Examination of Witnesses (Questions 420
TUESDAY 16 OCTOBER 2007
Q420 Mr Breed: Mr Applegarth, can
you just confirm a few things. Did you and do continue to lend
up to 125% of the value of the property valuation on mortgages?
Mr Applegarth: No, we lend secured
up to 95% but then we also sell unsecured lending as well.
Q421 Mr Breed: So the total borrowing
that somebody has can be as much as 125% of the underlying value
of the security?
Mr Applegarth: It could but only
95% is actually secured against the property.
Q422 Mr Breed: And do you lend up
to five or six times the income of an applicant?
Mr Applegarth: Theoretically yes,
but it has to be a very high-quality applicant to get that loan.
It accounts for about 1% of our lending.
Q423 Mr Breed: Do you consider the
lending policy prudent?
Mr Applegarth: Yes I do because
there is a great deal of difference between phoning up and asking
the maximum you can get and actually going through and applying
and qualifying for a loan, so all applicants are very heavily
credit scored, both at point of sale and on a monthly behavioural
rescore, and I think the evidence shows up in the actual quality
of the loan book and the fact that our arrears for the last 15
years have been consistently around half the industry average.
Q424 Mr Breed: Your arrears in the
past have been below the industry average. Bearing in mind the
increase in the volume of your business is in the first six months
of this year, it is fairly unlikely for arrears to start to appear
within a few months of advancing a loan, do you believe that the
quality of your loan book is going to continue to reveal in the
future arrears and defaults at half or so the industry average,
based upon the significant amount of business that you have taken
in the first six months of this year?
Mr Applegarth: I do because one
of the exercises you have to do in order to get your Basle II
approval is to actually go through your credit scoring dynamically
and take a loan from point of sale and go through arrears and
possessions and feed it back. I think the last 18 months can be
characterised for us as learning the lessons from our lending
and applying them back into front end loans. You can track each
time cohort of lending as you go along, and it looks like the
last 18 months lending is actually better quality than the previous
two to three years.
Q425 Mr Breed: Do you think it is
believable that any institution which advances up to 125% of property
value and lends to people five or six times their income is actually
likely to have a record of arrears and defaults of something like
half the industry average?
Mr Applegarth: It depends if you
are a picky lender or not and, yes, we are a picky lender. If
you take the extremes of lending policy, it sounds racy; if you
look at what happens in practice, it is not, so for the last 15
years our arrears have been around half the industry average.
Q426 Mr Breed: On that basis it would
not have been too difficult to offload your loan book on to a
welcoming market with such a fantastic record?
Mr Applegarth: That is what we
started doing, following up the answer the Chairman gave before.
On the back of the warning signs, you saw us announce a change
in strategy with the interim results that were slowing down the
rate of asset growth, which we had done from the third month of
this year, and we announced that we were going to sell various
higher risk asset books on the balance sheet. We completed the
sale of the commercial loan book, which is about a £2 billion
loan book, over three stages, with the third stage actually taking
place after 9 August.
Q427 Mr Breed: So in the third month
of this year you began to realise that things were not going very
Mr Applegarth: In the third month
of the year we picked up the warning signs that the US sub-prime
position was meaning a tightening in pricing and therefore we
slowed down the rate of growth and we gave new guidance against
our profits for the year, recognising the tightening in pricing.
Q428 Mr Breed: So in the five months
between March and August, when obviously things were getting tighter
and more difficult, you still had not managed to successfully
ensure that the bank did not run out of money?
Mr Applegarth: We slowed down
the rate of lending, we announced a strategy where we were removing
higher risk assets off the balance sheet but, in the event, it
could not cope with the complete closure of markets on a global
Q429 Mr Breed: When was the first
time that you contacted the FSA and expressed your concerns about
this possible problem that you would have?
Mr Applegarth: Our traders first
noted a dislocation in the market on 9 August. We first formally
contacted the FSA two working days later.
Q430 Mr Breed: So in the third month,
in March, and presumably in April, May, June and July, you did
not advise the FSA and at no time during that period of time did
you have to complete a return to them which might indicate certain
Mr Applegarth: Sorry, I answered
the question thinking that you meant when did we first inform
the FSA after the dislocation of the markets on 9 August.
Q431 Mr Breed: When did you first
inform that FSA that felt you might have a particular problem?
I might have assumed it would have been in March?
Mr Applegarth: We notified the
FSA about a change in our strategy. We are on something called
a close and continuous relationship so as we changed the strategy
so we told them. We are in very regular
Q432 Mr Breed: Was that in March?
Mr Applegarth: It will have been
in March and before because we were discussing with the FSA as
part of our Basle II process and they came to our Board meeting
in January, I think it was, and we took them through what we were
intending to do going forward in terms of moving to a slower growth
Q433 Mr Breed: So they came to your
Board meeting in January and they satisfied themselves that it
was all right. You kept in close and continuous touch with them,
so between March and August you and the FSA between you still
failed to ensure that the bank was able to continue to trade with
a liquid liability book?
Mr Applegarth: We certainly failed
to foresee the global closedown in liquid markets.
Q434 Mr Breed: And the FSA did not
point that out to you at any of the meetings between March and
Mr Applegarth: I do not know of
anybody who foresaw the global freeze.
Q435 Mr Breed: Do you have a Risk
Mr Applegarth: Yes we do.
Q436 Mr Breed: Who is the Chairman
of the Risk Committee?
Mr Applegarth: Sir Derek is.
Q437 Mr Breed: Sir Derek, were you
entirely happy that during that period of time the Risk Committee
operated satisfactorily and reviewed its risks so that it could
ensure that the bank could continue to trade?
Sir Derek Wanless: The Risk Committee
and the Board discussed the strategy on a continuing basis. I
am perfectly happy, yes, with that.
Q438 Mr Breed: You are satisfied
that you had the right strategy for that particular period between
March and August?
Sir Derek Wanless: We talked from
the time about the funding strategy, which was an annual look
at all of our funding sources, about both retail and wholesale
funding, and we talked about the ways in which that strategy was
robust against many circumstances.
Q439 Mr Breed: Were you in contact
with the FSA?
Sir Derek Wanless: I was not personally
in contact with the FSA. The Risk Committee is a Board Committee
which meets three times a year.