Examination of Witnesses (Questions 1300
TUESDAY 4 DECEMBER 2007
Q1300 Mr Todd: Do you think this
episode has enhanced your ability to win audit business in this
Mr Sexton: I think our ability
to win business is dictated by our ability to deliver a quality
audit in whatever market.
Q1301 Mr Todd: Therefore, you think
it has done no reputational damage at all?
Mr Sexton: I believe that the
audit process as judged by reference to the specifics of Northern
Rock in the annual and interim reportsour opinion on the
latter was signed on 25 Julydiscloses very accurate information
about liquidity and other structures within Northern Rock.
Q1302 Mr Todd: Financial institutions
do not have to get their audit from you; there is a competitive
marketplace here. You think it has made no difference and the
market believes that you have performed a technical task to the
best of our ability and you are a good provider of these services
Mr Sexton: I believe that to be
Q1303 Mr Todd: Good! I am glad you
are so confident. I turn to events in April when the bank chose
to alter its lending pattern, at least so it told us, to reduce
the level of new loan activity. Did you have any role in suggesting
that it might need to do that to reduce the level of risk?
Mr Sexton: I am not involved in
the detailed delivery of audit services to Northern Rock, but
to the best of my knowledge, no.
Q1304 Mr Todd: Mr Hitchins, do you
have anything useful to add to that? Were you closer to this?
Mr Hitchins: No.
Q1305 Mr Todd: Looking at Granite,
you have said that it is a small vehicle. To what extent did you
audit the function of Granite? Did you see that as a material
part of your audit of Northern Rock?
Mr Sexton: The assets and liabilities
that sit within the so-called Granite structure appear on the
balance sheet of the group accounts and, therefore, they were
subject to audit.
Q1306 Mr Todd: Did you examine the
risk that obviously was faced in the end by Northern Rock that
it would not be able to securitise through the vehicle it chose
and obviously that was a material factor in the eventual collapse
of the bank? Was the scenario that securitisation opportunities
would effectively dry up one that you examined?
Mr Sexton: A specific requirement
of auditing standards is to consider the work that management
and the board have done in connection with their ability to continue
as a going concern. The primary reason for that work is to ensure
that the assets and liabilities are properly valued, but as part
of that work we look at all the information available.
Q1307 Mr Todd: You have not quite
answered the question. Bearing in mind that the vehicle of Granite
and the securitisation of loans were absolutely critical steps
in the ongoing operation of Northern Rock, did you examine a circumstance
in which this would cease to be a functioning alternative?
Mr Sexton: The audit team would
have considered the availability of continuing funding based on
Q1308 Mr Todd: Do you imply that
because it had not happened before they did not think it was a
risk worth considering, because it is an historical function looking
Mr Sexton: That is not what I
am implying or saying. I am saying that they would have considered
many, many scenarios but they would have regard to historical
performance and the ability to raise funds. It was in February
that we issued our report.
Q1309 Mr Todd: When eventually the
Bank of England found itself having to support this institution,
not surprisingly people wanted a clear picture of the assets and
liabilities of the bank. It appeared that that picture was not
readily available to any of the tripartite partners. Was the preparation
of an appropriate picture of the assets and liabilities of Northern
Rock at that point something in which you played any role?
Mr Sexton: For the purposes of
discussion with the Bank of England in September?
Q1310 Mr Todd: Yes.
Mr Sexton: I do not know the answer
to that question.
Q1311 Mr Todd: Could you ask your
team? I am slightly surprised that you have not had more detailed
conversations with the team involved in Northern Rock before coming
here, because you have qualified a number of your responses by
saying that you were not directly involved and you are not too
sure exactly what happened.
Mr Sexton: I believe I have said
that I oversee the audit. I have spoken to the audit team about
the key elements of our reporting dates, both the annual and interim
reports. I cannot answer your very specific question in relation
to that matter.
Q1312 Mr Todd: Presumably, a critical
issue in valuing the assets and liabilities of Northern Rock because
it is a mortgage institution is the assumption about the future
housing market in the UK. Is that reasonable?
Mr Sexton: I would imagine that
to be the case.
Q1313 Mr Todd: Therefore, what assumptions
did you have in place when you gave Northern Rock advice on valuing
its loan book?
Mr Sexton: I am slightly confused.
The implication of your question is that we gave them advice on
valuing their loan book.
Q1314 Mr Todd: Presumably, you tested
whatever its assumptions were to see whether or not they were
Mr Sexton: That is correct. In
February as part of the going concern review for the annual report
we would have looked at its forward-looking assumptions for the
purposes of the balance sheet presentation, and for the purposes
of our 25 July opinion we would have updated those again basically
by reference to management discussion as required by the APB guidance
Mr Hitchins: It is important to
bear in mind that the mortgages are in the balance sheet of Northern
Rock at cost with the amortisation of relevant fees and expenses.
The work that the auditors have to do is to assess whether or
not the bank has made sufficient provision for impairment of the
mortgages. In that context as one element we look at what assumptions
management has made as to the future trend in UK house prices.
Another element is the percentage of coverthe loan to value
ratiothat the mortgage has. All of those factors are looked
into. It is not really a valuation, but we are responsible for
auditing management's impairment allowance.
Q1315 Mr Todd: What was your take
on that at the time you conducted it? Obviously, one of the current
speculations is that Northern Rock's loan book may not be quite
as resilient as it might have appeared in the past because of
the expectations in the UK housing market.
Mr Hitchins: I cannot comment
on the details of it because, obviously, I did not do that piece
of work myself, but in principle we signed a clean opinion in
February and so we would have had a look at it and satisfied ourselves.
Q1316 Mr Todd: I have been a bit
frustrated by the absence of much detailed knowledge of what PwC
actually did for Northern Rock during this audit process. Can
you provide us with a summary of how you worked with Northern
Rock on the assumptions of impairment that they produced?
Mr Sexton: What we will more than
happily do is provide you with a commentary on the nature of the
information we sought that the company had put together in January
for the purpose of its review.
Q1317 Mr Todd: The other aspect I
am interested in is your role of the September process in trying
to sort out the valuation of Northern Rock and its assets and
liabilities at that particular time when, very understandably,
public authorities were wondering quite what they were getting
themselves into. You said you were not too sure what happened
Mr Sexton: I said I was unaware
of the precise work that we might or might not have done.
Q1318 Mr Todd: Will you also provide
a note on that?
Mr Sexton: Yes.
Q1319 Mr Love: It has been reported
that the big six accountancy firms, if I may call them that, have
produced a report on valuing bank holdings. The getting together
of the big six is unprecedented. Why is this being done?
Mr Sexton: It is not unprecedented.
From time to time the so-called big six do get together when there
is a matter of public interest. We feel that we can be helpful
to the markets in general in encouraging people to think about
particular issues. A short paper has been produced which reiterates
largely the existing accounting standards in connection with the
calculation and presentation of value-based assets. That is the
paper to which you are alluding and the one to which the Financial
Times article referred.
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