LS:Congratulations on an incredibly successful year but before exploring how you got there, it might be helpful to put you and the bank into some kind of context. Heritable has been around for 130 years but probably things only started to take off after it was acquired by Landsbanki. Were you given an explicit brief or has your modus operandi and strategy evolved since you were put in charge?
MSD: Well I joined in September 2002. The business had been acquired by Landsbanki from Wachovia in 2000. It had £80m on the balance sheet and was really very small. Heritable had a history of doing loads of different things but basically its core activity was property development finance – that was it.
When I was recruited, I was asked what I would do with the bank and I came to the conclusion that I should do what I’d done previously at Sun Bank. So the last five years have been about recruiting good people, building assets and adding new businesses. We acquired one business and started several others – diversifying assets, distribution, and liabilities and thereby generating profits.
Specifically, in 2002 we were doing property development finance. In 2003 we started specialist mortgage lending and set up a treasury team. In 2004 we added retail deposit taking and in 2005 we acquired Key Business Finance and started Heritable Asset Finance.
Since then we have been steadily growing the assets of these various business lines we have.
On the funding side, we were wholesale funded from the parent company in 2002 and we added treasury deposits, taking money market deposits in 2003, and started retail deposit takingfrom then on. Since 2004 we have fully funded the growth of the business with deposits. Our balance sheet has gone from £80m to £1.25bn and our profitability has grown with it.
LS: That virtually answers the next question, which relates to this year’s spectacular growth in profits, namely, was it from a low base?
MSD: Well it was a low base back in 2002 but year-on-year the story is very different. The compound annual growth rate in assets has been 60% and in profits it has been 46% over five years, so that represents something of the progression that we have achieved.
LS: Given your position as a retail-funded balance sheet lender, there must be a temptation to grow your assets even faster, say, through the purchase of mortgage books?
MSD: With the credit crunch there’s undoubtedly a huge opportunity for buying assets or loans in the market. On the group level, I’m also responsible for running Icesave and Landsbanki Guernsey, so there are two other deposit-taking businesses under my wing. But we have been very conservative in the disposition of those deposits. We have plenty of liquidity around the group but the risk is that if you use up that liquidity to buy assets, that changes the structure of your balance sheet and although you might get a one-off gain, the reality is that you have disturbed the natural progression of your business. Landsbanki has 76% of its loan book funded by deposits – that is a real position of strength in this market.
Occasionally you get opportunities to make a bit of quick money but that really doesn’t interest me. I’m interested in momentum, putting momentum into the business, getting all the teams to drive their businesses forward at a steady organic rate. I’m happy to do an acquisition but really to get capability, not to create scale. I like to see a business really humming.
LS: Obviously retail funding is now seen as a strength but until last summer securitisation was the sexy thing and investor appetite seemed insatiable. How difficult was it not to go down that route?
MSD: We looked at it about 18 months ago. We got all the feedback that our business could easily be securitised and the investment bankers were very keen to get their hands on it. However, it was something we decided not to do for the simple reason that securitisation only works if you are growing very fast and become a multiple issuer. But I’ve been around this market long enough to see the risks of over-dependence on any one source of funding. I would never want to have to move my business model from a blend of funding options to one that is purely securitisation funded. This recent credit crunch is not the first time we have seen problems for mono-funded businesses like this.
We’ve actually done a form of securitisation for our Key Business Finance operation. We have a non-recourse loan facility where we place the assets with a European bank, off balance sheet effectively, and that has suited us and so we have used it. But it represents a very small part of our funding.
The danger of securitisation is that it can condition the way you operate, so you end up doing the same as everybody else because there are rules that you have to conform to. You know the very reason we’ve been successful is because we don’t behave like a larger organisation. We behave in a way that is true to ourselves, I suppose, and true to our customers.
LS: Following up on that, your operating model seems to be the mirror opposite to the norm. You don’t appear to outsource and you do everything from your offices near Berkeley Square, Mayfair, which must be one of the most expensive places in the world to work from. Isn’t that a little like swimming the Channel with lead boots on?
MSD: To my mind it’s not about outsourcing. The three savings businesses that I’m responsible for are all outsourced. We put in the ingredients of marketing, treasury and operational oversight into them but they’re outsourced. That’s because we couldn’t add any value by doing it in-house – they are very specific functions and we benefit from the pooling effect.
On the mortgage side it’s different. We like to service our own clients. We do our mortgage business through intermediaries but we build up very strong relationships with the intermediary and if the customer will give us a chance we’ll do the same for them. Some do and some don’t but it means that you have a very good grasp of exactly what’s happening with your customer and exactly what the dynamics of the market place are. If customers are redeeming, for example, you get the chance to find out why. It is much harder, I think, with a remote outsourcing relationship.
We do a surprising amount of repeat business through intermediaries with the same customers, particularly in the buy-to-let market. And again we are in control of the brand from the customer perspective. If the customers didn’t like us when the intermediary said to them we are going to re-do this with Heritable, they’d say no, we’d like you find somewhere else, but they don’t.
LS: And does this hands-on approach help to reduce instances of property or valuation fraud?
MSD: I hope so. When you run your business to a formula you run the risk, as I think has happened in the US sub-prime market, of the model becoming the point instead of the point driving the model.
Valuations are intended to give you an accurate valuation on a property you want to lend against and the opportunity to understand the additional risks that might be associated with it. By doing the underwriting ourselves we’re able to give ourselves the chance to find that out. And we do quiz valuers. We do find that in today’s market there are values that don’t always hang together and we will question them.
We’re very fortunate because we’re involved in property development finance, so we really do know what values are and what the cost per square footage should look like. It means that you can often look at the rent yield on a valuation, or effectively the price per square foot, and just benchmark it a bit so that you can say this looks a bit suspect. At least you can go and have a conversation with the valuer about why they’ve valued it higher than we would have expected in today’s marketplace.
So I agree it’s a hands-on business but the ingredients for success are all about the hands that go on it.
LS: At Lending Strategy there’s a view that reports of Armageddon are slightly exaggerated. Do you have a take on that?
MSD: We’ve seen a slight upturn in mortgage arrears and on the property development side we’ve seen signs of pressure but not signs of distress and probably that’s what we’re seeing on the mortgage side as well.
We are quite close to our customers, particularly those who might have missed the odd payment, but we’re not seeing any signs of serious problems. With property developers the signs of pressure come with the time it now takes to sell properties.
LS: And what about the spate of frauds we have been hearing about involving new build developments?
MSD: Some poor developments have been nicely disguised by house price inflation and developers will very often overrun on costs and time, or over specify the project because they assume they’ll get a better price and with a bit of house price inflation you can get through all that. The next period will be about developers being tested a little bit more and I think the same will apply to buy-to-let investors.
But undoubtedly there will be opportunities in a tighter market if people start offloading repossessed properties. Somebody else could buy those as new investments and get good yields off them but they’ve got to get their sums right. You know this notion of buying for capital appreciation is more speculative than real.
LS: Turning away from the market for a moment, you once mentioned that you remember Mike Lazenby, chief executive of Kent Reliance Building Society, from your days back at HSBC Bank. Is that where you started your career? And bearing mind your respective careers, would you say it was a good school for future CEOs?
MSD: It was great. HSBC sponsored me through university – I did two degrees – and they gave me 17 jobs in seven years, some of them concurrently. They trained me to a fantastic extent and when you add all those ingredients they certainly were a good school for what I have done ever since, having being involved with the running of Sun Bank (subsequently acquired by Portman Building Society) and now Heritable.
I don’t know if you’d get the same training today but I’m certainly eternally grateful to them. It’s been useful since for HSBC – I don’t think they suffered entirely by my departure – we always seem to be doing business with them somewhere along the way, so they’ve had a good return on investment.
But for me the fun is in a smaller bank. You can get your arms around it, you can really understand what’s going on and you can really focus on making money legitimately because youunderstand the ingredients – you borrow money for a price, you sell it for a price, and that’s what banking is all about. In a large bank you’re often told that you have to price at a certain level but you don’t really understand why. And you can’t really work out who has made the money, whether it’s the lender or the funder – it all gets lost in the mix.
A small bank is more tangible and for me, I love running a business. I unashamedly put the success of our business down to having really good people who are willing to take the space that I give them.
LS: So the big banks are a good recruitment ground for you?
MSD: Absolutely. But a lot of people here worked with me at Sun Bank and we’ve recruited people from a number of specialist banks because they brought with them a specialist skill.
LS: Now for a very obvious question – the current credit crisis – how long do you think it will go on?
MSD: It’s going to be a lot longer than everyone thinks. The headlines have gone away but there are no signs of it letting up. It may well take until the third or fourth quarter of this year before things start to sort themselves out. Markets don’t like uncertainty. The regulators don’t know how to deal with the current situation and certainty will only return when everyone feels confident that the bad news has all gone.
LS: What about the idea that the outlook will get better once the financial reporting season is over?
MSD: I never bought into that one. The reporting season gets the right messages out there but then those numbers have to be validated, so you have at least to wait until the next quarter’s results to see if they were right. I don’t think anyone really knows.
A lot of the valuations, particularly in the US sub-prime exposed banks, relate to indices and those indices are moving, so their marking to market is something they have no control over. They can probably say, hand on heart, “we’ve cleared everything out that we knew about at the end of the year” but in the first quarter, if the indices drop again, then they are back in the same trouble again.
It’s also very difficult to distinguish between paper losses and real losses. There’s a lot of talk about fraud, as well, in the mix but that has to materialise, it has to result in a write-off somewhere before you can establish what the cost is.
The problem is working out who is holding on to that loss. If you take it at a transaction level that there’s a repossession of a small property in Cleveland, Ohio, then that could be transmitted across the globe through financial instruments, as everyone has a tiny piece – no one is in control of it. And in the same way that the risk was taken on through the system, the realisation of the loss has to get through the system before it materialises. I’m sure there’ll be people who will never know if they have lost or gained money.
LS: Does this suggest that there is a problem with globalisation?
MSD: This market tells me that there are some real dangers because globalisation and the systematic transfer of risk across markets creates a sort of normalisation of risk – you rely on a rating agency to give you a rating on a transaction but they are rating all transactions in much the same way. The transaction is created to fit. It goes through the mill and ends up in a bond portfolio somewhere. But when you scale that up to a global activity what you’ve got is in a sense a one-way bet. Once you get a systemic problem it affects all in the same measure because it has been constructed in exactly the same way.
But when you run a niche business you do precisely the opposite. You don’t do what the market’s doing in general – you’re always trying to find ways to do things differently and that gives you some resilience. Some markets aren’t resilient because they’re not spreading risk and are actually concentrating it.
LS: The knack, one supposes, is to see this happening. Elsewhere in the magazine there’s a feature predicated on the idea, post Northern Rock, that every CEO should have the ability to see into the future written into his job description, but it’s hard enough to keep up with what’s happening at the moment. How do you cope with information overload?
MSD: I’m extremely well networked and I get other people to help me form my own views. But as a modern CEO you are absolutely bombarded with information and you just have to take on board what you can.
My sense is that you never predict precisely what’s going to happen. All you can do is develop a robust business model and set sail confidently and have someone at the front of your boat looking out for the icebergs.
As things are today I’m confident that we have a robust business that can withstand pretty much anything that I can think of at the moment. What I’m not so confident about is what’s lurking under the water and I don’t think anybody can be confident because I don’t think any one of us could have preLSdicted the Northern Rock problem.
Mark Sismey-Durrant – personal profile
CEO Heritable Bank of Landsbanki Heritable Bank, a rapidly growing specialist lender, operating in the property development, residential mortgage and SME finance sectors, and a specialist savings provider. The business is built around experienced, innovative teams and high quality, bespoke service. It has been in business for 130 years and part of the Landsbanki Group since 2000.
Always wanted to be a mortgage lender?Not at all. Anyway, I see myself more as a banker and a businessman. Mortgage lending is something I have been involved in for 17 years, but I have at the same time been involved in other forms of SME lending and deposit-taking activities. What I really wanted to be was a professional cricketer – but I just wasn’t good enough.
Likes:Walking the Northumbrian coast and Hills with my family and our Labrador, Molly. I am also a very practical person and really enjoy hard physical work such as building or carpentry.
Hates:Laziness and bad manners.
Relaxation:Apart from spending time at our Northumbrian cottage, I watch my sons play lots of sport and walk Molly with my wife Helen and play golf when I can.
Favourite food/restaurant:I love the great restaurants around the office in Mayfair, but my favourite is St Helena in Elstow near Bedford – simply unbeatable.
Current bedside book:I read a wide range of books, from Classics to modern thrillers. At the moment I am reading a John Rebus novel by Ian Rankin.