Annex 4: The Retail Division
Introduction
1. The Retail Division was the largest
division in HBOS in terms of customer loans and generally of profits.
The Division combined the retail banking activities of Halifax,
primarily in mortgages and savings under the Halifax and other
brands, with those of BoS, which comprised a branch banking business
in Scotland and products delivered through direct channels throughout
the UK. The enlarged HBOS Retail Division was arguably the leading
UK retail financial services business. It had market leading positions
both in mortgages, with a 20 per cent share of new mortgages written
in 2008, and in deposits, with a 13.2 per cent share of Household
Liquid Assets at the end of 2008.[333]
During the period following the merger, the Retail Division broadened
its activities, increasing its shares of financial service products
other than mortgages and deposits. The Division achieved a 16
per cent share of new UK current accounts in 2008, when it also
had a 10 per cent share of unsecured lending balances and 11 per
cent of new credit card accounts. The Retail Division was also
the leading UK bank distributor of insurance, both investment
and general insurance products.[334]
The Division's strategy
2. From the point of the merger the
Retail Division followed a strategy positioning itself as the
"customer's champion," claiming that it offered "outstanding
value for money" right across its product range and products
and prices that were "easy to understand." [335]
The Retail business was the one division in HBOS that held a leading
incumbent position, in the form of its mortgages and savings business,
which was a potential opportunity for competitor banks. At the
time, the mortgage market saw a significant increase in competition
from existing players and new entrants, particularly due to the
abundance of wholesale funding at attractive rates. However, HBOS
saw itself as a challenger organisation in most other retail financial
service products, with the opportunity to gain share by distributing
them to its existing customer base. Consequently, the Retail strategy
involved managing the effects of competition on its mortgages
and savings business, while increasing its share in other products.
3. A key element of the Division's mortgage
strategy was to grow 'non-standard' mortgage lending, particularly
buy-to-let and self-certified mortgages, where margins had remained
higher than with standard mortgages and the overall profitability
was thought to be more attractive, despite higher credit risks.[336]
At the end of 2003, £36 billion (20 per cent) of the Division's
portfolio was classified as non-standard.[337]
By the end of 2008, this figure had risen to £66.5 billion
of mortgage lending (28 per cent)[338].
As a result, 35 per cent of the Division's book had a loan-to-value
ratio of over 70 per cent by the end of 2007, and this proportion
rose to 62 per cent by the end of 2008[339],
due to the fall in house prices. These proportions are significantly
higher than for any other mainstream mortgage lender, which makes
the Division's portfolio more vulnerable to a housing market downturn
than those of other leading mortgage banks.
4. The strategy of expanding shares
in products outside mortgages and savings was successful in increasing
shares as outlined in paragraph 1 of this annex. The Retail Division
unsecured loan book totalled £16.7 billion at the end of
2008.[340] Retail also
built significant shares in new current accounts and the distribution
of insurance products. At the end of 2008, the Retail Division
had customer deposits of £144 billion and customer loans
of £255 billion, a gap of £111 billion.[341]
The Division was therefore the largest element in the overall
HBOS group customer funding gap, representing over half the Group's
total funding gap of £213 billion at the end of 2008.[342]
The Division's impairments
5. As LBG does not publish divisional
results for the HBOS Group, it is not possible to know precisely
the impairments the Retail Division has incurred since the financial
crisis. We do, however, know the figures for 2008. The HBOS 2008
disclosure shows Retail impairments of £2.2 billion, of which
£1.1 billion was against secured lending, up from just £28m
in 2007.[343] By contrast,
Lloyds TSB only incurred impairments of approximately £170m
against mortgages in 2008. In order to get an idea of the size
of HBOS's mortgage impairments for 2009-11, it is possible to
look at the aggregate LBG Retail impairments against secured lending
for the period, which were £1.5 billion.[344]
Assuming the bulk of LBG impairments against mortgage lending
continued to be related to HBOS loans, we estimate that HBOS mortgage
impairments for the 2008-11 period would have been some £2
billion (which represents 1 per cent of the 2008 book of secured
loans).
6. There was a general deterioration
in UK banking industry unsecured loan arrears experience in the
early part of the last decade. HBOS was no exception. As a result,
the bank tightened its unsecured lending criteria in 2004.[345]
Consequently, the Retail Division's unsecured lending grew relatively
moderately in subsequent years, averaging annual growth of 3 per
cent in between 2003 and 2008. However, the Division's impairments
continued to rise, initially because the lending it wrote in 2002-03
'seasoned' and thereafter because of the economic downturn. The
Division's unsecured impairments were £486m in 2003 and £1.1
billion in 2008, averaging about £1 billion a year over the
2003-08 period;[346]
and we estimate that they continued at a similar level subsequently.
These figures would be equivalent to annual impairment charges
of 7 per cent of loans per year, which shows that HBOS's unsecured
loan charges were generally significantly larger than for its
mortgage portfolio, both in absolute terms and as a proportion
of the book.[347]
7. Although experiencing some deterioration
as a result of the crisis, particularly in respect of non-standard
mortgages, HBOS's Retail impairments were substantially less than
either the Corporate or International Divisions incurred and were
not a material factor in the failure of HBOS. We estimate that
total Retail impairments would have been some £7 billion
between 2008 and 2011. The Division generated profits before impairments
of £3.5 billion in 2008.[348]
Even allowing for significant pressure on this figure in
subsequent years and for charges against the mis-selling of payment
protection insurance, the Division's pre-impairment profits would
have allowed the Group to absorb the likely level of impairments
and still generate profits.[349]
8. The prime reason for the resilience
of the Retail Division was the resilience of its credit quality.
There are likely to have been several factors for this. The Retail
business was the market leader in mortgages and savings. It was
not a relative new entrant, unlike the International Division
and, to a lesser extent, the Corporate Division. The market position
of the Retail Division was therefore stronger, and it generated
higher quality business. Group senior management and central risk
functions had greater understanding of the Retail business and
several had direct expertise having worked on the Retail side.
There was therefore greater involvement by senior management and
central functions in Retail and greater willingness to accept
that on the part of the Division.
9. The Retail Division participated
in higher risk mortgage segments and grew the proportion of higher
risk lending. However, such business remained a minority of its
mortgage exposure, with mainstream mortgage loans still 72 per
cent of the mortgage portfolio at the end of 2008. This focus
is in contrast to HBOS's corporate lending, both domestically
and internationally, where the divisions adopted a strategy of
specialisation in higher risk segments, including CRE. The downturn
in the residential property market was not as pronounced as in
the commercial property area, which resulted in significantly
less pressure on mortgage asset quality than on CRE. Should there
be a downturn in the residential property market, the higher LTVs
resulting from HBOS's growth in non-standard mortgages would be
likely to make its portfolio more vulnerable than those of other
leading mortgage banks.
10. Although the Retail Division incurred
higher losses than its major competitors and still today retains
higher risks in its mortgage portfolio, it was not a major contributory
factor in the failure of HBOS. The Division is likely to have
remained profitable during the crisis period and subsequently,
albeit at a reduced level. Nonetheless, the Division's customer
funding gap was a major factor in the Group's overall funding
gap.
333 HBOS, 2008 Annual Report and Accounts, p
7 Back
334
HBOS, 2007 Annual Report and Accounts: Delivering our strategy...,
p 16 Back
335
HBOS, 2001 Annual Report and Accounts: The New Force, pp
12-13 Back
336
HBOS, 2003 Full Year Results Presentation, lloydsbankinggroup.com,
slide 27 Back
337
"HBOS plc Preliminary Results 2004: Stock Exchange Announcement",
HBOS Press Release, 2 March 2005, p 13 Back
338
"HBOS plc Preliminary Results 2008: Stock Exchange Announcement",
HBOS Press Release, 27 February 2009, p17 Back
339
Ibid., p17 Back
340
Ibid., p17 Back
341
HBOS, 2008 Annual Report and Accounts Back
342
Ibid., p 42 Back
343
HBOS 2008 full year results press release, p 15 Back
344
"HBOS plc Preliminary Results 2008: Stock Exchange Announcement",
HBOS Press Release, 27 February 2009 Back
345
HBOS, 2004 Annual Report and Accounts: Making growth work harder
for shareholders, p 11 Back
346
HBOS Annual Reports and Accounts for the years 2003 - 2008. Back
347
Interest margins on unsecured lending would, of course, have been
materially higher to compensate for this fact. Back
348
HBOS, 2008 Annual Report and Accounts, p 7 Back
349
This calculation is still likely to hold true, even if the £1,155m
of charges taken by HBOS against mis-selling of payment protection
insurance in 2011 are included. Back
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