Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 420 - 439)

TUESDAY 16 OCTOBER 2007

DR MATT RIDLEY, MR ADAM APPLEGARTH, SIR IAN GIBSON AND SIR DEREK WANLESS

  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 well?

  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 basis.

  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 liquidity problems?

  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 model.

  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 August?

  Mr Applegarth: I do not know of anybody who foresaw the global freeze.

  Q435  Mr Breed: Do you have a Risk Committee?

  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.


 
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