TENSIONS between HBOS’s senior management and the bank’s auditor KPMG have been exposed in the long-awaited bumper report into the financial institution’s epic failure.
The 500-page tome, which took over three years and £7m to compile, reveals that the bank’s management took an upbeat and optimistic view of the funds it had set aside to cover possible bad loans, a scenario flagged up on several occasions by KPMG.
Around November 2008, KPMG undertook deeper audit work for the year-end financial statements, which led them to realise that HBOS’s processes for assessing impairments and provisions could “no longer be relied on”. KPMG was also “explicit in its view that the corporate impairment figures originally proposed for the 2008 year-end were “outside the acceptable range”, which resulted in provisions being increased by £1.9bn.
Yet despite sounding the klaxon, much of KPMG’s previous warnings were unheeded by HBOS management.
The report by the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), which covers the years between 2004 and 2008, found that HBOS had “kept its auditors under pressure” in an attempt to keep the provisions for bad loans down and tried to defend impairment figures which were later increased to levels that KPMG viewed as “just within the acceptable range”.
Within its corporate division, despite the deteriorating economic outlook in 2008, there was reluctance to accept that the loans were going bad, and HBOS was reluctant to re-categorise and escalate them to the division’s specialist ‘impaired assets’ team. Indeed, that optimism meant that throughout 2008 the division proposed levels of provisions which did not reflect the declining market conditions, and were increased following “intensive discussions” with KPMG.
Even then, HBOS consistently chose the level of corporate provisions at the “least prudent end of the range deemed acceptable by its external auditors”, though the approach had changed by the time that the 2008 year-end impairment figures were finalised in early 2009.
The report notes that senior management “were slow to recognise objective trigger events and to escalate distressed loans for assessment”. And even when a trigger event was recognised, “they were reluctant to accept that a loss would be incurred and continued to believe in their ability to execute long-term ‘workout solutions’ that would enable them to exit the loans without loss”, it found.
It also highlighted that in April 2008, KPMG presented its review of interim profits for the first three months of 2008 to HBOS’s group audit committee, “KPMG was highlighting problem loans and was questioning – and in some cases challenging quite hard – whether additional provisions were needed, KPMG was not conducting any independent testing as this was not year-end audit work,” it said.
In the period leading up to September 2008, “HBOS was given a number of warnings about corporate’s approach to provisioning and warnings that corporate provisions were towards the bottom of the acceptable range and that with the economic situation deteriorating, even higher provisioning was to be expected”.
However, there is “no evidence that the group audit committee or the board acted on these warnings, for example by challenging the culture and attitude of the corporate division”.
A number of HBOS senior management and board members have pointed to KPMG reports which found that the impairment provisions were within ‘the acceptable range’, but the responsibility to assess impairments correctly and to make appropriate provisions remains with the bank’s board and senior management, the report notes.
“It is no answer to point to sign-off by the auditor,” it said.
While the revelations have led to calls for a probe into the advice given by KPMG to HBOS – its external auditor from its inception in 2001 until 2008 – the accountancy regulator, the FRC found there were ‘no reasonable grounds’ to suspect misconduct by the firm or individual auditor.
In response to publication of the report, Andrew Tyrie, chairman of the Treasury Select committee and the last Parliamentary Commission on Banking Standards (PCBS), has urged the FRC to reconsider its original conclusion not to investigate KPMG.
Tyrie said it was clear from the report, and the conclusions of the PCBS, that the “audit process was an important part” of HBOS’s failure, and added that he will write to the FRC about the “misjudgement made of the scale of impairments on the balance sheet, and about whether the auditors allowed themselves to be influenced by undue pressure from senior executives and the board of HBOS”.
He said the FRC “will need to consider afresh their original conclusion that there were no grounds for an investigation of KPMG, relevant senior KPMG people, and relevant senior HBOS management in relation to the audits of HBOS’s financial statements for 2007 and 2008”.
“It is surprising that the FRC didn’t conclude – and a long time ago – that this work was needed, not least to provide greater public confidence about bank audits after the catastrophe of 2008. Albeit belatedly, they should now do so,” Tyrie said.
To date, the FRC has declined to investigate KPMG and, following the publication of the Bank of England’s report, it reiterated that it lacked sufficient grounds to suspect the auditor of misconduct.
KPMG welcomed the recognition that it “provided robust challenge and delivered clear warnings” to HBOS, which resulted in a more prudent approach to provisioning than would otherwise have been adopted.
“We also welcome the FRC’s announcement that it has reviewed the audit work performed on loan loss provisions and concluded that there were not reasonable grounds to suspect misconduct by KPMG,” it said.
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