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UNCLAS SECTION 01 OF 02 LONDON 002909
SENSITIVE
SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV UK
SUBJECT: APOLOGIES, EXCUSES, AND GLOOM - TESTIMONY OF EXECUTIVES OF
NATIONALIZED BANKS
LONDON 00002909 001.2 OF 002
1. (SBU) Summary: The executive teams of the UK's two nationalized banks, Bradford & Bingley (B) and Northern Rock (NR), were quizzed by MPs on the Treasury Committee November 18. B executives gave a gloomy outlook for the bank's mortgage books, with GBP 600-800 million losses expected from the
housing market downturn. The bank has cut 2,000 jobs since August, with further reductions expected. MPs were shocked by
the extent of a 2006 deal with General Motors, while one said sarcastically that it was good to know that HMG was
supporting the U.S. car industry. Northern Rock is showing slow, but steady, progress. Although it is expected to have
losses through 2009, it has undergone a substantial restructuring and has made good progress on repaying its government
debt, said its executives. However, it is unlikely that the bank will return to the private sector as quickly as
anticipated, given the current economic environment. The MPs were particularly critical of the remuneration policies of
both banks and held a separate inquiry into the role of bonus structures in the financial crisis. End Summary. Bradford & Bingley -
The Story So Far
------------ ------------------------
2. (SBU) Bradford & Bingley's (B's) GBP 40 billion mortgage business, currently in public ownership, has been put into run-off, ceasing to accept any
new business, and will not return to the private sector. Richard Pym, the bank's Chief Executive, told MPs on the
Treasury Committee (November 18) that he expects the bank's loan book to lose GBP 600-800 million in value from the
housing market downturn. He added that this estimate was based on an assumption that house prices will fall 25 percent.
The bank is now stress-testing for a much larger fall in prices. He told the Committee that at the end of September, the
proportion of borrowers in arrears stood at 3 percent, significantly higher than the industry average. The buy-to-let
market, in which B specialized, has been hit harder than the residential market, but Pym said the recent cut in the Bank Rate to 3 percent
would have a "significant effect" in assisting landlords by lowering their mortgage repayments. MPs expressed concern
that HMG, through B, is now one of the biggest players in the UK's vulnerable buy-to-let market. 3. (SBU) There have been 2,000 job cuts at
B since the end of August. Pym said that the bank is "mindful of its obligations" to the community in West Yorkshire and
said further job losses would be in phases. They currently have a voluntary retirement/dismissal program and an
agreement with HMG that there will be no compulsory job dismissals before March 31. Former Chairman Rod Kent said the
Board takes full responsibility for what happened and apologized to MPs for the Board's stewardship of the company,
whose reliance on wholesale funding and niche mortgages led to its difficulties. 4. (SBU) Jim Cousins, a Labour member
of the Committee, expressed astonishment at the 2006 deal B made with General Motors Acceptance Corporation (GMAC), under which, he said, the bank continues to have to buy
inferior mortgages. (Note: In December 2006, B made a deal with GMAC to buy a minimum of GBP 350 million of its loan assets per quarter for three years. The hearing
revealed that B has actually acquired a total of GBP 6.5 billion so far and will need to purchase more of GMAC's loan book, which
consists of mainly buy-to-let assets, until the deal expires at the end of 2009. End note.) By spring 2009, he said
sardonically, HMG will be the proud owner of GBP 7 billion of such mortgages and added that it is good to know HMG is
supporting the U.S. car industry. Kent said that it had been a commercial deal to secure business in a highly
competitive market but acknowledged that the arrears rate on these mortgages is higher than B's average. Cousins pressed Pym, who was not at the bank when the deal was made, whether it was mutually beneficial. Pym
said that ideally, the underwriting terms would have been more flexible. Northern Rock -
Slow Progress
------------------------------
5. (SBU) Over the last six months, Northern Rock has repaid a large proportion of its government loan, has completed a
workforce restructuring, and is on its way to returning to the private sector, according to Ron Sandler, a senior bank
executive. However, he added that the bank had substantial losses in the first six months of the financial year and is
expecting further losses in 2009. The main risks to the bank are external, namely a continued deterioration in the
economic environment, particularly the housing market. NR's executive team told MPs that there is little likelihood that
the bank will return to the private sector in the near-term given the economic environment. 6. (SBU) The Committee MPs
quizzed NR's management about the perception that the nationalized bank has a particularly aggressive repossession
policy. (Note: NR expects to be responsible for 10 LONDON 00002909 002.2 OF 002 percent of all repossessions this year.
End note.) NR executives told the MPs that its repossession rate, of 0.56 percent, is three times the industry average
but that this has nothing to do with its repossession policy or desire to quickly repay the government debt. Instead,
they blamed the high rate on the bank's controversial 'Together' loans, which were mortgages of up to 125 percent of the
value of the property. MPs suggested that NR should show a greater level of forbearance given that they were bailed out
by the taxpayer. The executives told the Committee that they are working on an industry-wide solution for mortgage
forbearance to help customers at risk of losing their home through new mortgage rescue packages.
Executive Remuneration Under Attack
-----------------------------------
7. (SBU) Executives from both banks were questioned about the levels of compensation paid at the senior management
level. The MPs said that executive remuneration with a short-term focus leads to excessive risk taking. They questioned
the fairness of the staff bonus system at B where the remaining 1,100 staff are in line for a bonus of 9 percent of salary, while senior executives accrue bonuses
of up to 150 percent of salary.
8. (SBU) At a separate Committee hearing (November 19) the Trades Union Congress (TUC) and Institute of Directors (IoD),
which represents the financial industry, surprisingly agreed that there needs to be reform of City bonuses in the wake
of the banking crisis. There was consensus that remuneration structures need to be examined and aligned more closely
with risk. Brendan Barber, TUC General Secretary, and Miles Templeman, Director General of the IoD, agreed that there is
need for urgent reform of remuneration committees, calling for more independent and knowledgeable people. Carol
Arrowsmith, a partner at Deloitte, denied that remuneration structures had caused the crisis and said that
performance-linked remuneration is a good thing. But she added that a model where bonus forms such a large proportion of
individual's pay may encourage risk-taking.
9. (SBU) Comment: The liabilities of Northern Rock and Bradford & Bingley have substantially increased HMG's debt burden and are likely to remain on the public books during and long
after the economic downturn. These liabilities will have a significant impact on Chancellor Darling's Pre-Budget Report
(November 24), limiting his fiscal flexibility. The Chancellor is expected to outline new fiscal rules, having already
broken HMG's self-imposed sustainable investment rule that debt not exceed 40 percent of GDP. In October, government
debt stood at GBP 640.9 billion, or 42.9 percent of GDP. TUTTLE