Project Verde

Supplementary written evidence submitted by Lord Levene , 14 January 2014

Background

It is worth remembering the climate and conditions in 2009 surrounding ‘Project Verde’ and the required sale of 632 branches of Lloyds Banking Group (‘LBG’), which came about as a result of a decision of the EU.

That decision [1] stipulated, among other things, that ‘This proposed divestment package will facilitate the entry of a new competitor or the reinforcement of a smaller existing competitor on the UK retail banking market and will therefore remove the distortions of competition created by the aid.’

Also in 2009, the Government of the day published a White Paper on ‘reforming financial markets’ in which the then Chancellor recognised the significant barriers facing new entrants to the banking sector and determined to tackle the challenges facing the Government in its desire to increase competition and new entrants [2] .

When the coalition Government took office, again there were warm words about the need to increase competition in financial services and the banking sector to create a more competitive industry [3] .

Against this backdrop therefore, I was asked in 2010 if I would be prepared to become Chairman of a new venture – NBNK – and agreed to do so because I was shown that the institutions behind NBNK had a commitment to make up to £2bn of funding available for a new bank. My job was to recruit a board, recruit the core of new management, establish the new vehicle and prepare for a bid for UK banking assets so that NBNK could become ‘a new challenger bank’.

Our supporting institutions immediately subscribed £50mn to cover the initial costs of NBNK and I recruited a board with different talents, all of whom had a deep understanding of different elements that would be required for the venture. The credentials of the board were impeccable, containing a blend of senior banking, political and legal experience. Subsequently, I recruited Gary Hoffman, a former Deputy Chairman of Barclays Bank and, at the time, Chief Executive of Northern Rock.

At this point, it is important to note than on 9 July 2010, I arranged to meet with Mr Clive Adamson, at that time the Director responsible for Major Retail Groups with the then FSA. The main reason for my visit was to enquire as to the procedure we would need to follow to obtain a Banking Licence for NBNK. Mr Adamson told me that we would not need to acquire in advance a small existing bank in order to have their licence available to us. On the contrary, he said that the quality of our board and their antecedents was very well known by the FSA and we could proceed with our work and obtain a licence with no difficulty when we were ready to start operations.

The acquisition of the Project Verde assets became an immediate priority. Discussions continued with LBG throughout the remainder of 2010, albeit with a lack of urgency from the LBG side. This changed with the appointment of Antonio Horta-Osoria and in early 2011, the public signal came that the Verde branch sale would be accelerated.

It is important to put on record NBNK’s acceptance that the timetable for the bidding process was a matter for LBG and that, frustrating though it may have been, NBNK had to (and did) accept that LBG was under no obligation to comply with its own publicly communicated timescales for the Verde Process.

Timeline – important questions

I have enclosed a timeline of key dates through the Verde process that I hope will be of assistance to the Committee. I also attach some documents referred to in the timeline, which I am prepared to put on the record.

Picking out some of the key moments from the timeline, there are a number of questions that have vexed me for some time:

1. Immediately after the second round bid deadline in September 2011, it became clear that NBNK had been the only bidder to meet the deadline. On 1 November 2011, LBG formally requested NBNK to make a revised offer. At this point, we also learned that LBG was still in discussions with the Co-op. Changes were being made to the package of assets for sale. Why, when the Co-op had had plenty of time to get its act together, did LBG go to such lengths seemingly to induce the Co-op to bid? I am not persuaded that this was solely about competitive tension. The IPO was always on the table so the absence of a Co-op bid would not have left LBG without a choice.

2. Within two days of our final Round 2 bid in December 2012 , LBG announced that the Co-op had been successful. Even the process of announcing this decision was, to our eyes, curious. The announcement was made earlier than LBG had previously said it would announce, we had continued to be invited to meetings etc. right up to the very final moments when, presumably, a decision had already been made. Why this haste to announce? Was it that LBG had already made up its mind? And is it credible to believe that the announcement had been made without the involvement of the Treasury?

3. Our board met on 10 January 2012 to digest the LBG decision – an extract of our minutes is attached as Appendix 1 at pages 6 - 8 of this Briefing. This sets out quite neatly the several concerns that we have (and have had for a long time) about the process. Namely, that it was not a fair race; and that the Co-op was not in any shape at all to undertake the acquisition. In those minutes, we refer to our belief that the FSA should be concerned about the Co-op. This was a matter to which we returned later in January when Gary Hoffman and I met with the Chairman of LBG. At the meeting, we handed him our paper entitled ‘Key risks to the Co-op and Verde transaction’, which the Committee has already seen. In giving evidence to this Committee, Sir Win denied any knowledge of this document, and has since attempted to play down its importance. The initial reaction from the LBG Press Office to this document is attached in the form of a file note dated 24 June 2013 as item no.CC in the Time Line. Nevertheless, awkward as it may be for LBG to accept, both we at NBNK and leading market players at the time (who spoke with us privately) were of the clear view that the Co-op bid could never succeed. Were such misgivings communicated to the LBG board? Have the LBG board minutes been seen by the Committee? And why was the Treasury so effusive in its welcome of the Co-op bid when we know that there were dissenting voices making clear the truth – the Co-op was not and, in its state at the time, never would have been capable of taking on the Verde branches, which indeed was exactly what transpired.

4. Once the Co-op exclusivity arrangement ended – inevitably without agreement as to heads of terms – we were invited back into the process. LBG sought comfort in three areas. These were: our position with the FSA; technical points about price mechanisms; and our ability to raise the capital to support our bid. We thought – and LBG did nothing but encourage us to have this thought – that we were able to satisfy them on all three points. Once again, LBG provided new data that changed the shape of the Verde package and dramatically reduced the bid value. By this time, some of our directors believed that LBG was institutionally determined not to sell to NBNK and that it was difficult to escape the conclusion that Lloyds was using NBNK as a stalking horse for the IPO option, or to postpone the disposal altogether. In the end, the board reached the conclusion that it should submit another bid in good faith, and that residual concerns about the shape of the Verde package should continue to be negotiated.

5. In May 2012, my office received a call from the office of the Governor of the Bank of England asking me to attend a meeting with him. The meeting took place on 28 May and he and I met alone. The Governor told me that he understood that our bid would not be accepted, that he could not intervene in the matter and that the only thing I could do would be to meet with the politicians (that meeting with Mark Hoban and, in part, with the Chancellor, took place on 26 July 2012). Subsequently, on 27 June, the Co-op was announced as the preferred and exclusive bidder . As you know, NBNK was informed that its new offer had not been accepted and that the Co-op’s bid would be progressed on an exclusive basis. During this period – summer 2012 – we had contacts with senior banking figures, during which it was made clear to us that pressure on LBG to appoint the Co-op was coming from within the Coalition.

Why did NBNK’s bids fail?

Several reasons have been presented to the Committee by various parties as to why NBNK’s bid was not acceptable.

The LBG view appeared to be that NBNK failed on price, on ability to execute from a technical perspective and uncertainty about capital raising .

I dealt with these points in a memorandum to the Committee on 26 June 2013 and do not propose to re-state all of the arguments here. In summary, however:

· on price – when viewed properly, NBNK’s bid was higher than the Co-operative’s and delivered upfront payments significantly higher than those that the Co-operative would have delivered;

· on technical execution – NBNK repeatedly had assurances from LBG that it had satisfied LBG’s concerns on these matters; and

· on capital raising – repeatedly, NBNK provided letters of comfort and other reassurances from its committed investors. LBG appeared to accept this, even to the point that its staff decided not to take up NBNK’s offer to have direct meetings with NBNK’s financial backers.

Others, including Reverend Flowers in his evidence to this Committee, speak of NBNK’s lack of a banking licence and the fact that it was not already a bank. However, as explained above, we were told by Mr Clive Adamson of the then FSA that we didn’t need one until we were to start operating as a bank. Again, to the maximum extent possible in these situations, NBNK’s discussions with the Regulator were as positive as they could be. While no regulator will ever pre-judge a final decision, by the time of our final bid in June 2012, there were no outstanding matters that we had not addressed with the Regulator, and LBG was well aware of that. If our bid had been accepted, then in effect we would have been obtaining a licence on the back of the status attaching to the Verde assets, which the FSA had already confirmed would be granted Advanced IRB Status. All issues raised by the Regulator had been dealt with satisfactorily.

It was precisely the point of NBNK’s existence that it had no legacy issues because it had not operated as a bank. Its credentials and proposed modus operandi were such that, had LBG and others had the imagination and courage to embrace it, NBNK would have been a well-supported, well structured, technologically robust new exciting challenger bank on the high street, led by a team of experienced, proven banking industry experts.

Political interference?

Here is the official line:

1. The suggestion of political involvement was denied by Mark Hoban at our meeting with him on 26 July 2012: we were told that there had been no contact with those involved and that the whole decision was a matter entirely for the board of Lloyds and the Government would not express any preferences in terms of the bid. This point was reinforced subsequently by the Chancellor in writing (item Z in the Time Line). The Chancellor made it clear that the responsibility for the divestment process lay with LBG, that the selection of the Co-op as the preferred bidder was purely a commercial decision by the board of LBG and that it was not taken to further to Government’s objectives to increase competition and to promote mutuals in the UK banking sector. The Chancellor also said that while he had been kept closely briefed by his officials on developments throughout the divestment process, it was not the Government’s role (nor that of UKFI) to be involved in the commercial negotiations.

2. The Secretary of State for Business, Innovation and Skills also wrote to me on 30 July (item DD in the Time Line) saying that as the Treasury Select Committee was looking into the transaction, he should not comment on details that I had raised with him at that point. He did, however, include a handwritten postscript that read ‘clearly there are big issues around the failed transaction and your concerns are understandable.’

3. Meetings also took place with the Chairman of the Public Accounts Committee and with the Chairman of UKFI. In all cases, political involvement has been denied.

And yet, doubts remain:

1. NBNK realised from an early point that politics and the Verde final decision would inextricably be linked. How could it be otherwise, given my opening remarks about successive Governments’ desire to increase competition, reduce barriers to new entrants and – biased though it appears in hindsight - promote mutuals ?

2. NBNK had meetings with officials from the UKFI, the Treasury and the FSA. These were always business-like and informative and on the record. At no point do I recall any calls from politicians of any party asking to be kept informed of progress or encouraging NBNK’s bid.

3. Prior to the final decision of LBG, I was told by the Governor of the Bank of England, Lord King, that, irrespective of the details of NBNK’s bid, it would not be accepted because a political decision had been taken to make the award to the Co-op.

4. The evidence of Reverend Flowers before this Committee speaks clearly of the volume of contact between Ministers and the Co-op.

5. Respected journalists are thwarted in their Freedom of Information attempts to obtain papers and periodic articles appear that indicate there is a "smoking gun" somewhere. Frankly, given everything that has come to light about the Co-op, it is incredible to suggest that nobody in LBG, in Government or in Regulation could have known about or predicted what was to happen – unless of course there was a collective will to push through the Co-op, bid come what may.

In conclusion:

a) the Government has succeeded in ensuring that its own clearly expressed policy to see ‘a new challenger bank’ has met with failure;

b) the Co-op, through its involvement in this transaction and another, has managed almost totally to self-destruct;

c) the UKFI, as a watchdog for the public interest in State ownership of financial services industries, has failed in its duty; and

d) most disappointing of all, the 632 branches are still owned by the same parent. What we will have left – post IPO – is an entity for which LBG ultimately has provided the money, the IT platform, the management team and the customers (while in the process, ensuring that the people running the IPO, who were arguably conflicted during the bidding process in any event, will personally profit).

January 2014

APPENDIX 1

NBNK INVESTMENTS PLC

EXTRACT

Minutes of a Meeting of the Board

held at Fifth Floor, One Angel Court, London, EC2R 7HJ

on Tuesday 10 January 2012 at 8.30am

172. Update on Lithium bid

Gary Hoffman described the manner in which the Company had been advised by Lloyds Banking Group (‘LBG’) on 14 December 2011 that it had decided to appoint the Co-operative (‘Co-op’) as the exclusive bidder for the Project Verde assets. The message had been that the deciding factor was not price, but execution risk. LBG’s board’s unanimous view was that execution risk was lower with an existing banking player. Since NBNK had no infrastructure, the implication was that NBNK’s bid had been considered too similar to that of an IPO. LBG had, half an hour after speaking with Gary Hoffman, made an announcement that the Co-op had been selected as exclusive bidder with an intention to agree heads of terms by 31 March 2012.

The Chairman said that he had received a telephone call from LBG’s chairman conveying similar messages, but indicating that the announcement on exclusivity did not necessarily constitute the ‘end of the story’.

There were a number of unsatisfactory aspects about the decision and the manner of its communication. In particular:

· LBG had taken its decision one day earlier than it had publicly stated would be the case;

· LBG had continued until the very last moment to make unreasonable demands of NBNK’s executives to attend meetings, etc at unreasonable times and with unreasonable notice, by which time the decision had effectively already been made;

· important stakeholders (e.g. UKFI, FSA) appeared not to have been notified by LBG in advance of its public announcement; and

· there were concerns that the whole bid process had been managed in a way that favoured the Co-op’s bid over NBNK’s, while leaving the IPO option on the table should the exclusivity process with the Co-op break down.

On the latter point, [adviser to the board] expressed strong views that this had not been a ‘proper contract race’, and he gave some anecdotal examples of events in the 7 months leading up to the decision to illustrate his view. He asserted that one of the reasons for NBNK’s failure to achieve exclusivity was that NBNK’s proposition had not adequately been explained to LBG’s NEDs – there had been no ‘champion in the boardroom’ at LBG to argue for NBNK’s case. He argued that NBNK should remain alert to any opportunities that might arise should the exclusivity process break down. That might include dialogue with LBG NEDs to emphasise the strength of NBNK’s proposition.

Gary Hoffman reported on market intelligence received about the progress being made by the Co-op since it had been granted exclusivity. On financing, he understood that the Co-op would need to consider a group restructure or asset disposal in order to finance the acquisition, and that its financing package would rely more on debt than equity. On execution risk, the Co-op had been placed on negative watch by Fitch, which ought to mean that the FSA should be concerned about the Co-op’s execution capabilities. Arguably, failure of LBG/Co-op to execute raised wider concerns of financial stability.

Approaches had been made by the Co-op to engage NBNK staff to enhance execution capability and there were market rumours that the Co-op’s integration of the Brittania Building Society (which had been troubled for some time) would be put on hold so that priority could be given to absorption of the Verde assets. Unless resolved, these execution difficulties would cause difficulties for the Co-op over a 2-4 year period.

Gary Hoffman said that a further opportunity to re-enter the Project Verde process could only arise in the first quarter of the year. If NBNK was to remain actively engaged in order to capitalise on such an opportunity, it would be important during this period to promote NBNK’s continued status and credentials as widely as possible. This would include engaging LBG, UKFI, FSA etc to reinforce the strengths of NBNK’s bid and to make clear that NBNK could still provide a credible alternative to the Co-op (and an LBG IPO). Whatever misgivings might linger about the Verde bid process, nothing would be gained from challenging it whereas something (potentially) could be gained by careful re-enforcement of NBNK’s continuing credentials to be a challenger bank and to deliver a successful execution.

The board recognised the importance of shareholder support for any strategy that it might adopt. There had been very little shareholder feedback since LBG’s decision in December 2011 and the board needed to have some idea of shareholder sentiment before deciding its next step.

Taking all factors into account, the board resolved that its strategy should be as follows:

a) the Executive should produce a draft paper setting out the Company’s possible next steps;

b) the paper should consider all options, including an immediate cessation of activity, and it should clearly set out objectives, costings and timelines of any proposal to continue in existence, emphasising the 8 cost savings that were implemented immediately after the 14 December decision, and the Company’s ability to scale up its resources again if necessary; and

c) Kinmont and Cenkos should informally engage shareholders to seek their preliminary views on whether or not the Company should continue for a short time, in order to take advantage of any opportunity that could arise should the LBG/Co-op discussions falter.


[1] Commission approves restructuring plan of Lloyds Banking Group; European Commission – IP/09/1728 (18 November 2009).

[2] Reforming Financial Markets, July 2009, CM7667 presented to Parliament by the Chancellor of the Exchequer.

[3] Coalition Agreement, May 2010.

Prepared 22nd January 2014