Bearing down

It's not a good idea to dump the pilot in the middle of a storm. Who knows what will happen two years down the line when it has calmed down

IT MUST have felt like the longest seven days in the career of HBOS chief executive Andy Hornby. As he and his advisers waited nervously ahead of Friday's deadline on the rights issue, the news from America could not have been worse timed.

Fannie Mae and Freddie Mac, two giant US mortgage corporations, had to be rescued by the Federal Reserve and US treasury, sending investors on both sides of the Atlantic into a spin about what next might befall a deeply beleaguered banking sector.

With the attention of the City focused on the struggling share price, Hornby also confirmed a long-running rumour that the bank was to make job cuts. The announcement that 650 of its 65,000 employees were to be axed across the UK made local headlines but went almost unnoticed by the markets who were more concerned that the £4bn issue of new shares would get away smoothly.

With the shares closing at 268p on Thursday – below the 275p rights price – and two other banks, Bradford & Bingley and Barclays, also squeezing shareholders for cash, it looked as if it was going to be touch and go.

A rally in HBOS shares after Friday's 11am deadline came too late to make any difference. Most shareholders had made their decision earlier in the week. Many institutions would have decided on Tuesday or Wednesday what to do and that was when bank shares took a nosedive. For many investors it would have been enough for them to say no.

It now looks like the issue will have a subscription of between 10% and 20%, leaving the underwriters Dresdner Kleinwort and Morgan Stanley, and their sub-underwriters, to pick up the bill for the rest. If the share price holds above 275p this week they will at least be able to sell the shares at a profit.

While Hornby and market watchers are being broadly philosophical about the outcome, there will be comparisons with Royal Bank of Scotland's rights issue. Just over a month ago, RBS boss Sir Fred Goodwin saw shareholders take up more than 95% of new shares in its record £12bn rights issue. RBS may well have been vindicated in making the first move, not least because the HBOS issue has spanned a further weakening in the global economy and the FTSE falling into bear market territory. But questions have also been asked of the strategy followed by Hornby, who at 41 is a relatively young chief executive, and his team. HBOS positioned itself as a mortgage bank and its corporate division continued to lend to house builders, despite gloomy predictions for the sector.

Hornby, once hailed as banking's "boy wonder", will now be forced to answer questions from investors, many of whom are institutional pension funds, and the HBOS' board about where it goes from here. They will also want to hear that, unlike Alliance & Leicester which has fallen prey to Abbey-owner Santander, it will not become a takeover target.

When Hornby took up the job as HBOS chief executive in 2006, following James Crosby's early retirement, he was described by analysts as a "superstar". But since then almost £30bn has been wiped off the bank's valuation in the past 12 months.

Like A&L and Bradford & Bingley, HBOS has been exposed to a weakening in the UK housing market.

The HBOS group is by far the country's biggest mortgage lender, with a 20% market share through brands such as online bank Intelligent Finance, The Mortgage Business – which only deals through intermediaries and is involved in the risky self-certification market – and Birmingham Midshires, one of the country's biggest providers of buy-to-let loans.

Its share of the market is more than double that of Abbey, its closest competitor, which has just over 9% of the total.

One analyst said: "A sizeable chunk of HBOS's £235bn loan book is self-cert and buy-to-let. If you look at self-cert in the early-1990s downturn, its performance was a lot worse than the mainstream mortgage market. There are no comparable figures for buy-to-let available, but it is expected to show a similar poor performance. These are big drivers for concern. It was clearly too dependent on mortgages, in contrast to HSBC, one of the most diversified banks."

Eric Spreng, manager with Redmayne Bentley stockbrokers, warned that the full extent of HBOS's lending strategy may not yet have been realised. There has not been a collapse in housing prices and if house prices were to fall by, say 25%, HBOS would be plunged into greater difficulties, he says.

Hornby and his team – most notably Peter Cummings, chief executive of Bank of Scotland Corporate – have also been accused of failing to spot the danger signals in the beleaguered house building sector. In the past few weeks builders, including Taylor Wimpey and Barratt, have cut thousands of jobs and their share prices have plummeted.

As recently as April, BoS Corporate invested £27.5m in Scottish builder Tulloch Homes. It has a 50% stake in Crest Nicholson, an undisclosed holding in Miller Group, and also bought into retirement homes specialist McCarthy & Stone.

Cummings is a BoS "lifer", having joined BoS in 1973, and is highly regarded for his deal-making skills. His pay packet reached £2.6m last year, overtaking even Hornby, as his loan book and reputation grew.

But Cummings will now see 650 employees losing their jobs in HBOS's banking and commercial businesses which are being merged into a single business to serve small and medium-sized enterprises. As well as cutting costs, HBOS says it hopes this move will help it compete with its four larger domestic rivals who dominate that sector.

The question now is whether shareholders will call for heads to roll, or take the view that HBOS's management team, in common with other banking bosses, are victims of circumstances, in this case an international crisis, rather than the perpetrators. One analyst said: "Hornby has only been chief exec for a little more than two years. He didn't put the strategy of being a mortgage bank in place, and he hasn't done a lot to change that strategy since."

Another said that investors would do well to look back on the last banking recession in which those with exposure to unsecured lending – credit cards and the like – and financial markets were the ones to get into trouble. HBOS has also fended off criticism for being too reliant on the UK market, but it is those with exposures in America that have been hard hit this time around.

It would appear that Hornby's position is safe and that the markets will empathise with his role at a time of global turmoil which could last some months and which will have more twists and turns. Bryan Johnston, director with Bell Lawrie, private client stockbrokers, said: "It's not a good idea to dump the pilot in the middle of a storm. Who knows what will happen two years down the line when it has calmed down."

A few shreds of good news did emerge from across the Atlantic last week, with Wells Fargo's shares jumping 32% when the bank announced it was raising its dividend to 10% and the US Census Bureau revealing that housing starts in June were "considerably above expectations".

However, these relatively small glimmers of hope are unlikely to have a positive impact in the UK for some time to come. In such a testing global economy, analysts say HBOS is faring better than the likes of A&L and Bradford & Bingley. Last week's £1.3bn offer by Santander for A&L was seen as a bargain buy at a time when all the mortgage banks could be up for grabs. David Cumming, head of UK equities at Standard Life Investments (SLI), said: "It (Santander] is acquiring A&L on giveaway terms."

Although B&B got investor backing for its critical £400m rights issue rescue on Thursday, its executives came in for further criticism from shareholders. SLI, the buy-to-let lender's top shareholder, backed the rights issue but warned that it now needed to see action. "We look to your board to take steps to restore value to our clients' shareholdings in B&B," said Guy Jubb, head of corporate governance at SLI.

And while Barclays secured £4.5bn from investors on Friday to bolster its balance sheet, the bulk of the money will be provided by "anchor" investors led by Qatar, China and Singapore, rather than ordinary shareholders.

Against this grudging support, the board of HBOS will be hoping to placate anxious shareholders and will do so by arguing that the bank is fundamentally sound. John Wriglesworth, economist at the Wriglesworth Consultancy, said: "There's nothing wrong with HBOS's strategy. Of all the mortgage banks it is the only one that will survive as it is. It shouldn't change its strategy."

But analysts are divided on whether it is a likely takeover target. Spreng said: "There is no doubt that there's potential for a takeover. When the share price gets to a level where it is perceived as cheap, it leaves it open to potential suitors."

While Hornby has survived the rights issue, he must now regain the trust of the City and investors. In March he proved he can take decisive action when he moved quickly to quash rumours that HBOS was in trouble after short-selling forced its share price to plummet. At the time he said: "I went on the front foot and issued a denial straight away."

But he has also been accused of errors of judgment, including his decision to go to London to address analysts rather than attend the bank's AGM in Glasgow in April.

Hornby will now be urged to move on from the current mire and explain to employees, shareholders and customers exactly what HBOS's strategy will be in the post-credit crunch era. He may have to decide whether it is committed to being primarily a mortgage bank or if it should evolve into an all-round bank in the mould of HSBC.

The next few months, or even years, will not be easy for any financial institutions and Hornby is under pressure to prove he is a safe pair of hands, with the maturity and confidence to steer HBOS into better times.