Northern Rock - declaring Dividends, lining pockets, failing to declare insolvency, deceiving shareholders, mortgage holders and the public J'accuse !

The Basel Committe on banking Supervision are responsible for issuing Basel II -a set of recommendations on banking laws and regulations which aim to create an international standard that banking regulators can use when creating regulations about how much capital banks need to put aside to guard against the types of financial and operational risks banks face.

The stated intention is to protect the international financial system should a major bank or a series of banks collapse.

This translates into a set of risk and capital management requirements which have been designed so that baks holds capital reserves appropriate to the risk the bank exposes itself to through its lending and investment practices.

The general principle being, that the greater risk, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.

What is currently the final version to date was issued on July 4th 2006 with three aims (or pillars in the jargon);

1. To ensure capital allocation is more risk sensitive
2. To Separating ad quantifying operational risk from credit risk
3. Attempting to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage (This is the situation where a regulated institution takes advantage of the difference between its real (or economic) risk and the regulatory position - e.g re-locating a business in a less regulated / tax zone - Virgin islands, Jersey etc.,)

95 national regulators indicated they were to implement Basel II, in some form or another, by 2015 which indicates that there was not perceived to be any desire to rush the implementation of the new and updated protocols.

This is what the Financial Services Association say about Basel II on their website (Page last updated 23/05/07) ...(inter alia)

This revised capital adequacy framework will further reduce the probability of consumer loss or market disruption as a result of prudential failure. It will do so by seeking to ensure that the financial resources held by a firm are commensurate with the risks associated with the business profile and the control environment within the firm. The new Basel Accord will be implemented in the European Union via the Capital Requirements Directive (CRD). It will directly affect banks and building societies and certain types of investment firms. The new framework consists of three 'pillars'. ....


This is what the CEO Adam Applegarth said on Page 4 of the Interim results published July 26th.. (Warning 40page pdf)

"We are pleased to have achieved approval for use of our Basle II rating systems. This means that the benefits of Basle II enable us to increase our 2007 interim dividend by 30%. Going forward our dividend payout rate increases to 50% of underlying EPS from around 40%. "

..after having said in a prior pragraph....

"The outlook for the full year is being impacted by sharp increases in money market and swap rates seen in the first half. This has resulted in a negative impact on net interest income as mortgage pricing in the market generally has lagged behind increases in funding costs in the year to date. "

On Page 15 of the report is the announcement of the details of the dividend declared by the Directors, based on their view of the company, it's capital base, solvency, market conditions, future prospects, cash flow etc.,...

Dividends

The introduction of Basle II, which requires less capital to support new lending, also enables a review of the Company’s dividend policy. It is proposed that for 2007 and beyond, dividends will be maintained at a payout ratio of around 50%. The interim dividend therefore increases by 30.3% to 14.2p (2006 - 10.9p) payable on 26 October 2007 to shareholders on the register on 28 September 2007.

It is interesting therefore that on Wednesday June 27th - 3 days before the Accounts were drawn up, and one month before the Directors (who hold some 340,000 shares) declared a 30% dividend increase that the Guradian reported.. under the headline -"Northern Rock in a hard place "written by Rupert Jones

"Shares in Northern Rock tumbled more than 10% today after it issued what was effectively a profit warning, conceding it had mispriced its mortgages.

Britain's eighth-biggest bank said its underlying profits were likely to rise 15% this year to about £422m - below analysts' average forecast of 17% growth to about £430m.

At one point this morning the shares were down by almost 14%, at 832p. They closed down 113.5p at 834p....



The bank said expectations for higher UK interest rates "have risen further than anticipated". As a result, it is suffering from a "structural mismatch between Libor [London inter-bank offered rate] and bank base rates".


It warned that higher funding costs, delays in pushing through the rate rises to borrowers on fixed-interest mortgages and other factors would cost the group up to £200m in net interest income. This will be partially offset by other gains of up to £50m. " (Ends)



Therefore it is not difficult to see why ..

1. The Directors have consulted Freshfields about issuing and paying the declared interim dividend.

2. That many people expect the interim dividend will not to be paid.

3. That many people believe the declaration of the dividend in the circumstances was reckless.

4. That this indecision has led to a false market in the shares as no-one can be cetain that a dividend will be paid.

5. That the FSA should have acted to clarify the position at some time between today and when the Directors first approached the Bank of England for financing.

6. That a view can be taken that the Directors have prepared false accounts.

7. That the haste in adopting , what appears to be the more relaxed Basel II standards they seized an oportunity to declare a dividend and thereby put the future of the business at risk - bearing in mind what the FSA say - "It will do so by seeking to ensure that the financial resources held by a firm are commensurate with the risks associated with the business profile and the control environment within the firm. " The quoting of the Basel II standards merely confusing the vast bulk of shareholders and providing a spurious and quasi lega authenticity to their actions - one which slipped by the Rolls Royce minds of the BOE and the FSA.

8. That the Directors are not "fit and proper" to run the business and the FSA should suspend the share price and direct the necessary operations to put the business in the hands of managers capable of managing the business so that it does not put the enterprise at risk.



Matt Ridley (Chairman at £300,000 a year and Adam Appelgarth (£1.2 Mn , plus divvies plus a fat pension) and their fellow Directors have a great deal of explaining to do - not only to their shareholders, but their mortgage holders, and the public at large.

.. and so have the FSA, the Bank of England and the Chancellor of the Exchequer past and present.