FSA Warned U.K.’s HBOS About Risks of Lending, Ellis Says

HBOS Plc, a U.K. bank bailed out amid the 2008 financial crisis, took notice of a warning from a regulator in 2004 that its pace of expansion was an “accident waiting to happen,” former Finance Director Mike Ellis said.

Ellis presented the Financial Services Authority’s risk assessment at a January 2004 board meeting, which said the “group’s growth outpaced its ability to control risk,” he told the Parliamentary Commission on Banking Standards today.

HBOS’s assets more than doubled to 681 billion pounds ($1.1 trillion) from 2001 to 2008 as the U.K.’s biggest mortgage provider increased lending to entrepreneurs and real estate developers. About 40 percent of the bank’s 117 billion-pound corporate loan book was allocated to real estate and commercial property. Lloyds Banking Group Plc, which purchased HBOS in 2008, had to seek a 20 billion-pound bailout that gave the government a 43 percent stake.

“The FSA’s early warning signal” was “taken extremely seriously and a number of steps were taken to address the points they raised,” said Ellis, who was finance director of HBOS from 2001 to 2004 and from 2007 to 2008.

The bank’s reliance on wholesale funding markets was also recognized by the lender as a “potential strategic risk” by 2004, said Ellis.

‘Achilles Heel’

The gap between deposits and lending got bigger by the time of his return in 2007, increasing the bank’s dependence on wholesale funding, said Andrew Turnbull, the panel’s chairman.

“That indeed was the Achilles heel that brought you down,” said Turnbull. It was identified as a “weakness” though wasn’t responded to with urgency, he said.

Later in the hearing, Peter Hickman, who was group risk director from 2007 to 2008, said the lender’s loan-to-deposit ratio and its property investments meant “stories were more likely to be believed by the market” about HBOS’s financial weakness, allowing short-sellers to profit.

A sharp drop in the bank’s share price in March 2008 “certainly had all the hallmarks of a deliberate attempt to undermine the share price, presumably to make money from the sharp movement down,” he said. “They could have threatened the bank’s existence.”

HBOS fell 32 percent in the three weeks to March 19, 2008.

-- Editors: Jon Menon, Edward Evans