Monday, 23 July 2012

Is Co-op really a contender with Lloyds' Verde?


Lloyds and the Co-op?


What Co-op is acquiring is the 632 branches that Lloyds has had to sell, with all the Lloyds TSB Bank branches in Scotland, the Cheltenham & Gloucester branches across the UK and the rest made up of other Lloyds TSB branches. They will also get the CEO of Verde, Paul Pester, his team and the management and the staff for those branches. Lloyds Banking Group will provide and manage the systems for the foreseeable future.

What does this mean? Starting with the customers there is no guarantee that the customers for those branches will move to Co-op. Whilst Lloyds Banking Group can't market to those customers to transfer their business back to Lloyds, customers are not obligated to stay and could easily move their accounts to another bank, including Lloyds. Evidence of this was seen when Santander bought the RBS branches that had to be sold. Customers did not like the idea of being sold and many have moved their accounts before the transaction went through. As a consequence the value of the deal to Santander has gone down significantly.

Looking at the leadership and staff of the new bank - it is the old leadership and staff. Many of these people will have been at either Lloyds or TSB for many, many years, so there is no guarantee that they won't continue to deliver banking the way that they always have done. Indeed the systems will enforce the processes and incentives of the existing Lloyds Banking Group. Verde, or TSB as it will be branded, could be just a mini-me Lloyds Bank, without the scale to compete.

Having Verde run on the Lloyds' existing systems for the foreseeable future has two distinct disadvantages for the Co-op.

Firstly, the acquisition benefits of rationalising systems and processes that usually underpin any M&A deal are not going to be realised. Instead the Co-op will end up running their Co-op and Britannia branches using the Co-op systems and processes (assuming the completion of the migration of the Britannia systems onto the Co-op platform) and the TSB branches using the Verde systems and processes. Many of the synergies that the bank would have hoped to realise from their 1000 branches will not be achieved until they can move onto a single platform. Due to the complexity and the cost of the Verde systems the migration has been kicked into the long grass. The Co-op will have all the overheads of having to support three brands in the market, Co-operative, Britannia and now TSB. Not only is there expense in running multiple brands, but significant scope for confusion amongst customers. Rather than having a new 1000 branch contender there will be three brands fighting to compete for customers all with less scale than the Big 5.

Secondly Antonio Horta-Osorio, the CEO of Lloyds Banking Group, recognises that the systems underpinning Lloyds are simply not good enough to compete in today's retail banking market. This is why he is spending hundreds of millions of pounds on the 'Simplification' programme to improve the efficiency and effectiveness of the banking systems to enable them to compete in the mutlichannel, always available, digital world. However those improvements will not be applied to the Verde systems. To use an Olympics analogy it is like your older brother giving you his old Nikes while he is upgrading to the far superior ones. Who would you expect to win in those circumstances?

With the size and scale of Lloyds Banking Group there is far more scope for investment in making the retail bank fit and efficient than there is for the Co-op. Not only that, when the Co-op wants to make upgrades to their TSB systems they will be dependent on Lloyds Banking Group to make those changes for them. Whilst Lloyds can be recognised for its history and experience of  excellence in retail banking it is not well known for its provision of IT services and certainly not as a commercial provider of IT services. The Co-op may find itself held back by the speed and agility of not only its systems but also its IT services provider.

The celebrations of the Co-op creating a contender of scale to compete against the Big 5 banks may be a little premature.

Saturday, 23 June 2012

RBS pays the price of underinvestment as systems fail



It was for good reason that Fred Goodwin, the former CEO of Royal Bank of Scotland, was nicknamed Fred the Shred. Slashing costs and running a lean bank was what he was famous for. However the retail bank was not just lean, it was positively anorexic. RBS was very proud of the way that the merger with Natwest was delivered on time and below budget. They were also very proud of the fact that they had the lowest cost:income ratio amongst Western banks. However it is not difficult, in the short term, to have a good efficiency ratio if you starve the business of investment. In the longer term this lack of investment will come back to bite the organisation.

The impact of the lack of investment is being realised at RBSG (which owns the RBS, Natwest and Ulster Bank brands) as the bank has had one of the worst customer visible, publicly embarassing technology problems a UK bank has had in recent times. Many customers have not been able to access their accounts online and balances have not been correct due to 'technical problems'. Branches have had to extend hours both at the beginning and the end of days and even, shockingly, opening on Sundays. It couldn't have happened at a worst time of the month as this is the time when many salaries are being paid in and bank balances are typically at their lowest.

RBS, Natwest and Ulster Bank share the same systems. This was a significant part of the business case for the merger of  RBS and Natwest. The merger was based on migrating the Natwest systems onto the RBS platform. One of the reasons that the merger was completed on time and below budget was because of the no arguing approach that regardless of whether the Natwest IT was better it would be migrated onto the RBS platforms. This reduced costs which could have resulted from extended debates between the two banks as to the virtue of the systems. This philosophy came about following the Lloyds Bank and TSB merger where, after lengthy debate and two years pursuing a strategy of migrating onto Lloyds Bank's platforms, the decision was reversed and the Lloyds' platforms were migrated onto the TSB ones, which were far more modern and flexible than Lloyds'. The RSB management were determined not to make the same mistakes as Lloyds TSB had made.

The consequences of RBS, Natwest and Ulster Bank all being on the same platform is that the technical problem has impacted all three banks, albeit Natwest has been hit the most. The extent of the impact is further evidence of the lack of investment in re-architecting what are very old systems to give them greater resilience.

The impact of the lack of investment in RBS systems has not only caused the very public problems for customer service but also major delays in the handing over of the branches that Santander has acquired from RBS as a consequence of the forceed sale that RBS was required to make following taking state aid to stop it going under. Where the transfer of the branches was meant to take place in 2011 it is now projected to be completed in 2013. Not only is RBSG going to incur signifcant additional project costs for the separation, but also the amount that Santander will eventually pay for the branches will be substantially reduced due to the fall in bank valuations in the meantime. Separating the set of branches from the mothership has proved to be far more difficult than expected due to the archaic nature of the systems. These systems, many of the designers of which retired some time ago, were designed in a monolithic fashion rather than in a modern, modular way, meaning that it is the equivalent of removing a part of a limb from a live body nerve by nerve, vein by vein.

RBS is not alone in facing the symptoms of having creaking, old, underinvested systems. Nab (National Australia Bank) and CBA (Commonwealth Bank of Australia) have had a number of very public systems failures over the last couple of years, see http://www.itsafinancialworld.net/2011/04/deja-vu-as-nab-systems-down-once-again.html , however the difference is that both Nab and CBA have had major programmes underway for several years to replace their core ageing systems. Neither of these replacement programmes have gone smoothly, both are significantly late and over budget, but they will emerge with better systems, designed for the 21st Century and able to deliver a customer service designed with the digital age in mind.

The reality is that most of the major banks across the globe are facing the same problem of ageing systems and a reluctance to spend the money necessary to replace them. These are major programmes and for many CEOs will take longer than their tenure at the top of the bank, so there is little incentive for many CEOs to do anything about it.

Antonio Horta-Osorio, the Lloyds Banking Group CEO has recognised the challenge. On completing the merger of Lloyds TSB and HBoS he immediately kicked off a major simplification programme. He recognised that having all the brands on a single set of applications was only the first step towards making the bank ready for the 21st century. However simplification is not a core banking replacement programme, which is actually what is needed. It could make some difference. However it could simply be an exercise in rearranging the deckchairs on the Titanic. Simplification is like putting a patient with chronic coronary heart disease on a better diet and exercise routine rather than giving them the heart transplant they require.

Horta-Osorio came to LBG from Santander where the importance of the core banking system is recognised as being key to delivering the bank's strategy. Santander has its Partenon platform that has been instrumental in enabling the success of many of Santander's takeovers of banks across the globe including Abbey National, Alliance & Leicester and Bradford & Bingley.

Out of the public humiliation of RBS and the financial impacts of the delay in transferring the sold branches to Santander it is to be hoped that some good will come. Stephen Hester, the RBSG CEO should take this opportunity to take a long hard look at the investment that is needed to get RBS the banking systems that it needs to service its customers in the 21st century.

Friday, 8 June 2012

M&S to take on high street banks



UK retailer Marks & Spencer is to launch M&S Bank, rolling out 50 branches over the next two years. A 50:50 joint venture with HSBC with current (checking) accounts to be launched in the Autumn and mortgages 'later'. This gives M&S a head start on Tesco who has had to delay the launch of its current accounts until 2013. Ironically these two 'new' retail-based banks are frequently adjacent neighbours on retail parks across the UK, where the big four high street banks are rarely to be found, so it maybe that they find themselves competing with each other rather than taking on the big boys.

Of course neither Tesco or M&S are really new entrants into Financial Services both have been offering products for some time. M&S first started offering FS products in 1985 and has the successful &more credit card, but this will be the first time it is calling itself a bank.

The timing of M&S's announcement is good. Not only does it come after a set of disappointing results for its retail business, it comes at a time when the high street banks are both unpopular and mistrusted. This can only be good for M&S with it's slightly older, more affluent and loyal customer base.

With the opening hours of the branches being the same as the retail stores and the initial prototypes of the branches looking very retail, calm and sophisticated and, as they are keen to point out, with fresh flowers, this will, to coin their phrase, not be any bank it will be a Marks & Spencer Bank.

But will it really shake up competition in the banking sector? Fifty branches over two years is not that many. Given that Virgin already has 75 branches (since its acquisition of the 'good' Northern Rock), Yorkshire Building Society has 227, Handelsbanken (the least well known, but the bank with the highest customer satisfaction) has over 100 branches and whoever (Co-op, NBNK or a flotation) acquires the Verde branches, that Lloyds Banking Group has to dispose of, will have 632 branches, just like Metro Bank with its 12 branches, this is not going to be an immediate threat to the high street banks.

Certainly in the short term it will not make a significant difference to the M&S share price. However it has every chance of being a success that will build over time. M&S has decided not to take the route that Tesco is finding to be so challenging of going it alone without a bank behind it. M&S by partnering with HSBC is able to stick to what it does best - retailing while HSBC can focus on managing the banking operations. The CEO of M&S Bank, Colin Kersley, was with HSBC for 30 years, so he knows the bank extremely well. The UK CEO of HSBC is Joe Garner, who spent his early career with Dixons. The two organisations have worked together for a number of years (HSBC acquired M&S Money) and understand where each is coming from, so this has to be a significant advantage.

Overall from a consumer perspective this move by M&S is to be welcomed. Whilst Joe Garner is quoted as saying that this is 'the most significant innovation that HSBC has carried out since First Direct' only time will tell whether he is right.

Tuesday, 29 May 2012

Is forgiveness the answer to the financial crisis for Greece?

Though justice be thy plea, consider this,
That, in the course of justice, none of us
Should see salvation: we do pray for mercy;
And that same prayer doth teach us all to render
The deeds of mercy.
~ William Shakespeare, The Merchant of Venice. Act IV, scene i

I recently listened to a lecture by Professor John Geanakopolos, James Tobin Professor of Economics at Yale who argued using Shakespeare's 'Merchant of Venice' that the solution to both the US and European financial crisis was forgiveness.

He laid out the situation in the US, based on his detailed research, that there are a very large number of house owners with negative equity i.e. their loans are higher than the value of their properties. Many of these home owners had been encouraged by the banks to borrow large amounts on the basis of the rising property prices, put up very small deposits, as little as 2% of the property value, based on little evidence of their earnings, the so-called 'lo doc' loans or self-certification, as it is called in the UK, and often interest-only i.e. paying only the interest and not any of the capital back. The argument being that with property prices rising so quickly when the property was eventually sold there would be more than enough profit to pay back the original capital. Professor Geanakopolos reasonably argued that this was irresponsible lending on the part of the banks.

He then went on to make the case as to why it would be in the banks' best interests to forgive 50% of the loans for those who were struggling to make mortgage payments. He demonstrated that when the repossession process is started (which can take up to two years to complete), the home owner ceases to make any attempt to pay back the loan, stops taking any care for the property and may even damage the property. As the neighbourhood deteriorates due to the unkempt properties the value of not only this property but others in the area declines further. He demonstrated that by the time the costs of the repossession and the sale of the property were totted up that the return that the banks got was 25% of the value of the loan. Given that, Professor Geanakopolos argued that the banks would actually be better off if they forgave the home owner 50% of the loan thus giving the home owner the chance for reduced mortgage payments and an ability to continue to live in their property and to contribute to the US economy. This is an argument that he has taken to both the Obama administration and the financial regulators in the US, but has not yet, not surprisingly, received full popular backing.

Clearly this raises the question of whether people, some of whom have unwisely over-stretched themselves, who could be regarded as having been over-greedy in aspiring to buy properties beyond their means and, possibly even been dishonest in their reporting of their income (for those taking out lo-doc or self-certification loans) should be rewarded for their avarice by having their loans written off, while other more honest and risk-averse people who work hard to pay their mortgages despite rising costs get no such forgiveness? The counter argument being that the banks and their agents are guilty of being irresponsible in lending to these people who clearly could not afford these properties if the property boom faltered and deserve to be punished for their behaviour.

Whilst there is clearly some merit in the argument for the write down by the banks for the US housing market, particularly since this is impacts millions of households, the argument became more tenuous when Professor Geanakopolos, an American of Greek descent, argued that the Germans should forgive the Greek debt in a similar way to resolve the Euro crisis, which is having an impact on the US economy and globally. 

Whilst some similar financial arguments could be made for the Greek situation in terms of it is better to get some money back than none, there is a fundamental issue that needs to be addressed and that is that the proportion of Greeks that pay tax, pay the appropriate level of tax and the proportion of tax that is actually collected and finds its way to the Greek Government is woefully low. This particularly applies to the wealthy and middle class Greeks. For instance there is a swimming pool tax in Athens, which following a flyover the city it was clearly demonstrated that only a very small proportion of Greeks were paying. Whilst the Head of the IMF, Christine Lagarde's comments suggesting that Greeks were avoiding paying taxes caused a very angry reaction from politicians in Greece, she has a valid point.

In Russia Putin understood this. He lowered taxes and increased the number and effectiveness of tax collectors. The result was an increase in tax revenues.

Unless the level of tax collected is raised and a higher proportion of Greeks share the burden of taxes to pay back the debts that have been racked up then forgiveness will only be seen as a reward for tax evasion.  Forgiveness needs to come with strings attached - something that Shylock would certainly have agreed with. 

Friday, 18 May 2012

RBS forced to go down under for Retail Banking chief



RBS has announced that its new head of Retail Banking will be Ross McEwan. Despite the Scottish name, which undoubtedly is helpful at RBSG, Mr McEwan is from down under. He replaces Australian Brian Hartzer who is returning to his homeland to take up a similar role at Westpac (see http://www.itsafinancialworld.net/2011/11/wanted-ceo-for-uk-retail-bank.html ). It is not only native Australians that are making the journey down under, but there has been a flood of banking executives working in the UK who have decided to up sticks and move to the Southern Hemisphere (see http://www.itsafinancialworld.net/2012/01/trickle-becomes-flood-as-bankers-leave.html ).

Whilst a number of UK banking executives were approached and interviewed for the role that Ross McEwan will fill none of them were interested. This has to raise the question why? Certainly for executives with successful careers at banks free of government shareholdings such as HSBC and Santander there are clear reasons why a move to RBSG may hold little appeal. Given the turgid time Stephen Hester has had with his compensation and personal life discussed very publicly in the press and in Parliament to the point where even he considered resigning, why would anyone put themselves into that position when they don't need to? With the level of government implicit and explicit interference in the running of RBSG, there have to be better places to work. For the ambitious executive who sees heading Retail Banking at RBS as a career stepping stone the question is what would be the move after that? Almost certainly not into the CEO role of one of the UK banks as RBSG is a damaged brand and there are no obvious CEO roles coming up at the UK banks in the next few years. The probability is, as evidenced by Brian Hartzer, that the next move after heading up Retail Banking at RBSG would most likely be a CEO role in Australia. Not all UK banking executives or their families would see that as attractive.

With the Vickers ICB (Independent Commission on Banking)  recommendations coming into law including the ring-fencing of retail banking, the increased scutiny of bankers' compensation and the antagonistic attitude of British politicians towards bankers, the UK Government has made a career in UK banking very unattractive. For the state-backed banks, RBSG and Lloyds Banking Group, this has been made even more unattractive which means that these organisations are finding it even more difficult to attract top talent. The time it has taken for Lloyds Banking Group to find a replacement for Truett Tate, the head of Wholesale Banking is just one example of this.

Yet it needs to be recognised that to turn around these banks top talent is needed because these are some of the toughest challenges.

RBSG and Lloyds Banking Group are not alone in struggling to hire and retain top talent, it appears that having recruited Rumi Contractor from HSBC to become the UK Retail  and Business Banking COO in January that they have already parted company.

With HSBC CEO Stuart Gulliver suggesting that, with the increased cost of conducting retail banking, that pulling out of the UK is a real possibility, resulting in significant layoffs, reducing the number of  quality UK banking executives dramatically, there is a serious threat to the sector.

For the UK to retain its position as one of the key the Financial Services centres of the world, the sector needs to be able to attract the right talent. This is critical to the recovery of the UK economy. Isn't it about time that the politicians took the lead and put an end to the relentless bashing of the banks?

Friday, 4 May 2012

Why Lloyds shouldn't dismiss selling Scottish Widows



Following the rumour that private equity vehicle Tungsten, formed by Duke Street founder Edmund Turrell and his brother, was preparing a multi-billion bid for Scottish Widows, Antonio Horta-Osorio, CEO of Lloyds Banking Group, stated that the Group was 'absolutely' not selling Scottish Widows. Should Horta-Osorio have adopted the Sean Connery line regarding his return as Bond and said 'never say never' - was he over hasty in his response? Is there no price at which Lloyds should sell Scottish Widows? There are many reasons why the disposal of Scottish Widows should not be dismissed out of hand.

Scottish Widows was bought in 2000 for £7bn by the then Lloyds TSB CEO, Peter Ellwood, ably assisted by his deputy Mike Fairey. At the time many thought that Lloyds TSB had overpaid for  Widows, but it was a major plank in Peter Ellwood's strategy to build a major bancassurer. He was not alone at that time having a vision of creating a money supermarket, a one-stop shop for retail financial services from a bank. This vision was shared across the globe with the likes of Citibank acquiring Travellers and ING and AXA all pursuing this vision. However that was with the optimism of the new millennium and now in 2012 following the financial crisis most, if not all of those who adopted this strategy have abandoned it.

Certainly one reason that bancassurance has proved not to be successful is the fundamental difference in culture between a retail bank and a life assurance company. Retail banking is all about transactions, taking a short term view - daily interest charges, leveraging the differences between the deposit and the lending rates, taking and managing risk, whereas life assurance is much more focused on the long term with low volumes of transactions and risk aversity. Bringing the cultures of these two types of business together is like trying to mix oil and water, as has been shown in the market.

Apart from the cultural differences there are other reasons why Lloyds Banking Group could be better off without Scottish Widows. With the impending imposition of  Solvency II regulation, insurers are going to be required to hold higher levels of capital than they currently do, which will make doing the business of life assurance more expensive. Layer on top of that, for the likes of Lloyds Banking Group, Basel III and the recommendations of the Independent Commission on Banking (ICB) and the capital requirements are even higher. Long gone is the efficiency of being able to apply the same capital to both the insurance company and the bank. With the cost of acquiring capital being a lot higher than it was at the beginning of the century this further increases the cost of simply doing business.

It is surprising that Antonio Horta-Osorio is defending the bancassurance model, since the bank he came from, Banco Santander, one of the banks that has survived the financial crisis better than most, despite being headquartered in Spain, has always vehemently argued against both the bancassurance model and investment banking and could justifiably say that they have been proved correct. It was most commentators' expectations that given his experience and training that Antonio Horta-Osorio would see the disposal of Scottish Widows as one of his highest priorities.

Another reason to be shot of Scottish Widows is the introduction of the rules coming out of the Retail Distribution Review (RDR). RDR fundamentally challenges the bancassurance model, makes the cost of selling life assurance and investment products much higher. It has seen Barclays and HSBC amongst others, withdraw from selling mass market assurance products and subsequently laying off thousands od staff in the process. Lloyds Banking Group  is almost a lone voice on the high street still offering assurance and investment advice to the mass market. This may be a smart decision on the part the Group or could it be that the others are all correct?

Certainly if there is someone prepared to make a good offer for Scottish Widows then it could be in shareholders' (and that means UK tax-payers and the UK Government) best interests that LBG makes the deal as this would be a rapid way of paying down debt and should see a significant increase in share price.

The cost and difficulty of separating Scottish Widows from the rest of Lloyds Banking Group is far lower and far simpler than that of separating the 632 Verde branches that LBG is negotiating with Co-Operative Financial Services. The reason for this is that, despite Lloyds TSB acquiring Scottish Widows in 2000, the level of integration between Scottish Widows and the rest of Lloyds Banking Group is relatively low. It has been managed largely at arms length and therefore carving out would not be that difficult, so this is a deal that could be executed relatively quickly and the benefits achieved faster than other disposals.

Certainly if Scottish Widows was sold that would give Antonio Horta-Osorio and his team the chance to focus on the core issue of restoring what was a great and much-admired bank not just back to where it was before it was forced to buy HBoS, but to be even better and even more a bank for customers of the 21st century.

Tuesday, 1 May 2012

NAB withdraws to the north - the end of innovation?



The announcement by National Australia Bank (NAB) that they are to close 29 of their business lending centres in the south-east of England and withdraw back to their northern roots, abandoning 80,000 customers, marks the end of an experiment initially started by John Stewart, then CEO of NAB, and more recently Lynne Peacock, until last year CEO of NAB in the UK.

John Stewart and Lynne Peacock worked together for many years at the Woolwich Building Society, where they were responsible for launching the UK's first flexible mortgage, the Open Plan mortgage, combining a savings account with a mortgage account, offsetting savings interest against mortgage interest. Ironically the Open Plan account was based on Australian flexible mortgages. Such was the success of the Open Plan account that Barclays decided to acquire The Woolwich and centre their mortgage business around their acquisition.

John Stewart was seen as an entrepreneur,leading Financial Services industry development and was subsequently hired by NAB to lead the business in Melbourne. He brought Lynne Peakock along, initially in Melbourne and then to lead the UK business consisting of Clydesdale Bank and Yorkshire Bank.

Once again, looking at how he could make a small player in a crowded market stand out from the crowd, he and Lynne Peacock came up with a strategy to take the strong Yorkshire Bank brand down to the sout-east and take on the Big 4 banks in their traditional territory. They came up with an entrepreneurial model where banks managers were allowed to operate like a franchise, to be directly rewarded for the performance of their branches, or Business Lending Centres, to be able to make lending decisions with less referral to the centre and therefore quicker decisions for customers. Their Business Lending Centres look like airline lounges, customers could use them to conduct their own business when in town, creating a very different customer experience. They even went so far as to organise 'speed-dating' for buinesses, whereby SMEs could meet other SMEs in order to do business with each other introduced by NAB. At the time  NAB was, once again, seen as leading the way in terms of a new banking model, of a new customer experience and indicating where the banking industry needed to go. The model was successful with the lending book growing at above market rates.

Many of the ideas that he and Lynne Peacock came up with have been emulated by other banks such as Handelsbanken (see http://www.itsafinancialworld.net/2012/02/who-said-branch-banking-was-dead.html , http://www.itsafinancialworld.net/2011/06/forget-virgin-money-or-metro-bank.html ), where the bank manager is master of his own business. NBNK in describing the type of banking they want to launch also describes something that is very similar to the NAB model. Metro Bank has gone some of the way towards this as has Virgin Money.

The reason that this has not worked for NAB is twofold. Firstly the focus was on commercial property lending. Since even before 2008 the commercial property market was overheating and finally burst, but like HBoS, NAB continued to lend and has, as a result, got a disproportionate amount of bad loans. Undoubtedly one of the reasons why the book grew so fast was because of the franchise model where the managers were paid in direct relation to the loans they made, which encouraged lending and discouraged caution. The second reason is that whilst NAB provided an excellent customer experience the customers were not prepared to pay for that. This is something that many banks face in a heavily commoditised market where there is the perception of 'free banking'.

In many ways it is a great shame (not least for all the people who will lose their jobs), that what NAB set out to do has failed. Certainly a number of the players, such as JC Flowers and NBNK, who have stated that they want to enter the UK banking market should consider whether acquiring the UK southern assets of NAB should be an option, rather than acquiring all of NAB UK.

Monday, 16 April 2012

Is NBNK drinking at The Last Chance Saloon?



With the speculation that NBNK are pulling out of the bidding for National Australia Bank's UK banks, Yorkshire and Clydesdale, due to the price being asked being unrealistically high. given is that the level Given that the level of impairments in NAB's UK mortgage book could be as high as 30% and the desire of Cameron Clyne, CEO of NAB, to get a price that the market won't bear, this, if confirmed, would be a wise move on the part of NBNK.

Given the market sentiment towards the banks, particularly with the uncertainty of what will happen in Europe and the faltering UK economy, now is not a good time to sell banking assets. For NAB or any other banking organisation looking to sell out of the UK when there is a focus on building capital reserves taking the write down on UK banking assets would not be seen to be a smart move by investors.

NBNK (New Bank) is an investment vehicle backed by some of the biggest asset managers and led by Lord Levene, former Chairman of Lloyds of London, the insurer not the bank, with the sole objective of buying banking assets. Having lost out to Virgin Money, which bought the Northern Rock 'good' bank, and not being selected as the preferred option for the Lloyds Banking Group sale of 632 branches (Project Verde), the options for NBNK do not look good.

With the negotiations between Co-operative Bank and Lloyds Banking Group for Verde floundering, NBNK last week put in a revised proposal for Verde. The response from Lloyds Banking Group was cool. Whilst they acknowledged the receipt of the letter, they re-emphasised that they are in exclusive talks with the Co-operative Bank.

It is increasingly unlikely that the Co-op negotiations will end successfully with questions over the structure, governance, ability to raise capital and the ability to execute on the deal being raised by the FSA (Financial Services Authority).

If the Co-op is unable to get to an agreed deal will NBNK be re-invited into negotiations? Currently the Lloyds Banking Group stanc is that their fall back position is a floatation of a mini-me version of Lloyds TSB. However this would require investors backing the IPO and there is certainly skepticism amongst the investment community as to whether that would be achievable. If banking assets are seen as generally undesirable at the moment what is going to change for a Lloyds Banking IPO? The concerns about an IPO would not just be limited to the ability to raise the finance, but equally the leadership of the mini-me Lloyds TSB would be scruitinised by the FSA. The current leadership of Verde does not consist of obvious big hitters and would need to go through the FSA approval process, before the deal could get away. For Tesco it took nearly two years to get that approval.

For NBNK, if they are invited back into negotiations then they would need to conduct a very detailed due diligence as the deal execution risks are very high. After all the systems and processes that Lloyds Banking Group are putting into the deal can't be that good, otherwise why is LBG spending more than a billion pounds on the post-merger 'Simplification' programme, much of which is being spent on the technology that they are suggesting that the buyer would be stuck with for not an inconsiderable time?

For NBNK with so few opportunities out there to acquire banking assets, are they now drinking at The Last Chance Saloon? Is it time to call last orders, to close down the fund and gracefully walk away?

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.