A study of The Commons Select Committee on Northern Rock will produce many fascinating nuggets as obervers and commentators trawl through it's pages - and many more no doubt will remain hidden. Here is just one fascinating insight the report affords into the ways the crooks ran Northern Rock.
Lord Patel has been fascinated with the Interim results of Northern Rock for some time. The Directors were able to very swiftly produce accounts on July 25th 2007 for the 6 month period to 30th June 2007 (showing a profit rise period on period of 0.7%) and declare an increase in dividend of 30.3%.
That they were able to do this was due to the adoption of what is called the Basel II "advanced" regulatory rules controlling requirements for capital adequacy.
The Basel Committee on Banking Supervision explains the 2 ways that are available to banks under the Internal Ratings-Based Approach of managing credit risk ;
1. Foundation - banks provide their own estimates of PD [probability of default] and rely on supervisory estimates for other risk components.
2. Advanced - banks provide more of their own estimates of PD [probability of default], LGD [loss given default] and EAD [Exposure at default], and their own calculation of M [Effective maturity], subject to meeting minimum standards.
The "Advanced" route adopted by the Directors of Northern Rock requires a waiver from the FSA (Financial Services Authority Handbook, BIPRU 1.3, Applications for Advanced Approaches ) - which was approved by the FSA on 29th June 2007 -Northern Rock's Interim Results, for six months until 30 June 2007 and the consequences of this important waiver are explained on p 14/15 of the Interim results..
Take a deep breath here...
Capital Management and Basle II
On 29 June 2007, we received notification of approval by the FSA of our Basle II waiver application. Our regulatory capital requirements, comprising both Pillar I and Pillar II, are therefore calculated under Basle II with effect from that date.
We have adopted the Retail Internal Ratings Based (IRB) approach for our residential and personal unsecured loans, the Foundation IRB approach for our treasury portfolios and the Standardised approach for commercial loans and operational risk.
The implementation of Basle II results in our Pillar I risk weighted assets at 30 June 2007 falling from around £33.9 billion under Basle I to £18.9 billion under Basle II, a reduction of some 44%. The risk weighting for our residential mortgages reduces to mid-teens %, treasury assets to around half of Basle I requirements, also around mid teens %, reflecting the low risk nature of these portfolios and personal unsecured loans to slightly below Basle I requirements.
Under Pillar II, the Group is required to hold capital to cover risks other than credit and operational risk and for risks not wholly captured under Pillar I. Overall, Pillar II capital is expected to amount to around 40% of our total capital requirements, including the effect of transitional adjustments that place a floor on capital requirements in the first three years of implementation.
This floor is calculated as 8% of Basle I risk weighted assets less collective provisions, multiplied by 95% in 2007, 90% in 2008 and 80% in 2009.
We continue to treat securitised assets as “off balance sheet” for regulatory capital purposes, resulting in deductions from both Tier 1 and Tier 2 capital for the first loss piece retained by Northern Rock. ****
Deductions are also equally made from Tier 1 and Tier 2 capital in respect of the excess of expected losses over provisions, whereas under Basle I Tier 2 capital benefited from the add back of collective provisions.
The introduction of Basle II, together with the planned disposal of capital inefficient assets and continued capital management such as the Whinstone programme results in an anticipated regulatory capital surplus over the next 3 to 4 years. This surplus will enable the reduction of previously planned subordinated debt issues and permit capital repatriation of up to £300 to £400 million over this period. Such repatriation will follow the release of capital as a result of asset disposals and will ensure that available capital is sufficient to support existing rating agency credit ratings and maintain an appropriate mix of Tier 1 and Tier 2 capital.
During the first half of 2007 we issued $650 million (£328 million equivalent) of Upper Tier 2 subordinated debt.
Or as CEO "Shagger" Applegarth , in between visits to the buy to let department, could more simply explain this recklessness with the shareholders funds in answer to Question 135 when he met the Select committee ..
" ....when you get your Basel II approval, the relative risk weighting of certain assets in your balance sheet changes. So what we had, because of the quality of the loan book, was you saw our risk weighting for residential mortgages come down from 50% to 15%. That clearly required less capital behind it, so that links to why we were able to increase the dividend.."
It is a reasonable assumption that to the Directors "We continue to treat securitised assets as “off balance sheet” for regulatory capital purposes, resulting in deductions from both Tier 1 and Tier 2 capital for the first loss piece retained by Northern Rock." meant - we can now pretend that we don't need to have capital to back up Granite and all that other other SIV shit.
..and therefore we can now pay out a dividend increase of 30.4% 3 days after the FSA gave us waiver approval. Luvvly Jubbly. Trebles all round and Adam is off to the Presidential Suite in the Four Seasons Hotel in Washington with Amanda Smithson to shag his brains out.
Hopwever 2 weeks later, by August 7/8/9 th the Directors were having a chat with Mervyn's minions about raising the odd £30Bn. (See BBC Radio 4 interview with the King of the Bank) simply to keep the business going ... and eventually they had to ditch the interim divvy entirely.
Incidentally to Question Q 220 Chairman of the FSA Sir Callum McCarthy ( 64 on February 29th) who it was announced on January 12th, just ahead of the report's publication that he would be "standing down" in September) strongly rejected the notion that the Basel II waiver process was a "a box-ticking exercise".
The next section of the report after the above is Section 46.
It commences, " The problems affecting Northern Rock were those of liquidity and funding, rather than solvency" ... too fucking right, the Directors were pissing away all the money on divvies they couldn't properly fund ... a liquidity problem that resulted in insolvency... ie. they could not pay their debts as they fell due... but of course the CEO had unloaded his shares at the top of the market i January ... the divvy was just another ploy to suck in the mug punters.
Dark secrets lurk somewhere in this unholy and (to the taxpayer) every, very, expensive mess.
******** Although the "Highlights" Press release can boldly claim "Total underlying assets of £113.0 billion - an increase of 28.3% from June 2006 ,underlying assets of £88.0 billion. Statutory assets of £113.5 billion, growth of 27.8% . Capital assets - now you see them, now you don't need to count them in under Basel II **** and all approved by the FSA !!!!