. The estimated impairments against
Australia totalled £3.6 billion in the 2008-11 period, equivalent
to 28 per cent of the Division's loan book at the end of 2008.
The figures are increased by the appreciation of the Australian
dollar against sterling during the period, which we estimate added
some 20 per cent to the sterling figure for impairments. However,
even allowing for this, impairments would still have totalled
over 20 per cent of the loan book in local currency terms. The
Australian economy has been one of the most resilient in the world,
and impairments there for the leading banks have been amongst
the lowest as a proportion of the loan book of any major banking
17. The International Division's Australian
impairments would have been material to the HBOS Group as a whole
in absolute terms. They were also high relative to the Australian
corporate loan book - indeed, as a proportion of the loan book,
they were higher than those of the Corporate Division.
Losses in HBOS's International Division
18. We estimate that the impairments
taken against Ireland and Australia in the 2008-11 period total
Senior former HBOS executives described the losses in HBOS's International
Division as "appalling",
and gave a range of explanations as to their cause. Many referred
to the seizure in financial markets generally, including that
they particularly affected asset markets, which in turn, particularly
affected the HBOS businesses, due to their CRE exposure. Most
witnesses also referred to the problems in the Irish economy and
the losses of banks in Ireland generally. Some accepted that these
factors alone could not explain the scale of HBOS's international
impairments, particularly relative to the losses incurred by other
local banks. A few witnesses accepted that the scale of losses
implied mistakes on the part of the HBOS Group. Colin Matthew
said that, with the benefit of hindsight, the "principal
weakness" in the approach the Division followed was that
"the expansion plans were wrongly timed", but he defended
other aspects of the Division's strategy.
Jo Dawson later assumed responsibility for the former HBOS businesses
in Ireland and Australia, when at LBG. She claimed that she then
became aware of significant asset quality issues and the need
to strengthen risk management.
19. HBOS's losses in the International
Division were in large part due to the Division's strategy. The
Division followed an ambitious growth strategy in Ireland and
Australia, involving over-optimistic targets and assumptions for
market share growth from local competitors. The Division's pursuit
of rapid business growth led to a concentration in higher risk
corporate areas, notably in CRE and related sectors, rather than
in potentially more sustainable and less risky areas, which would
have involved a slower build. The specific nature of the Division's
loan portfolio resulted in higher credit losses. The nature of
the losses mirrored those incurred in HBOS's UK Corporate Division.
After the Corporate Division, the International Division was the
next most significant source of HBOS's impairments. While the
International Division's losses were smaller than in Corporate
in absolute terms, they were significantly bigger as a proportion
of the loan book in both Ireland and Australia. While all major
banks suffered high losses in Ireland, HBOS's were by a significant
margin the second worst as a proportion of the loan portfolio.
The company also incurred heavy losses in Australia, where the
economy and the banking industry have been relatively resilient.
The evidence from those two countries clearly suggests that HBOS
had significantly worse asset quality than other banks.
286 ENA comprised a collection of essentially separate
businesses: European Financial Services; a primarily German life,
pensions and investment business; a retail banking network in
Spain; a mortgage business in the Netherlands; and corporate banking
in the USA and Canada. Back
Qq 1462,1558, B Ev w 238 Back
B Ev w 391 Back
B Ev w 298 Back
B Ev w 390 Back
HBOS, Group Business Plan 2008 - 2012: "When The Going
gets Tough...", p 78 Back
HBOS, Group Business Plan 2008 - 2012: "When The Going
gets Tough...", p 30 Back
B Ev w 420 Back
B Ev w 414 Back
The growth rates in the table are adjusted for the disposal of
BankWest and divisional restatements. Back
At its peak in 2007, the division represented 16 per cent of group
customer loans. Back
B Ev w 238 and Q 1463 Back
BQ 151 Back
B Ev w 247, 238 Back
BQ 561 Back
Q 1468 Back
BQ 838 Back
B Ev w 249 Back
"2012 Half-Year results", Lloyds Banking Group News
Release, p 123 Back
Lloyds Banking Group, 2011 Annual report and Accounts: Becoming
the best bank for customers, p 155 Back
Lloyds Banking Group (LBG) does not publish divisional figures
for HBOS, but it is possible to estimate the impairments subsequently
required in Ireland and Australia. LBG does disclose impairments
in Ireland and Australia for the enlarged group. Reconciling the
HBOS 2008 press release disclosure on the International division
(pp 32-41) with the combined figures for LBG in its 2009 Annual
Report & Accounts (p 37), it can be shown that substantially
all the LBG customer loans in Ireland and Australia were originally
loans made by HBOS. This would also be logical as the former Lloyds
TSB did not have the local presence in these markets that HBOS
did. We therefore assume that the LBG impairments in Ireland and
Australia relate to former HBOS exposures. It is not possible
to estimate impairments taken against the ENA portfolio, as LBG
disclosure is likely to include charges against loans originated
by Lloyds TSB. Back
Q 1293 Back
Q 1463 Back
Q 1557 Back
B Ev w 248 Back
B Ev w 186 Back