Tuesday, 20 March 2012

Will the sale of Verde by Lloyds Banking Group to the Co-op complete and it is good for consumers?



The announcement by Lloyds Banking Group at the end of last year that LBG were in exclusive talks with Co-operative Financial Services (CFS) for the sale of the bundle of  632 branches and brands that is referred to as 'Verde' raised the question of whether this is good for UK banking and consumers. Clearly Gary Hoffman, Chief Executive of NBNK and former CEO of both Northern Rock and Barclaycard, didn't think so. “Lloyds has made the wrong decision. There is no question that the execution risk with the Co-op is much more significant, and over a very short period of time this will be proven". It could be argued that this is just sour grapes, given that Gary Hoffman's NBNK (a vehicle with significant institutional backing set up to buy one or more banks) was also bidding for Verde and didn't make the cut, however Gary Hoffman is one of the most experienced retail bankers in the UK and led Barclaycard to be one of the most successful credit cards businesses in the world, so he does know what he is talking about. With the expiry of the exclusivity agreement and the invitation of NBNK back into discussions, Gary Hoffman may yet prove to be right.

Merging Verde with the Co-operative ticks all the boxes for the ICB (Independent Commission on Banking) in that it will create a competitor with around 7% market share in current accounts and is building on an established player, both recommedations made in the ICB report. However that still doesn't answer the question of whether it will really become an alternative to the Big 5 banks.

Unlike Virgin Money (see http://www.itsafinancialworld.net/2011/12/is-northern-rock-decision-good-for.html ), the existing Co-operative Financial Services is largely undifferentiated from the Big 5 banks. Whilst it makes a lot of its ethical stance it was still caught up in the Payment Protection Insurance (PPI) misselling scandal, writing off £90m, which, in fairness, is a lot less than the major high street banks, but is still significant. CFS is hardly the most customer centric organisation. Until very recently the payment terms on its many charity-branded cards were so tight that unless you opened the credit card statement on the day you received it and made payment within a couple of days it was impossible to avoid charges for late payment. Hardly a customer friendly or ethical way to operate. This has now been addressed.

If you look at the high street presence of the combined CFS and Britannia branches (CFS acquired Britannia Building Society in August 2009), the offering and customer experience is dated and certainly no better than the major high street banks. With the addition of the Verde branches CFS will have around 1000 branches.

In the digital space CFS has in the past won many awards for its direct bank, Smile, but the lack of investment in this operation  has meant that it has not kept up with what customers are looking for from a digitally-enabled bank and is not sufficiently different to attract customers away from more traditional players. The same could be said of Intelligent Finance, the brainchild of Jim Spowart, which CFS acquires as part of the Lloyds Banking Group Verde bundle.

For CFS to really become the challenger that the ICB is so keen for it to be then CFS needs to significantly invest in fundamentally changing the branding and customer proposition that the combination of Co-Operative Financial Services, Britannia, TSB, Intelligent Finance and Cheltenham & Gloucester brings. With such a diverse group of brands with different values and attracting different segments it will not be clear to customers what it stands for and why they should engage with it. CFS will need to simplify, move to a single brand with a strong customer proposition which is more than just being an alternative to the other banks. It needs to design a customer-centric bank where branches are but one part of the overall way that customers can engage, digitially enabled and fit for 21st Century Customers. That requires a lot of investment, above and beyond the capital required to acquire Verde, the hundreds of millions required to integrate Verde whilst still keeping the lights on, and ensuring the Verde customers don't defect before they are transferred. With no shareholders to turn to and the wholesales markets still not working efficiently finding the funding at an affordable price is an enormous challenge for CFS.

Over the following few months as the negotiations continued with Lloyds Banking Group, CFS got to understand more about what it is undertaking, but still has to establish whether it can raise the funding and only then will it become clear whether CFS is going to be able to close the deal. If they do, but don't invest in the transformation, then what the UK consumer will get is just another high street bank and the hopes of a challenger that the ICB had will be just that, hopes. If CFS embraces the challenge then the re-born CFS could be a really exciting, ethical, customer-focussed challenger and the Big 5, as they wrestle with implementing ring-fencing, should be seriously worried.

The concerns don't only lie with the Co-op. For Lloyds Banking Group having just come off the back of spending nearly £4bn on the integration of Lloyds TSB and HBoS, the question of just how much it will cost to separate what constitutes Verde from the mother ship is concerning. Anything over £1bn would be a real challenge for LBG given everything else they have on their agenda. The Co-op target systems are not ideal, particularly as they still haven't completed the integration of Britannia, so increasingly the deal may be looking less attractive to LBG.

As is increasingly looking likely they reverse their existing banks into Verde sticking with the LBG systems, they will end up with superior systems than they have today. Unlike RBSG, the Lloyds Banking Group systems, based on the original TSB systems are real-time and not significantly batch-based. This gives them significant advantages in dealing with customers demanding real-time banking. However CFS will end up with the suboptimal LBG systems as Lloyds is spending significantly on 'simplifying' their systems, but only for the LBG version not the ones going to Verde. This means that Verde will be disadvantaged to LBG, so may not be as competitive.

The FSA (Financial Services Authority) is now demanding that, assuming the Verde deal goes through, given that Financial Services will be around 40% of the Co-op's business that the governance appropriate to a bank is put in place. This would mean having a board made up of executive and non-executive directors that would need to be FSA approved. Given the time it is currently taking for the FSA to approve executives is measured in months not weeks and that the Co-op doesn't currently have a CEO for its Financial Services business (though interestingly Gary Hoffman has allegedly had conversations about filling this role) this could be a deal breaker. However Lloyds Banking Group could sweeten the deal by providing a team of seasoned managers to run the business. Whilst this might put the FSA's concerns about leadership experience to bed, how radical will this new competitor be if it is being run by the same people who ran Lloyds Banking Group?

On top of that the Co-op as a co-operative is currently governed by its members. The FSA's requirements fundamentally challenge the way that the Co-op wants to run its business.

The possibility of  CFS walking away from Verde is looking increasingly unlikely.
There is still the chance that an  IPO is the more attractive solution for LBG given how cleaner and simpler that will be for the bank, however with bank asset prices at an all time low at what price would the IPO get away?

It looks like CFS may have got their deal, but will they suffer from buyers' remorse?

Monday, 12 March 2012

Why the culture of banks has to change



With the FSA (Financial Services Authority) report on what went wrong at HBOS (Halifax Bank of Scotland) before the bank had to be rescued by the UK Government and Lloyds TSB clearly showing that the issue was one of governance, there has never been a time when the need to change the culture of the banks has been clearer or more urgent.

The FSA report demonstrates that the corporate lending division of HBOS had a far riskier book than any of the other UK banks. HBOS continued to win deals in both the commercial and retail property markets in the UK, Ireland and Australia at lower margins and higher risks at a time when all the other banks were reducing their exposure to the sector or no longer pursuing new business. HBOS proudly proclaimed their success and growth in the market, not recognising that they alone were doing this. It doesn't appear to have crossed the minds of the executive that they were winning business that no one else wanted, or at least no one wanted at the rates that HBOS were offering. When the Head of the division proposed a growth of 10-12% in commercial lending not only was this not challenged he was told by the CEO of HBOS that this needed to be increased to 22%.

How could this situation have arisen?

The CEO of HBOS, Andy Hornby, had arrived at HBOS triumphantly from ASDA, part of the Walmart Group. With no background in Financial Services but having graduated top of his course at Harvard and having had a successful career with the strategy consultancy, Boston Consulting Group prior to ASDA, he was seen as the person who would shake up the sleepy financial services industry. He surrounded himself with people who agreed with his position. Those who didn't agree with him got short shrift. Benny Higgins (currently CEO of Tesco Financial Services), had joined from RBS, where he had had a very successful career, to lead the HBOS retail banking business. He left after only a very short while when he fell out with Andy Hornby over strategy.

What this meant was that no one was there to challenge the strategy and the decisions that the CEO of HBOS was taking. Not dissimilar to the situation that was described in the recent report on what went wrong with the corporate governance at RBSG under the leadership of Fred Goodwin.

It is undoubtedly for this reason that the FSA is asking for a change at the Co-operative if they wish to push ahead with the acquisition of the Verde branches from Lloyds Banking Group. The FSA are insisting that the board of the Co-op must have much more experience of Financial Services and be able to challenge the executive leadership of Co-operative Financial Services. This could be such a significant challenge for the Co-op to make them question whether they will continue to pursue the deal. Finding people who the FSA will approve to run or sit on the board of a bank is increasingly difficult. It took Tesco over two and half years to get approval to set up their bank. The FSA has an increasingly large backlog of people to be approved to work in senior roles for banks and it now takes months to get approvals for an individual, even if that individual has already been approved for a similar role at the bank or a rival bank. Such a delay in being able to pushed forward with Verde could make the deal so unattractive to the Co-op that they walk away from it. However given what went on at HBOS and RBSG it is not difficult to understand why the FSA is pushing for this.

The culture of banks where the CEO's and other executives' words are final and unchallengeable is not something new and has always been dangerous.

A recent example of this is the fine raised on RBSG for complaints. The fine was not for the poor service that RBSG was giving its customers but for the fact that the complaints received were modifed by staff before being submitted to the Banking Ombudsman. The reason given being that the staff were afraid of the consequences for their careers of the complaints being upheld. What does this say about the culture at RBSG today, many years after Fred Goodwin left?

A further example that illustrates why the culture needs to change is that of the misselling of PPI (Payment Protection Insurance). It was known throughout the banking industry that both personal loans and mortgages were being sold at prices below cost and subsidised by the excessively high margins on PPI policies, which were very hard to claim on. Yet because it was so profitable no one spoke out and the number of PPI policies that were sold grew exponentially. Why did no one speak out? Surely the hierarchical, command and control culture of the banks has to be key to this along with the pursuit of short term profits at the cost of the customer.

The £8.75m fine imposed on Coutts, owned by RBSG, for not putting in adequate measures to ensure that the money-laundering wasn't taking place or that they were doing business with PEPS (Politically Exposed Persons). One of the reasons cited by the FSA for this behaviour was that staff were incentivised to add additional customers and balances with no measure about the quality of the balances or the customers, is yet more evidence for the need for a fundamental shift in the culture enforced by alignment of incentives with the values that the banks should be upholding.

Without a fundamental change to the culture of banks, where both independent, experienced voices are listended to and encouraged to challenge the exexcutive of banks and with CEOs and senior executives who encourage their staff to challenge their thinking without fear of reprisals then another HBOS, PPI misselling or the latest misselling of derivatives to SMEs is inevitable.