Parliamentary Commission on Banking StandardsMEETING OF THE DIRECTORS held at The Mound, Edinburgh at 10.30 am on 28 October 2003
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MINUTES |
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Present |
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Lord Stevenson (Chairman) |
Coline McConville (by telephone) |
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James Crosby |
Gordon McQueen |
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Charles Dunstone |
Colin Matthew |
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Mike Ellis |
George Mitchell |
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Sir Ronald Garrick |
Sir Bob Reid |
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Andy Hornby |
Philip Yea |
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Brian Ivory |
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IN ATTENDANCE |
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*** |
*** |
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*** |
*** |
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Peter Cummings (item 4) |
*** |
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*** |
*** |
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Lindsay Mackay (Item 5) |
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APOLOGIES FOR ABSENCE |
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Apologies for absence were received from Tony Hobson, Phil Hodkinson, John Maclean and Louis Sherwood. |
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1. Minutes and Matters Arising
1.1 Minutes
The Minutes of the Meeting of Directors held on 23 September 2003 were approved subject to minor amendments.
The following minutes were noted:
The Audit Committee of 1 October 2003.
Committee of the Board of 10th October (Share Dividend).
1.2 AUDIT COMMITTEE—1 October 2003—Matters Arising
Sir Bob raised three issues arising from the Minutes of the Audit Committee held on 1st October, as follows:
it now appeared unlikely that there would be any impairment of the goodwill arising on the SJPC and Equitable acquisitions;
it was clear that there needed to be adequate systems and controls in place whenever the Group entered into new business areas—which, in effect, had been the case with TAG, although this had not been properly understood or reflected at the time; and
Mike Ellis was driving all parts of the Group to hit the necessary timescales in relation to the introduction of International Accounting Standards.
1.3 Oral update from the remuneration committee
Brian Ivory reported that, at its meeting held on the previous evening, the Remuneration Committee had considered a number of issues including:
feedback on the programme of meetings that had been held with institutional investors in relation to understanding their concerns about the Company’s 2002 Remuneration Report; and
preparation for the 2003 Remuneration Report, including reconfirmation of the reward philosophy, and any changes required to take account of institutional views.
A comprehensive Pensions paper had also been received, that would begin the debate about the Group’s approach to pension provision. A copy of the Pensions paper would be circulated to all directors, for information. (And this paper was circulated subsequent to the meeting).
2. Chief Executive’s Report and Management Information Pack
The Chief Executive’s oral update covered, in particular, current Trading and progress in relation to the Planning process, together with a number of other current issues—including some that had resulted in external publicity.
Trading remained satisfactory. Hitting consensus for the full year would be tough, but should be achievable. Retail’s results were no longer being helped by the rate curve, and account needed to be taken of the TAG and endowment situations. Momentum remained strong, however. HD’s results would be affected adversely by the lack of creditor insurance sales, as the unsecured loans market had contracted, and poor saies of investment products. Achieving a significant bounce in 2004 depended on the success of the Shared Services Programme and Project Crystal (which would reduce FTE in the investment businesses by about 25%). *** was fine: there were the earliest signs of green shoots at SJPC. Activity remained strong in Corporate, although the month’s results would be affected by lumpy provisions. Investor sentiment remained sensitive to growth in both assets and provisions. There had been excellent PR around developments at *** Treasury sales remained strong, and trading results had improved markedly. The fuli year’s outcome would be stronger than had been feared. Business Banking remained on track, including in Ireland and Australia, and there were no real signs of deteriorating credit conditions. BankWest would finish the year ahead of expectations.
The Planning Process was progressing. A number of clear challenges were emerging. Business credit, retail credit, stockmarkets and underwriting were at different stages of their respective cycles: and this would influence views on volumes, allocation of funding, and capital. Costs needed further attention. Funding constraints were very real, and fundamental to the Plan. Growth in the later years of the Plan—2005/6 and beyond—was an emerging agenda for investors, not surprisingly. Capital was under some strain, and this raised the issue of whether the Group should stop at 2.5 times dividend cover. In summary, with considerable stretch, the Group would hit or come sufficiently close to the 20% ROE target in 2004.
The reorganisation was bedding down satisfactorily, although there was more work to do in terms of ensuring the Group’s Internal governance arrangements were fit for purpose as at 1st January 2004. It was also essential to ensure that delivery did not slip in Quarter 4, as the final pieces of the reorganisation jigsaw were put in place.
A journalist working for the Money Programme claimed that applicants for self- certified mortgages were routinely encouraged to exaggerate their income. The majority of the Programme would concentrate on the role of intermediaries in relation to this type of mortgage, but had also allegedly exposed wrong doing by three branch-based Birmingham Midshires advisers.
About 19% of total lending was self-certified
Colin Matthew had visited Australia to join colleagues considering strategy in relation to the Group’s Australian operations. The aim was to agree organisational structures in Australia before the end of the year, ft was clear that BankWest had suffered from lack of strategic direction for some time, and the pressures imposed by its former listed status had resulted in the operation becoming overly risk averse. The business had significant potential, although the management team needed strengthening.
The FSA had indicated in a draft Notice its intention to impose a significant fine on the Group in respect of alleged anti-money laundering compliance failures (Project Mars). The FSA’s Notice did not properly reflect the efforts made bythe Group to co-operate and secure compliance, once this issue came to light, or the significant progress made. The Group’s response to the FSA was still being considered. The FSA had a positive view of HBOS and its management team—and this reaction to Project Mars did not fit well with that view, or the approach expressed by Andrew Proctor that the FSA would rather supervise and encourage than punish. The FSA’s approach and reasoning needed to be understood properly before the formal response could be finalised.
3. Business Banking—Motor Finance and Vehicle Management
The provision of financing for vehicles and fleets was a core part of the Business Banking customer proposition. Through the cycle, these were attractive businesses—even though, periodically, there could be significant shocks. They were amongst the highest ROE businesses in the Division, and had demonstrated a continuing ability to deliver market-beating growth. There were four key sub-divisions:
Motor Finance—a business to business operation whose relationships with dealers and manufacturers led to c. £2.4 billion p.a. of retail motor finance.
Vehicle Management—which provided a full range of vehicle management and contract hire solutions.
***—the Joint Venture with ***, with particular expertise in the management of large or specialist fleets.
*** — the truck and trailer rental company.
As *** explained, the Group now financed about one third of all UK new vehicle registrations. There were strong relationships with dealers and clear ambitions to increase market share. Fast and effective operational fulfillment was critical to success, and was delivered through a low cost platform that delivered market-leading speed. Motor Finance systems were leading edge in terms of speed, and weil ahead of the competition; but investment needed to continue, to ensure this competitive advantage was maintained.
The cost base was already the lowest of any independent motor financier, but a number of initiatives were planned to drive costs even lower. The Group was in a strong position to leverage its low cost base and processing skills to increase volumes in the major growth sectors and to challenge (Ford Credit) for market leadership.
The collapse in residual values had led many competitors to leave the market. But the Group’s vehicle management business had been partially protected by the quality of its vehicle mix, with concentration on marques whose residual values held up better than the average. Initiatives were in place to generate income from value added add-on services, whilst pursuing the goal of being the first-choice provider of known cost vehicle solutions. Although the Company car market had suffered as a result of attacks on this “perk” by successive Governments -this was leading to a new emerging market in Employee Car Ownership Schemes, and the Group was well positioned in the ECOS sector.
*** was the market leader in its truck and tailor sector with a very strong ROE and a market leading position. The next challenges were to broaden the product range—for example, by managing third party fleets as well as its own and to attack the cost base.
Proposed regulatory or legislative reform posed significant threats to this business, although the precise impacts could not yet be assessed.
4. Corporate Banking—Review Of Property Lending
Property was the largest sector in the Corporate book, with drawn balances of around £17.5 billion — about one third of the Division’s total lending (and about 7%-8% of the Group’s total customer advances). Most of this lending was in the form of senior secured debt—augmented by the Joint Venture business, where additional risk positions (subordinated loans and equity participation) were used to generate enhanced returns. A number of other competitors claimed to have withdrawn from or to be minimising exposure to the commercial property market—although this was clearly not true in a number of instances.
The portfolio was divided into:
Property Investment—with about £12 billion of drawn balances. This comprised a mix of office, retail and industrial space—typically wholly or mainly pre let to strong covenants;
Housing Associations—with a market leading position of c. £3 billion in advances. Margins were now under significant pressure in this sector. The Division would be very selective about entering into any new commitments;
Property Development—with about £2.5 billion commitments. This was the highest risk sector—but, even here, most developments were pre-let or pre-sold, or supported by additional security.
Case studies were presented in relation to examples of transactions supported by the Group, that were innovative and provided attractive returns:
*** described a major brownfield redevelopment in East London, with mixed residential, commercial and leisure usage; which involved initial funding to secure appropriate planning approvals and an equity stake. If the development proceeded, the Group should be able to leverage its stake as preferred lender to offer or provide financing to builders or other developers. This was fairly typical of the relationship banking approach, working in partnership with a partner from the earliest stages of securing consents, through marketing and onward sales;
Peter Cummings illustrated a 50:50 joint venture funding arrangement in relation to the acquisition of various shopping centres with significant pre-lets, managing the quality of tenants, and maintaining and improving the asset base. Part of the funding had been sold down, to help manage the Group’s overall exposure and drive returns. This arrangement had been in gestation for some time—poaching an attractive customer through the Group’s capability to offer equity participation.
Overall, the quality of the Property portfolio was high—with only a small number of High Risk Connections. Given lessons learned during the last property recession, together with strong deal structuring skills, a diversified portfolio, and a strong focus on risk management and mitigation, this was firmly believed to be a safe and well rewarded asset class for the Group.
5. HBOS Treasury Services
Competitive advantages enjoyed by the HBOS Treasury operation included:
scale, which helped provide clear insight into markets and developments;
the Group’s very strong credit rating;
a large captive customer franchise across the Group and its corporate customers; and
a highly motivated team of professionals.
The strategic aims of the business were to:
grow and diversify capabilities and sources of wholesale funding;
develop the recently approved “narrow focus” capital markets business;
grow product sales, particularly to corporate customers of the Group; and
expand the low risk Structured Investment Portfolio, whilst maintaining proprietary trading at, broadly, current scale and level of risk.
Funding and liquidity was at the core of Treasury’s operations. HBOS had the greatest reliance on wholesale funding of any UK clearing bank, with clear funding plans that were regularly updated. Investor appetite for HBOS securities was monitored constantly, to identify attractive timing and available capacity, necessary to maximize funding opportunities.
The Group had established an excellent track record for innovative, well received, competitively priced, benchmark transactions—to diversify sources of funds, maximise liquidity and lower overall pricing. There was a comprehensive Investor Relations programme. Nonetheless, the Group’s Customer Funding Gap was larger than that of the Big Four banks combined. Given growth in the dependence on wholesale funds, and the need to hold more prudential liquidity than for customer deposits, the average maturity profile of wholesale funds needed to be lengthened. Under the Group’s current transfer pricing regime, this would steadily hit Treasury revenues, as increased funding costs were “absorbed”, rather than passed onto the banking Divisions. The shape of the Division’s results would be transformed during the Business Planning period, with other revenues—largely from sales—replacing Funding and Liquidity income.
The sales operation had been reorganised to be customer rather than product focused ~ to increase sales penetration across to Group, as well as to leverage the Group’s growth. The pool of expertise had been strengthened through selective hires to increase skills and capabilities, but the product range also needed to increase, as the Group currently lagged behind competitors in terms of the breadth of offering. This was being addressed, but would take some time to resolve. Good progress was being made in developing Ml and infrastructure that would support the necessary sales activity, and development of the product range.
The Liquid Market Trading activity was a center of excellence that had produced significant returns, based on arbitrage positions in liquid instruments held for relatively long periods of time. As a visible centre of excellence, this activity increased the profile of the Division, internally and externally, and helped with the recruitment and retention of key skills.
6. Intelligent Finance
The business had played a key part in delivering the Group’s market share ambitions, whilst establishing a new brand with a reputation for innovation; proving that offset customers would prove more resilient and resistant to churn.
However, the business had lost control of its costs and service quality after a successful launch—and had not yet built the necessary critical mass. A strong performance in relation to growing assets had not been matched by growth of liabilities.
To help address these issues the four strategic imperatives for 2004 were to:
extend the product range beyond offset, where the narrow product range had restricted growth for example, due to the lack of a fixed rate mortgage product;
increase cross-sales significantly, improving both retention and other income;
reduce the cost base significantly through reducing FTE’s, increasing integration with other parts of the Group and improving systems functionality, to reduce labour intensive workarounds; and
whilst delivering a step change improvement in customer service, as customer service issues remained challenging.
Intermediaries remained an important source of business for IF—particularly in the case of mortgages, and slightly less so in the case of other products. IFA’s had been good at selling the offset concept: but the Group now needed to move towards direct promotion of the concept, to reduce reliance on IFA’s. Cross selling and service improvements were linked: cross sales needed to improve dramatically, but service needed to improve to ensure that customers enjoyed the experience and were retained.
The Board was very supportive of this strategy, and the aim to return more closely to the original concept for the business. The advertising had failed historically to do justice to the concept—and the aim would be to improve this position. The business still had significant potential. Morale remained strong—but the emphasis on cost controls and break-even could begin to damage morale unless or until the business moved forwards.
7. The Mound Edinburgh—Restoration Project
The status quo in relation to The Mound, as the Group’s working headquarters, was untenable in the long term. The Group either needed to commit to the building for the long term, in which case the building needed to be much more functional and have a fundamentally broader range of potential uses, or the Group should leave the building. “Project Dulux” was outlined. This sought to restore the building sensitively, whilst improving functionality, and creating attractive conference and meeting space for the Group’s needs. This approach was supported by the Board—although it was acknowledged that this would be a high profile and potentially contentious issue locally.
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9. Schedule Of Advances—Business And Corporate Banking
Schedules of the principal advances made by the Business Banking and Corporate Banking divisions during September 2003 were noted.
10. Date Of Next Meeting
The next meeting of the Board would be held at 10.30am on Tuesday 25 November 2003 at The Mound, Edinburgh.