Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 440 - 459)



  Q440  Mr Breed: The FSA did not contact you or talk to you about the risk profile of the bank?

  Sir Derek Wanless: The FSA at this stage were talking extensively to the executive about the ICAAP process and Basle II and the executive were talking to the Board on a regular basis on where that process had got to.

  Q441  Chairman: Mr Ridley, what was the business plan agreed in 2006 regarding the amount of mortgage lending that the company would do in 2007?

  Dr Ridley: We planned in 2007 to grow our mortgage lending at a slightly slower rate than we had in 2006 to increase the assets on the balance sheet by about 20%.

  Q442  Chairman: So what was the mortgage lending in terms of share of the market in 2006?

  Dr Ridley: We did not target a particular share of the market but at the end of 2006 we had, I think 7.5% of the UK mortgage market.

  Q443  Chairman: And you ended up in 2007 with about 19% of the market?

  Dr Ridley: No, those are two different figures. 7.5% is the share of the total UK mortgage market; 19% is the share of net new lending that was done in the first half of 2007.

  Q444  Chairman: The reason I am asking that is that I looked at HBOS—they are one of the largest lenders—and they took 8% net lending in the first half of 2007? Is that correct?

  Dr Ridley: If you are right, yes.

  Q445  Chairman: But you ended up taking 19% at the end of the day, so was it not a case of looking at the market and then taking a punt to increase the amount because other big mortgage lenders had more conservative estimates about what they would take in the market?

  Dr Ridley: As I say, we did not increase the rate of mortgage lending in the first half of 2007. It was at exactly the same growth rate as the average had been over the ten years since we converted from a building society.

  Q446  Chairman: But it grew three times as much as any other company. That is general knowledge.

  Dr Ridley: One of the reasons for that is because we have become very good over the past few years at retaining our customers. We are unique in this industry in offering the same mortgage deals to existing customers—

  Q447  Chairman: One of the questions is, Sir Derek, have you the funding in place to support this? Where were the cautious voices?

  Sir Derek Wanless: The plan that was put to the Board, which the Board approved, was a funding and a lending plan, it was a complete plan for the business, and on the funding side we opened up new retail sources of funding, in Denmark for example. We had products in the UK, too, which were being successful, as well as having the diverse range of wholesale lending which meant that effectively we were funding around the world.

  Q448  Mr Todd: I may have misheard you, Mr Applegarth, but I think you said that after the warning signs appeared in the spring you took action to slow the growth of loans; is that right?

  Mr Applegarth: It is.

  Q449  Mr Todd: How do you reconcile that with what your Chairman has just said about the market share that Northern Rock were achieving in this period, which he said was much the same as in previous years and according to the business plan? It does not sound as if any slowing action was communicated to him. It is hard to visualise, bearing in mind the fact that you were taking 19% of the new mortgage market, that that indicated slowing down, but perhaps you can tell us how that is reconciled.

  Mr Applegarth: Yes, surely they are consistent. Our market share of the gross market is under 10% and, as the Chairman said, we retain our customers increasingly well, and that is what gave you the net lending market share. We started slowing lending down but, as you know, it takes about two and a half to three months to move house and therefore the actions you take have a delayed impact, so by the end of the year our balance sheet growth, once we had completed the asset sales, would have been somewhere around 16% or 17% versus the figures of the half year, which are higher.

  Q450  Mr Todd: So we will not really see the effects of the actions that you may have taken in the spring until the end of the year? Is that what you are suggesting?

  Mr Applegarth: You saw some of the actions in the pipeline of new business waiting to come through at the half year, and that was ironically one of the things we were criticised for at the half year—because we were going to deliver lower growth than the markets had been assuming.

  Q451  Mr Todd: So what sort of growth were you attempting then in this period after March when you were taking this remedial action that you referred to earlier?

  Mr Applegarth: We would have ended the year with an asset growth of around 16% or 17% but that was dependent on removing—

  Q452  Mr Todd: And that is not an aggressive growth rate?

  Mr Applegarth: It is a noticeably slower rate of asset growth than the previous ten years where we had averaged between 20% and 22%.

  Q453  Mr Todd: I suppose I must have been running dull businesses in the past, but certainly a growth rate of 16%, which in real terms is 12% or 13%, would have seemed pretty aggressive to me.

  Mr Applegarth: It depends from where you start. If you start as a small lender the percentage sounds a big number. It would be different if you had a much greater balance sheet.

  Q454  Mr Todd: I am hearing incredulity around me but, anyway, can we turn to the stress-testing exercise. You probably have read the evidence of the FSA to us on this. The FSA did do a full stress test on you in late 2006/early 2007 and actually combined their stress-testing exercise with their Basle II exercise with you; is that correct?

  Mr Applegarth: It is indeed, and as part of Basle II, which is a two and a half year process, you have to run a whole series of stress tests, including for example a 40% house price fall. Of course I read the FSA evidence, but what was not stress-tested was the event that was deemed implausible of the global markets all freezing at the same time, with rapid speed and for a long duration.

  Q455  Mr Todd: No, the FSA have not said that they alerted you to that possibility, however, they did—quoting Mr Sants—say that they had advised you that you needed to take into account more extreme scenarios than the ones you were presumably using at the moment. Did you a) take any note of what that they said and b) if you did, what in concrete terms did that suggest to you?

  Mr Applegarth: Yes of course we did because we had to satisfy them in order to get our Basle II approval. The extra tests they asked us to do were primarily to do with credit, such as the example I gave of the 40% house price fall. What we did not stress test and did not foresee was what was deemed implausible, which was the rapid and long-lasting closure of global markets. That was not stress-tested, no.

  Q456  Mr Todd: But nevertheless I think it is fair to say the FSA did not feel that your stress testing model was adequate at the time they reviewed you under the Basle II process?

  Mr Applegarth: There are always things you can do better and that was a continual process and had been for the previous ten years with them.

  Q457  Mr Todd: So it was a rather mild "there are things we can do better" but no specific criticisms or suggestions were made? However, they did suggest various other tests which included a dramatic fall in house prices, which I must admit I would have said was rather less likely than some of the events we have seen but still those were the only concrete proposals they made?

  Mr Applegarth: I think you would describe it as work in progress as opposed to a red flag.

  Q458  Mr Todd: Just turning to Sir Derek, did the Risk Committee review the advice that the FSA had given in the Basle II process on risk stress testing?

  Sir Derek Wanless: The Risk Committee in fact the Board—

  Q459  Mr Todd: You said they only met three times a year.

  Sir Derek Wanless: The Board looked at what the FSA said when they gave us the accreditation under the Basle II arrangement and they made an adjustment to the capital. It is an assessment of Northern Rock's own model so they made an adjustment to capital in respect of credit concentration risk, which was their major concern. They also mentioned pension risk, securitisation risk and stress-testing, in that order of priority.

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