Today’s blog focuses on the U.S. dollar funding shortfall that took place at Bank of Scotland PLC’s New York branch during the period from February 8, 2008 to March 16, 2009. Bank of Scotland is the main banking subsidiary of holding company HBOS PLC. The HBOS group was the largest mortgage lender in the United Kingdom and the group was affected by the same factors that forced the Bank of England to announce its support for Northern Rock PLC on September 14, 2007, followed by a complete nationalization of Northern Rock in early 2008. Data from the Federal Reserve show that Bank of Scotland PLC was forced to borrow $5 billion from the Fed on September 17, 2008, the same day that HBOS’s rescue by Lloyds was announced and almost a full month before the U.K. government announced a major capital injection to HBOS.
This is the nineteenth Kamakura case study in liquidity risk, following earlier blogs on AIG, Bank of America, Countrywide Financial, Merrill Lynch, a consolidation of the latter three firms, Lehman Brothers, Morgan Stanley, Citigroup, Dexia SA, Depfa Bank plc, Barclays, Goldman Sachs, the combined JPMorgan Chase, Washington Mutual, and Bear Stearns, Wachovia, State Street, BNY Mellon, HSH Nordbank AG, and Societe Generale.
Under the Dodd-Frank Act of 2010, the Board of Governors of the Federal Reserve was required to disclose the identities and relevant amounts for borrowers under various credit facilities during the 2007-2010 financial crisis. These credit facilities provide perhaps the best source of data about liquidity risk and funding shortfalls of the last century. This data is available for purchase from Kamakura Corporation and is taken from the Kamakura Risk Information Services Credit Crisis Liquidity Risk data base. We use this data to determine to what extent there was a funding shortfall at Bank of Scotland PLC during the credit crisis.
The data used for Bank of Scotland in this analysis are described in more detail below. The data consist of every transaction reported by the Federal Reserve as constituting a “primary, secondary, or other extension of credit” by the Fed. Included in this definition are normal borrowings from the Fed, the primary dealer credit facility, and the asset backed commercial paper program. Capital injections under the Troubled Asset Relief Program and purchases of commercial paper under the Commercial Paper Funding Facility are not included in this definition put forth by the Federal Reserve.
A detailed chronology of the 2007-2009 credit crisis is given in these two recent blog posts:
van Deventer, Donald R. “A Credit Crisis Chronology Part 1 Through February 2008: This Time Isn’t Different,” Kamakura blog, www.kamakuraco.com, May 13, 2011.
van Deventer, Donald R. “A Credit Crisis Chronology Part 2 March 2008 Through March 2009: This Time Isn’t Different,” Kamakura blog, www.kamakuraco.com, May 14, 2011.
The key headlines relating to Bank of Scotland, HBOS, and Lloyds can be summarized as follows:
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January 8, 2008
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HBOS saw profits crash 70 per cent to £848million in the first half of this year as bad debts soared by nearly a third to £1.3billion (Source: The Mirror).
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September 17, 2008
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Lloyds rescues HBOS, the largest mortgage lender in the UK (Source: Reuters).
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October 13, 2008
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Royal Bank of Scotland Group PLC, HBOS PLC, and Lloyds TSB Group PLC will get an unprecedented 37 billion-pound ($64 billion) bailout from the U.K. government (Source: Bloomberg).
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October 13, 2008
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As part of its bail-out, the Government is buying £8.5bn of new HBOS shares at 113.6p, an 8.5pc discount to the company’s closing price on Friday. HBOS is also placing £3bn of preference shares with the Government (Source: The Telegraph).
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January 19, 2009
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HBOS Lloyds merger creates UK super bank as merger closes January 19 (Source: Belfast Telegraph).
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February 13, 2009
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Lloyds stuns City by revealing potential HBOS loss of £11billion. Shares plunge by 32% after dramatic deterioration in bank’s health (Source: The Guardian).
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February 27, 2009
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Lloyds confirms £10.8bn HBOS loss (Source: Financial Times).
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This blog reports on “primary, secondary, or other extensions of credit” by the Federal Reserve to Bank of Scotland PLC during the period February 8, 2008 to March 16, 2009. There were no borrowings by the other major banking affiliate within HBOS, Halifax, nor were there significant borrowings by Lloyds during this period. Bank of Scotland PLC New York Branch’s borrowings from the Federal Reserve can be summarized as follows:
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Borrowing dates:
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First borrowing September 17, 2008 for $5 billion,
with borrowings continuously outstanding until
January 12, 2009.
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Average from
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2/8/2008 to 3/16/2009
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$2.4 billion
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Average when Drawn
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$8.1 billion
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Maximum Drawn
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$12.0 billion on October 23, 2008.
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Number of Days with
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Outstanding Borrowings
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117 days
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The graph below shows the pattern of Bank of Scotland PLC borrowings, which began on the same day that the emergency merger with Lloyds was announced and continued until just before the close of the merger with Lloyds on January 19, 2009.
Default Probabilities During the Credit Crisis
The graph below shows the 1 year Kamakura Risk Information Services default probabilities for Bank of Scotland until the close of its merger with Lloyds. We also show the 1 year default probabilities for Lloyds for the full period covered by Fed disclosures, February 8, 2008 and March 16, 2009. Default probabilities for HBOS continued to rise even after the emergency merger was announced, finally peaking near 16%. Lloyds default probabilities peaked after the merger and just crossed the 16% level.
At the time of Bank of Scotland’s peak borrowing of $12 billion on October 23, 2008, the bank’s cumulative default risk was 19.10% for 5 years and 29.67% for ten years.
In the chart below, we compare Bank of Scotland’s consolidated funding short fall to those firms whose liquidity risk we have previously analyzed in this series. Bank of Scotland’s consolidated funding shortfall, measured by average drawn borrowing of $8.1 billion, ranks 12th among the firms analyzed in this series to date.
If one ranks the same firms by largest outstanding borrowing on a single day, Bank of Scotland ranks 16th, with a maximum borrowing of $12.0 billion:
Borrowings During the Bear Stearns Crisis, March 14, 2008 to May 31, 2008
Bank of Scotland was fairly unique among other institutions studied in this series, because it did not borrow during the Bear Stearns crisis from March 14 to May 31, 2008.
Borrowings from the Commercial Paper Funding Facility
The Federal Reserve’s disclosure of borrowings under the Commercial Paper Funding Facility listed no borrowing by entities affiliated with HBOS or Bank of Scotland PLC.
Implications of Funding Shortfall Data
Bank of Scotland PLC is another case where the U.S. Federal Reserve was providing substantial support to a troubled foreign banking institution for almost a month before the U.K. government announced its capital injection into HBOS and the other major U.K. banks. The amount of Federal Reserve financial support for major European banks has been significant but it has not yet received much attention in the press. We summarize this in another blog later in this series.
Background on the Federal Reserve Data
A summary of the Federal Reserve programs that were put into place and summary statistics are available from the Federal Reserve at this web page:
http://www.federalreserve.gov/newsevents/reform_transaction.htm
Today’s blog focuses on one set of disclosures by the Federal Reserve: primary, secondary and other extensions of credit by the Fed. This includes direct, traditional borrowings from the Federal Reserve, the primary dealer credit facilities, and the asset backed commercial paper program described at the link above. These borrowings do not include commercial paper purchased under the Commercial Paper Funding Facility nor do they include the equity stakes taken by the U.S. government under the Troubled Asset Relief Program.
Kamakura took the following steps to consolidate the primary, secondary and other extensions of credit:
- From www.twitter.com/zerohedge Kamakura downloaded the daily reports, in PDF format, from the Federal Reserve on primary, secondary and other extensions of credit from February 8, 2008 until March 16, 2009, approximately 250 reports in total
- Kamakura converted each report to spreadsheet form
- These spreadsheets were aggregated into a single data base giving the origination date of the borrowing, the name of the borrower, the Federal Reserve District of the borrower, the nature of the borrowing (ABCP, PDCF, or normal), the maturity date of the borrowing, and (in the case of Primary Dealer Credit Facility) the name of the institution holding the collateral.
- Consistency in naming conventions was imposed, i.e. while the Fed listed two firms as “Morgan Stanley” and “M S Co” Kamakura recognized to the maximum extent possible that they are the same institution and used a consistent name
- To the maximum extent possible, the name of the ultimate parent was used in order to best understand the consolidated extension of credit by the Fed to that firm.
For information regarding the Kamakura Credit Crisis Liquidity Risk data base, please contact us at info@kamakuraco.com. Please use the same e-mail address to contact the risk management experts at Kamakura regarding how to simulate realistic liquidity risk events in the Kamakura Risk Manager enterprise-wide risk management system.
Donald R. van Deventer
Kamakura Corporation
Honolulu, Hawaii
August 1, 2011
© Copyright 2011 by Donald R. van Deventer, All Rights Reserved.