Examination of Witnesses (Questions 440
TUESDAY 16 OCTOBER 2007
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
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
Q444 Chairman: The reason I am asking
that is that I looked at HBOSthey are one of the largest
lendersand 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 yearbecause 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
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
didquoting Mr Santssay 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.