Parliamentary Commission on Banking StandardsEXECUTIVE COMMITTEE
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Tuesday, 22 April 2008 at 8.00 am 33 Old Broad Street, London |
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MINUTES |
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Present |
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Andy Hornby (Chairman) |
Philip Gore-Randall |
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Harry Baines |
Peter Hickman |
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Peter Cummings |
Colin Matthew |
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Jo Dawson |
Dan Watkins |
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Mike Ellis |
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In Attendance |
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*** |
*** |
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*** |
*** |
1. Minutes
1.1 Minutes of 18 March 2008
The minutes of the meeting of the Executive Committee held on 18 March 2008 were approved.
2. Business Update
2.1 Oral Business Update
RETAIL
Dan Watkins confirmed that Retail profit in March had been in line with expectations, although impairments were increasing. Banking sales were going well. Overall, Retail had been on track with respect to both new business and principal repaid in March, although principal repaid had slowed in April. Further mortgage price increases were in the pipeline, in addition to those already made. Savings inflows were proving challenging, and there were some emerging concerns about the ability of the business to hit the agreed increased targets. The overall market for savings was likely to be smaller than originally anticipated. Significant pricing moves had been made ~ but thus far there had been a relatively limited impact on inflows.
RETAIL DISTRIBUTION, INSURANCE & INVESTMENT
Jo Dawson reported that investment sales were being adversely affected by volatility and investor sentiment, although April was showing some signs of improvement. Q1F assumed a significant recovery in H2. Household and motor insurance sales were going well, although PPI sales continued to struggle. Persistency would continue to be a challenge. Bancassurance was c.12% behind year on year, intermediary sales ytd were slightly ahead of (a poor) 2007; SJP were c.14% ahead year on year in the first quarter.
CHIEF OPERATING OFFICER
The Faster Payments programme remained on track. The Programme remained “Green”. There were still some unusual “demand” issues across various parts of the Group, that had the potential to adversely impact costs initiatives.
GROUP RISK
Peter Hickman confirmed that discussions continued with the FSA in relation to the 19m March event, and the Group had provided the FSA with information and leads to help the FSA investigation.
CORPORATE
Peter Cummings commented that Corporate in the month was behind expectations, in part due to the deferral of a projected transaction and in part due to an emerging impairment issue. The commercial business was focussed on deposit raising. Work in progress had slowed dramatically. All connections were being repriced as soon as the opportunity arose. The opportunity was also being taken when writing new business to reprice the entire exposure/back books. New pricing was being structured with reference to LIBOR.
INTERNATIONAL, TREASURY AND ASSET MANAGEMENT
Colin Matthew reported that trading in Australia continued to be generally strong, subject to some impairment issues that might emerge before the half year. ENA was in discussions with respect to one troubled US exposure. EFS performance was suffering from a lack of investor appetite, but the EFS business was believed to be trading ahead of the market generally.
Treasury performance would be covered later on the agenda.
COMPANY SECRETARY’S
Harry Baines commented that:
the draft Judgment in the Banking Fees test case, Phase 1a, was now available, subject to embargo, and would be handed down by the Judge at 10 am on Thursday, 24 April. That deadline was already in the public domain. The Judgment was believed to be in excess of 200 pages in length. Detailed conversations had taken place with the OFT and FSA about communications concerning the contents of the Judgment. The initial “holding” announcement would be made by the BBA, on behalf of all banks, it was possible that specific announcements may need to be made thereafter by individual banks;
the proposed review of NED fees, details of which had been circulated;
the HBOS response to the Financial Stability Consultation
Document, which had now been submitted, and had been followed by a positive meeting with Clive Maxwell and the HMT team; and
voting with respect to AGM resolutions, where there continued to be active engagement with individual institutional investors. Voting proper was still at a very early stage.
3. Group Finance
3.1 Financial Overview
Mike Ellis commented on the suite of inter-connected papers that together provided an overall view of the Group’s current and forecast financial position. There was a range of inter-dependencies between the various papers.
Although profitability remained highly volatile (not least with respect to the Treasury portfolio), the main business risk facing the Group remained funding and liquidity, it was entirely possible that further steps may need to be taken to reduce asset growth, where the level of mortgage principal repaid and Corporate sell downs (as well as the possibility of undershooting deposit targets) remained threats to revised asset growth plans. Q1F had been exceptionally difficult to compile. At this stage Q1F contained significant stretch, and serious downside risks.
The Contingency Planning paper had been prepared to identify the steps that the Group may need to take should there be a further significant deterioration with respect to the economic climate; funding; liquidity; profitability or capital.
The current forecast half year (2008) position with respect to Target Tier 1 Capital was unacceptable, and this issue would receive further attention.
A draft of the Interim Management Statement (“IMS”) that was being prepared for release on AGM day was being prepared and would be circulated for comment. It was now proposed to take additional markdowns due the illiquidity of ALT A and CBOs, where the markets remained very illiquid. This would reduce the forecast outturn for 2008, but would mitigate the possibility of further negative FVA’s.
in due course the Group’s business model would need to reflect a lessening of reliance on wholesale funds, prioritising the allocation of scarce resources to those areas best able to provide sustained delivery of shareholder value. This topic would be covered in greater depth at the Board Strategy Session in June. In the interim, structural changes would be considered that would assist the transition to a new business model.
The Group had a number of businesses that were candidates for sale and/or run off. The remaining ‘‘core” businesses—the “businesses of the future”—needed to be re-energised and reinvigorated. It was proposed, therefore, where practicable, to put the “non-core” businesses into a separate business line, outside the Divisional structure — with those responsible for selling or running off these businesses being intensely focussed on disentangling these businesses, and managing them (in run down, or with a view to sale) in a way that did not adversely impact the core business. Where there was shared infrastructure, which meant that total separation was not possible the aim would be to “free up” the management of the core businesses, whilst maintaining the focus on disposing of or exiting other businesses. The list of “candidates” for inclusion in the list of non-core activities, for treatment in this way, would be agreed in due course. Some adjustment to functional reporting lines might also be appropriate.
An additional review of the Group’s actual and relative capital position would be delivered to the Board on 29 April, together with recommendations for action. In view of the potentially serious downside risks, the Group should not allow itself to be relatively weak in terms of capital. Therefore, consideration would be given to raising additional capital, although the timing of any such move remained uncertain at this stage.
3.2 Funding And Liquidity Update
Mike Ellis reported on current market conditions and the Group’s funding capabilities. Money market funding, excluding repo, remained short dated but broadly of adequate size, although the Group had fallen short of its target funding levels around the end of the quarter due to unusually tight conditions. There were emerging concerns about the Group’s ability to hit deposit targets; slow asset growth; achieve selldowns; and the experience in relation to principal repaid—all of which could increase the Group’s funding requirements. The facility announced by the Bank of England had received a lukewarm external reception, although it should in fact be helpful. Corporate’s asset position remained stubbornly ahead of revised target levels; Retail were facing significant challenges with respect to deposit gathering. Levels of mortgage principal repaid remained a significant risk. It looked increasingly likely that additional actions might need to be taken to manage the Group’s position. Greater use was being made of repo markets to manage short dated cash positions, but new “trigger points” would be established, breach of which would require a report to the Board outlining any actions to be taken.
3.3 Q1F
Mike Ellis commented on Q1F, where the decision had been made to take additional illiquidity mark downs in respect of the Treasury ALT A and CBO portfolio, taking the total write down to c.20%.
Q1F included c.£210 million stretch, subject to a £100 million contingency, and forecast an outcome that was in line with analysts’ expectations (before the illiquidity mark downs), although clearly with significant downside risks (and more than would typically be the case). The impact of movements in HPI in the balance of the year could be significant. There were obviously very significant deviations from the original Group Business Plan, notably in Corporate Banking and Treasury. Profit volatility could still be significant in the balance of the year, although the major risk was funding and liquidity. At this stage the Q1F assumed that the dividend for the full year would be maintained at the current level, although this would be reviewed. Profit was heavily skewed towards the second half—exacerbated by Treasury FVAs in H1. The extent of the imbalance between the two halves could surprise the market. The forecast year end capital position would be within the target ranges, but there was a risk that the half year position could be more problematic. Great care would be taken to educate the market with respect to key issues, through the Interim Management Statement
At this stage there were not believed to be any credit impairments in the Treasury portfolio.
3.4 Business Contingency Planning
Mike Ellis commented on the Contingency Planning that had been carried out, to explore various options available to HBOS, should there be any further significant deterioration in market conditions.
In relation to Retail, given the actions taken to date, there was little more that could be done beyond ‘‘closing” entirely to new business. In practice, Retail would exit from business segments in order of priority, but it may be necessary to accelerate the process. Being “open” meant that business would be written, almost regardless of pricing or criteria changes, given similar moves being made by peers. The first step was likely to be to restrict new business to existing customers, through the direct channel only—perhaps “rationed” further by reference to amount of savings, length of relationships etc. Pricing alone was proving to be an insufficient filter.
In Corporate, the key imperative would be to honour existing commitments but to refuse to write new business (except perhaps to the extent that repayments provided flexibility to lend). These actions might need to be supplemented by portfolio sales. Steps were being taken to prepare assets for sale, so that the sales process could be initiated quickly once a decision was taken. But this was the least favoured route, and was likely to be pursued only as a “last resort”. Any sales were likely to involve a significant “hit” in terms of the price that would be achieved in a distressed sale environment, and there were significant doubts in relation to the ability to find any buyers at an acceptable price in current conditions. The Asset Solutions business would need to be run down, rather than sold, for example.
In the International businesses, asset growth had been cut significantly, but Sterling weakness was leading to asset growth being above revised Plan levels when translated into Sterling. In relation to the US corporate business, the approach would be to honour existing commitments, but not write any new business. There were some portfolios that could be considered for sale, but the core action would be to “close” to new business. In both Ireland and Australia, some growth in assets was still currently planned for 2009, Any further cuts in Australia would undermine the planned East Coast expansion.
The aim would now be to look hard at the likely outturn with respect to the Group’s asset position during the balance of the year—and to decide which contingency actions, if any, needed to be triggered. This could involve a mix of “sales” of businesses or portfolios, and further tightening of new lending. The risks of undershooting on deposits and exceeding asset targets meant that further asset “cuts” looked likely. A revised asset plan would be produced showing the Group returning to target levels ~ and the actions that would need to be taken to achieve that objective.
In terms of capital, the current forecast projected that the year end capital position would be in line with target ranges, although the position would be more challenging at the half year. Further work was being carried out to refine the Group’s Basle models, but Basle II was more sensitive than Basle 1 to change in the overall economic environment (for example, with respect to delinquencies and failing house prices).
Forced sales of Corporate assets could significantly reduce profitability and capital ratios. Corporate impairments could also impact capita! ratios—as would a failure to achieve non-equity issuance plans. It was inter alia for these reasons that the possibility of raising additional capital was being considered. A recommendation in that respect would be submitted to the Board on 29 April.
Subsequent to the meeting, at an ad hoc meeting of the Committee held on 24 April, it was agreed to proceed with a recommendation to the Board that the Group should seek to raise additional capital, by means of a fully—Underwritten Rights Issue––with the aim of making a Formal Announcement to that effect no later than 29 April, if it was judged that market conditions were right and if appropriate underwriting arrangements could be secured. Whilst the size of any capital raising was not finalised, a Rights Issue of up to £4 billion (net of expenses), together with payment of the Interim Dividend in paper rather than in cash, were likely to be recommended. It was noted that it might prove necessary to convene a special meeting of the Board to discuss that proposal, over the weekend of 26–27 April. Investment Banking advice had been sought, but the final scale of any recommended Rights Issue had yet to be decided. No final decision, as to whether or not to proceed, could or would be made until it was known whether the Investment Banks would provide underwriting and it was judged that market conditions were favourable.
The fully developed version of this paper would be presented to the Board, to highlight the full “shopping list” of major issues that could adversely impact the Group (a quasi “stress list”), together with a review of the Group’s relative position compared to the major peers. At this stage the aim was to identify the key risks, and the potential actions available. Strategic options were being kept under review, and would be considered in further detail at the Board Strategy Session in June.
The Board had been kept updated, and the intention was now to agree formal “trigger points” which, if breached, would require a report to the Board with recommendations for firm action.
3.5 Interim Management Statement (‘Ims”)
Mike Ellis confirmed that a draft would be circulated to ExCo members within the next 24 hours.
4. Strategic Issues
4.1 Uk Mortgage Strategy
Dan Watkins, *** and *** presented this review of the Strategy for the Mortgages business. The background was the significant decline in mortgage market profitability in recent years, given increased competition and the dominance of Intermediaries. Starting in 2007, the performance of the business had been stabilised, but there was little clear differentiation compared with the industry generally. Current market conditions, however, offered the opportunity to accelerate strategic initiatives whilst also seeking to lock in business for longer at improved rates.
Over the past 12 months HBOS had been successful in improving its risk performance through tightening eligibility criteria. More than 80% of business was now on terms in excess of three years.
For the future, the aim would be to:
lead the market in analysis and risk capabilities, to grow income ahead of assets;
leverage the scale of the HBOS business, by rationalising brands and infrastructure, to deliver cost savings and reduce acquisition and processing costs; and
optimise the sales mix, through using the Group’s distribution strengths to maximise the role of the direct channel, with only the balance being taken through the Intermediary channel.
Current forecasts suggested that overall demand for mortgages in 2008 would significantly outstrip supply. It was necessary, therefore, to consider a phased contingency plan, to reduce asset growth further, should this be required. The immediate focus was to limit asset growth and raise pricing to at least compensate for increased funding costs. New business should be optimised across return on capital; risk; and certainty of income. The intermediary channel was changing, although Intermediaries were likely to remain dominant for the foreseeable future. But it was clear that maximising profit and SVA would require all direct channels to be run to capacity.
Achieving the Group’s objectives in current market conditions was dependent upon Principal Repaid experience, even as the Group closed down various products and exited various product segments. By way of further initiatives, the Group’s preference would be firstly to exit the self certification market; whilst maintaining a position with respect to FTB’s and house moves as long as possible. Channels could also be exited selectively, with “direct” being the preferred channel. The overall objective was to help more customers own homes more easily, but taking into account capital impacts, as well as profitability.
The paper to the Board would give additional emphasis to consideration of the risk appetite of the business, with particular reference to subsectors of specialist lending—although significant reductions in risk had already been made, and directionally the business was already moving away from some of the so-called “higher risk” segments.
4.2 Corporate Real Estate
*** and *** commented that the Corporate real estate business aimed to provide senior debt funding packages across the property investment and development sectors, as well as a fully integrated JV funding package with respect to commercial real estate, hotel and house builder partners—in the UK and Europe. The JV business was a differentiated approach, although in current conditions there was no appetite to extend equity participations (except on an exceptions basis to existing customers). Historically, the cost income ratio had been extremely low, with low impairments ~ all leading to this being a highly profitable business, but there was likely to be a significant drop in profit in 2008 compared with 2007. Reducing churn had a material impact on the returns being made. Under normal circumstances, fees were a significant contributor to overall profitability.
There was a relatively high utilisation of limits, and a relatively high market share in the UK (although low in Europe). There were robust lending parameters, and this had resulted in a relatively conservative risk profile, although there were now some emerging signs of distress, particularly in the residential sector (although this was only a small slice of the overall Corporate Real Estate book). RWA’s and EL’s were also believed to be (possibly overly) conservative, and further work was being carried out with respect to Basle models. The majority of the Group’s exposure related to largely pre-let commercial developments, with very limited exposure to speculative development (where, typically, there was additional balance sheet support). The Group’s exposures were stress tested with respect to the most recent valuations (not the peak of the market). Cashflows continued to support lending, even with strained values (in the absence of widespread tenant default). The slowdown in the housing market and restrictions in mortgage supply were clearly risks.
Most of the pricing was fixed with reference to LIBOR, which had helped in current conditions. In the longer term this continued to be a very attractive business, although in the shorter term the business was exploring a range of options to develop third party funding or otherwise seek to reduce the potential strain on the HBOS balance sheet.
5. Comparative Treasury Positions
Colin Matthew’s paper compared the four main UK clearing banks from the view point of the impact of recent market conditions, with particular reference to their respective:
funding profiles, and external funding requirements;
composition of debt securities profiles; and
write-downs and impairments.
HBOS had the largest mismatch in respect of loans to deposits. In absolute terms the external funding requirement of HBOS was less than both RBS and Barclays. External audiences were concerned about the high loan to deposit ratio and the funding of the conduit—although other liquidity facilities provided were less onerous than Barclays or Lloyds.
In terms of debt securities, HBOS had disclosed more detail relating to its asset portfolio than other banks. The RBS asset backed holdings were substantially larger than those of HBOS—and probably of inferior quality. Other banks probably had larger potential exposures to monoline insurers.
Relative position would continue to be monitored closely as further disclosures become available.
6. Papers For Comment/Noting
The following papers were circulated to members of ExCo for
comment and were noted, namely:
Euro Commercial Paper Programme Proposed Limit Increase to Euro 25,000 Million
Treasury VaR Limits
ARROW II and RMP
Quarterly Key Credit Trends
SME Banking in England and Wales
Fountainbridge South Update
Group Programmes Update
Draft Board Agenda—28 April 2008
Schedule of Advances
7. Date Of Next Meeting
The next meeting of the Executive Committee would be held on 20 May 2008 at 9.30am in Edinburgh.