House of Commons Committee of Public Accounts

HM Treasury: The creation and sale of Northern Rock plc

Eighteenth Report of Session 2012–13

Report, together with formal minutes, oral and written evidence

Ordered by the House of Commons to be printed 5 November 2012

HC 552 Published on 16 November 2012 by authority of the House of Commons London: The Stationery Office Limited £8.50

Committee of Public Accounts

The Committee of Public Accounts is appointed by the House of Commons to examine ‘‘the accounts showing the appropriation of the sums granted by Parliament to meet the public expenditure, and of such other accounts laid before Parliament as the committee may think fit’’ (Standing Order No 148).

Current membership Rt Hon Margaret Hodge (Labour, Barking) (Chair) Mr Richard Bacon (Conservative, South Norfolk) Mr Stephen Barclay (Conservative, North East Cambridgeshire) Jackie Doyle-Price (Conservative, Thurrock) Matthew Hancock (Conservative, West Suffolk) Chris Heaton-Harris (Conservative, Daventry) Meg Hillier (Labour, Hackney South and Shoreditch) Mr Stewart Jackson (Conservative, Peterborough) Fiona Mactaggart (Labour, Slough) Mr Austin Mitchell (Labour, Great Grimsby) Sajid Javid (Conservative, Bromsgrove) Nick Smith (Labour, Blaenau Gwent) Ian Swales (Liberal Democrats, Redcar) James Wharton (Conservative, Stockton South)

The following Members were also Members of the committee during the parliament: Dr Stella Creasy (Labour/Cooperative, Walthamstow) Justine Greening (Conservative, Putney) Joseph Johnson (Conservative, Orpington) Eric Joyce (Labour, Falkirk) Rt Hon Mrs Anne McGuire (Labour, Stirling)

Powers The committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the internet via www.parliament.uk.

Publications The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the internet at www.parliament.uk/pac. A list of Reports of the Committee in the present Parliament is at the back of this volume. Additional written evidence may be published on the internet only.

Committee staff The current staff of the Committee is Adrian Jenner (Clerk), Sonia Draper (Senior Committee Assistant), Ian Blair and James McQuade (Committee Assistants) and Alex Paterson (Media Officer).

Contacts All correspondence should be addressed to the Clerk, Committee of Public Accounts, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5708; the Committee’s email address is [email protected]

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Contents

Report Page

Summary 3

Conclusions and recommendations 5

1 Creating a bank for sale 7

2 Learning lessons from the sale 9

Formal Minutes 11

Witnesses 12

List of printed written evidence 12

List of Reports from the Committee during the current Parliament 13

3

Summary

The run on deposits at Northern Rock in September 2007 was one of the key moments in a financial crisis whose effects continue to be felt today. After nationalising Northern Rock in February 2008, the Treasury eventually decided to split out a new retail bank, (Northern Rock plc), for sale, and to run-down the majority of the mortgage assets in a separate public sector vehicle, Northern Rock (Asset Management) plc (NRAM). Northern Rock plc was sold to Virgin Money in 2011 for proceeds currently estimated at £931 million, an expected loss of £469 million. The Treasury hopes to recover all the public funds provided to Northern Rock but this is far from certain as it relies on a profitable wind-down of NRAM to offset the loss on the sale of Northern Rock plc. Moreover, even if the Treasury’s predictions are correct there will still be an economic loss, currently estimated at £2 billion, to the taxpayer. It is therefore vital that the final decisions on the wholly owned banks are made with value to the taxpayer taking precedence over speed of exit.

The Treasury accepted its part in a “monumental collective failure” to understand and respond to the emerging banking crisis. The Treasury lacked the skills to understand Northern Rock. It took too long to nationalise the bank and failed to make an effective challenge to the bank's business plan, first after nationalisation in 2008 and again in 2009 when deciding what to do with the bank. The Treasury has started to address this lack of capacity: it has established UK Financial Investments (UKFI) with a small team of 12 people to manage the taxpayer shares in banks, and has conducted a review of its own skills and capacity. But huge challenges remain. The £66 billion cash spent purchasing shares in RBS and Lloyds may never be recovered, and the Treasury must also ensure it is prepared to deal with any future crisis, whatever form it may take, when it emerges.

In hindsight, the Treasury’s decision to create and sell a new bank turned out to be no worse than any available alternative, because no matter which part of the bank that was sold, or when, a larger amount of assets would need to be retained in public ownership. The decision to split the bank was intended to generate lending, but in public ownership the new bank lent only £9.1 billion against a target of £15 billion. UKFI took over management of the shares in 2010 but Northern Rock plc still lost money in 2011, and its strategy should have been challenged sooner.

There were only two competitors bidding for Northern Rock plc and EU state aid rules required the bank to be sold by 2013. Despite these constraints the sale was well-handled, although UKFI was fortunate that Virgin Money was keen to buy in 2011.

On the basis of a Report by the Comptroller and Auditor General,1 we took evidence from the Treasury and UK Financial Investments on the creation and sale of Northern Rock plc.

1 C&AG's Report, The creation and sale of Northern Rock plc, HC 20 (2012-13)

5

Conclusions and recommendations

1. The Treasury was part of a monumental collective failure to understand how the pre-crisis boom could lead to a banking crisis. The Treasury did not have sufficient capacity or the skills to understand and respond to the crisis when it began. It recognises that it took too long to realise that the crisis was systemic and too long, five months, to determine that a private sector buyer for the whole bank could not be found, even with Treasury underwriting. The delay in deciding what to do with the bank made a loss on the intervention difficult to avoid.

2. This will not be the last banking crisis, and the next one is likely to be different. The Treasury needs to retain a sufficient capability in its staff to understand and manage risks. It must find a balance between maintaining the ability to respond to an emergency and avoiding idle capacity. The Treasury has now published a review of its capacity (the White Review) and committed to updating the Committee on its response. The Treasury should update the Committee by June 2013 on progress made in implementing the recommendations of the White Review.

3. The rescue of Northern Rock currently has an estimated loss to the taxpayer of £2 billion. The final cost is not certain because it depends on the management of the mortgages retained in public ownership and the future performance of the UK economy. It is important for the taxpayer to know how much the interventions to bail-out banks have cost. UKFI should regularly review its estimate of the cost of the intervention to rescue Northern Rock and publish updated figures on a regular basis.

4. The Treasury did not effectively challenge the business plan put forward by the bank’s management to split the bank. The Treasury was told by its advisers in early 2009 that the business plan for the new bank put forward by the bank’s management was optimistic. Despite our previous recommendations, the Treasury did not mount an effective challenge to the assumptions in the plan and the final plan approved by the Treasury was still too optimistic. The Treasury must ensure it has access to the skills it needs to challenge all the banks in which it holds shares.

5. After it took responsibility for the management of the taxpayer shares in January 2010, UKFI did not challenge the strategy of Northern Rock quickly enough. It took almost a year before UKFI was able to challenge Northern Rock plc’s business plan. Only in early 2011 was cash, which the bank had failed to lend, invested in gilts instead to improve the bank's profitability. UKFI employed just 12 staff as at 31 March 2012, and its head of wholly-owned investments has now left and will not be replaced. UKFI is now increasingly reliant on the management teams of the wholly- owned banks (Bradford & Bingley and NRAM) to achieve a successful run-down of the mortgages retained in public ownership. UKFI should use the Treasury’s powers as sole owner of these banks to ensure the management work to minimise the overall economic cost rather than simply aiming for a quick exit.

6. Once UKFI decided to sell the bank, the sale was handled well, but the low level of competition does not give us confidence that the taxpayer will make a profit on the sale of RBS or Lloyds. There were only two competitors bidding for Northern

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Rock plc, and the Treasury was fortunate that one of them had a strategic interest in purchasing a small retail bank at the end of 2011. While significant, the £1.4 billion invested in Northern Rock plc shares was small in comparison to the £66 billion invested in RBS and Lloyds. The taxpayer is likely to hold its stake in RBS and Lloyds for many years. The Treasury should ensure that lessons it learns from the sale are captured and can be applied to future disposals, including any sale of RBS or Lloyds.

7. The government has many competing objectives for its shares in banks, and tensions between them will continue as the period of temporary public ownership extends. In line with our previous recommendations, the Treasury has separated its role as shareholder from its wider role as the nation’s finance and economics ministry. The Treasury should continue to ensure that its interest as shareholder is kept separate from its wider policy objectives.

7

1 Creating a bank for sale

1. In 2007 when Northern Rock collapsed the Treasury was not equipped to deal with financial stability issues. Although it was not the only body to be fail to foresee the crisis it was part of a monumental collective failure to understand that the pre-crisis boom could lead to a banking crisis.2 Even after the run on Northern Rock in September 2007, the Treasury was slow to realise that there were systemic risks throughout the banking system threatening the stability of the whole economy.3

2. The lack of people with the right skills meant that the Treasury could not reach a quick decision on how to save Northern Rock. The Treasury told us that, in hindsight, it should have nationalised the bank faster but that it spent the five months until September 2008 “trying to find ever more sophisticated devices, in effect, to bribe private companies to buy it”.4 Even with a taxpayer guarantee on the bank’s liabilities the Treasury did not find a willing buyer found and a cost for the taxpayer became difficult to avoid.5

3. After nationalising the bank the Treasury had to decide what to do with it. But as we reported in June 2009 it still lacked a proper understanding of what it had taken on.6 Northern Rock’s initial business plan in public ownership quickly proved optimistic,7 and the Treasury did not challenge, with sufficient rigour, the company’s forecast of future trading conditions.8

4. The Treasury eventually decided to split the bank to create a new vehicle that might generate lending. It hoped that by putting the £20 billion customer deposits into a retail bank it could get a better return than through a sale of deposits and this would reduce the capital required to hold the remainder of the mortgages to maturity in NRAM.9 Meanwhile the new bank could continue lending. But this was all based on a plan, put forward by the bank’s management, which had unrealistic economic growth assumptions. The Treasury did commission, in early 2009, due diligence on the plan which clearly highlighted several problems with the plan. However, the Treasury did not act on what it was told.10

5. The bank failed to deliver its plan. It lent £9 billion against a target of £15 billion. Meanwhile NRAM was winding down its old loans, so the real impact on lending was a net reduction of £5.6 billion over 2010 and 2011.11 UKFI told us that the lending targets were

2 Qq 21-23 3 Q 23 4 Qq 1-3 5 Qq 1-2 6 Committee of Public Accounts, Thirty-First Report of Session 2008-09, The Nationalisation of Northern Rock, HC 394, para 4 7 Committee of Public Accounts, The Nationalisation of Northern Rock, para 24 8 Committee of Public Accounts, The Nationalisation of Northern Rock, para 25 9 Q 41; C&AG’s Report, para 1.12 and Figure 2 10 Q 19 and C&AG’s Report, paras 1.16-1.18 11 Q 8, C&AG’s Report, para2.4

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not met because there was a “trade-off between profitability and volume” and that if more had been lent the bank might have lost more.12

6. UKFI took over the management of the shares from January 2010 but did not have an impact until December 2010. Although the Treasury and UKFI blamed the continuing low-interest rate environment, it took a long time for UKFI to change the bank’s strategy.13 Only after removing the taxpayer guarantee and finishing the detailed implementation of the split did UKFI seriously challenge the bank’s management to come up with a new strategy.14 The revised strategy was agreed in early 2011 and the banked invested unlent cash in gilts, improving profitability. But the bank still lost £18.6 million in 2011, the year it was sold.15

12 Q 11 13 Qq 5, 6, 13; C&AG’s Report, Figure 4 14 Qq 11-14 15 Northern Rock plc, Annual Report and Accounts 2011, http://companyinfo.northernrock.co.uk/downloads/results/2011_Northern_Rock_Final_ARA.pdf

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2 Learning lessons from the sale

7. The NAO reported that the sale was handled well by UKFI but still lost the taxpayer an amount currently estimated at £469 million.16 The £1.4 billion taxpayer shares were sold for proceeds which are currently estimated at between £886 million and £976 million. The proceeds include cash of £747 million received on 1 January 2012, further cash of £73 million received in July 2012, debt in Virgin Money worth £66 million to £117 million, and a clawback clause valued at up to £39 million. The midpoint of this range values the sale at £931 million and implies a loss to the taxpayer of £469 million.17

8. There was little competition to buy Northern Rock plc. UKFI was fortunate that Virgin Money had a strategic interest in immediately purchasing a small retail banking operation in 2011.18 Only two bids were available at any one time during the sales process,19 and had the sale been delayed it is not certain that any more would have been received. Indeed, current market conditions are less favourable than at the end of 2011.20

9. Whilst the timing of the sale and the lack of strong competition are important factors, a much larger portion of the mortgage assets remain in public ownership, and it is the handling of these assets which determines the overall cost to the taxpayer.21 UKFI expects to recover the loss on the sale and all the taxpayer support provided to Northern Rock from the profitable redemption of mortgages in NRAM.22 However, once risk and the time value of money are considered, the economic loss to the taxpayer of the intervention is currently estimated by the NAO to be £2 billion. This figure is the net present cost to the taxpayer of all the support provided, including the loss on the sale of Northern Rock plc.23

10. But the final reckoning will depend on how well UKFI manages the wind-down of NRAM. NRAM had £38.9 billion of mortgage and other lending assets remaining as at June 2012.24 UKFI may have opportunities to increase the return, for example by selling additional mortgages.25 It is in the taxpayers’ interest that it manages the run-down for value, not necessarily just looking for a quick exit.26

11. Since the sale, UKFI has shrunk further. The head of the wholly-owned section has now left and not been replaced, and the officer now responsible for oversight of NRAM also has

16 C&AG’s Report, para 15 17 C&AG’s Report, para 3.10 and UKFI Press Release, http://www.ukfi.co.uk/releases/UKFI%20Press%20Release%202012073_FINAL.pdf 18 Q 66 19 Q 68; C&AG’s Report, paras 3.2-3.7 20 Q 66; C&AG’s Report, para 3.15 21 Q 4 22 C&AG’s Report, paras 3.22-3.24 23 Q 96; C&AG’s Report, para 3.25, Figure 17 24 UK Asset Resolution, Interim results, June 2012, http://www.ukar.co.uk/~/media/Files/U/Ukar-V2/Attachments/press- releases/2012-07-27-report.pdf 25 Qq 45, 53 26 Q 60

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the much larger task of managing the taxpayer shareholding in RBS and Lloyds.27 In effect, UKFI is placing greater reliance on the management of UK Asset Resolution, the holding company established in October 2010, which combines NRAM and the remains of Bradford & Bingley.28

12. We heard that the Treasury has started building up its skills.29 It has set up UKFI with a small cohort of staff who have commercial skills and it has added an additional Second Permanent Secretary to strengthen senior management at the Treasury.30 It has also conducted and published a review of its skills, the White Review, in response to our previous recommendations.31 The Treasury committed to updating us on its response to the review by June 2013.32

13. The sale of Northern Rock plc is not directly comparable to other potential sales, but lessons may read across. The taxpayer has invested £66 billion in RBS and Lloyds shares33 and it seems inevitable that their “temporary public ownership” will last for some time if getting value for our investment remains the most important objective for Government. We were not convinced that the taxpayer would be making a profit on these banks any time soon.34

14. The Treasury has hived off the responsibility for managing the shares to UKFI, but has other objectives for its shares in banks.35 In 2007, we warned that “Reconciling public policy with shareholder value objectives can be difficult because the cost of meeting the former can have a negative impact on the latter”.36 The Treasury told us that UKFI would continue to focus on value for money, having regard to financial stability and competition while the Treasury took a broader view in line with its role as the nation’s economics and finance ministry.37

27 Q 57-61 28 Q 60, C&AG’s Report, para 3.22 29 Qq 17, 63 30 Q 18, 62, 63 31 Review of HM Treasury’s management response to the financial crisis, March 2012, http://www.hm- treasury.gov.uk/d/review_fincrisis_response_290312.pdf 32 Q 64 33 The Certificate and Report of the Comptroller and Auditor General on HM Treasury Resource Accounts 2011-12, (part of HM Treasury, Annual Report an d Accounts 2011-12, HC 46 July 2012),Figure 4 34 Qq 27, 37, 55, 69, 85 35 Q 27 36 Committee of Public Accounts, Forty-Second Report of Session 2006-07, The Shareholder Executive and Public Sector Businesses, HC 409, para 1. 37 Qq 79-87

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Formal Minutes

Monday 5 November 2012

Members present:

Margaret Hodge, in the Chair

Richard Bacon Meg Hillier Mr Stewart Jackson Mr Austin Mitchell Fiona Mactaggart Nick Smith

Draft Report (HM Treasury: The creation and sale of Northern Rock plc), proposed by the Chair, brought up and read.

Ordered, That the draft Report be read a second time, paragraph by paragraph.

Paragraphs 1 to 14 read and agreed to.

Conclusions and recommendations agreed to.

Summary agreed to.

Resolved, That the Report be the Eighteenth Report of the Committee to the House.

Ordered, That the Chair make the Report to the House.

Ordered, That embargoed copies of the Report be made available, in accordance with the provisions of Standing Order No. 134.

Written evidence was ordered to be reported to the House for printing with the Report (in addition to that ordered to be reported for publishing on 17 September 2012).

[Adjourned till Wednesday 7 November at 3.00 pm

12

Witnesses

Monday 17 September 2012 Page

Robin Budenberg, Chief Executive, UK Financial Investments, Sir Nicholas Macpherson, Permanent Secretary, Tom Scholar, Second Permanent Secretary, HM Treasury and Keith Morgan, Former Head of wholly-owned investments, UK Financial Investments Ev 1

List of printed written evidence

1 UK Financial Investments Ltd Ev 14

13

List of Reports from the Committee during the current Parliament

The reference number of the Government’s response to each Report is printed in brackets after the HC printing number.

Session 2012–13 First Report The Government Procurement Card HC 1915

Second Report Mobile Technology in Policing HC 1863

Third Report Efficiency and reform in government corporate functions HC 463 through shared service centres

Fourth Report The completion and sale of High Speed 1 HC 464

Fifth Report The Regional Growth Fund HC 104

Sixth Report HM Revenue & Customs: Renewed Alcohol Strategy HC 504

Seventh Report Immigration: The Points Based System – Student Routes HC 101

Eighth Report Managing early departures in central government HC 503

Ninth Report Preparations for the London 2012 Olympic and Paralympic HC 526 Games

Tenth Report Implementing the transparency agenda HC 102

Eleventh Report Improving the efficiency of central government office HC 288 property

Twelfth Report Off-payroll arrangements in the public sector HC 532

Thirteenth Report Financial viability of the social housing sector: introducing HC 388 the Affordable Homes Programme

Fourteenth Report Assurance for major projects HC 384

Fifteenth Report Preventing fraud in contracted employment programmes HC 103

Sixteenth Report Department of Health: Securing the future financial HC 389 sustainability of the NHS

Seventeenth Report Department of Health: The management of adult diabetes HC 289 services in the NHS

Committee of Public Accounts: Evidence Ev 1

Oral evidence

Taken before the Committee of Public Accounts on Monday 17 September 2012

Members present: Margaret Hodge (Chair)

Mr Richard Bacon Fiona Mactaggart Jackie Doyle-Price Austin Mitchell Chris Heaton-Harris Ian Swales Meg Hillier James Wharton Mr Stewart Jackson ______

Amyas Morse, Comptroller and Auditor General, Gabrielle Cohen, Assistant Auditor General, John Ellard, Director, NAO, and Marius Gallaher, Alternate Treasury Officer of Accounts, were in attendance.

REPORT BY THE COMPTROLLER AND AUDITOR GENERAL

The Creation and Sale of Northern Rock plc (HC 20)

Examination of Witnesses

Witnesses: Robin Budenberg, Chief Executive, UK Financial Investments, Sir Nick Macpherson, Permanent Secretary, HM Treasury, Keith Morgan, Former Head of wholly-owned investments, UK Financial Investments, and Tom Scholar, Second Permanent Secretary, HM Treasury, gave evidence.

Chair: Welcome. Finally, do you accept the NAO criticism that, even to Meg Hillier: Chair, before we start, could I make a date, there has actually been a loss to the public purse declaration of interests? I currently have a mortgage of £2 billion? I do not know who wants to start on with NRAM, and my husband had shares in Northern that, but I have been left more uncomfortable than the Rock just prior to its collapse, but he sold them, Report suggests we should be. fortuitously. Sir Nick Macpherson: Why don’t I start with a few James Wharton: I used to have shares in Northern remarks? Then I would be very happy to hand over to Rock, until it was nationalised. Robin and Keith on the details of the sale. The first thing I would say is that the main damage Q1 Chair: We are looking at a very complex issue, done on Northern Rock goes back to 2007–08, by and the Committee probably does not have the which I mean that, with the benefit of hindsight—this expertise that the Treasury Committee has, so ours is is hindsight—the Treasury was slow off the mark in slightly a layperson’s view. Having read the Report, terms of addressing the problem. You will recall that, from the point of the run on Northern Rock in which, on the whole, supports the actions taken in September 2007 through to nationalisation, there was splitting the bank and then selling Northern Rock plc, a five-month period of drift. That, I think, made it I am left asking a number of questions. quite likely that we would lose money on Northern Throughout this process, the management of Northern Rock in a way that certainly was not inevitable at that Rock never appeared to meet its objectives and point when we took a majority holding in RBS. business plans—it did not do what it said it was going The second general point I would make is that nearly to do. I therefore need convincing that the way you all banks over this period have disappointed, in terms handled things really minimised the loss to the public of their performance relative to plan. The most purse, because we have ended up with a loss of half a important factor behind that has been persistently low billion pounds. I do not feel convinced about that, in interest rates. Indeed, one of the reasons why terms either of the way that you oversaw the prospects for Northern Rock—the good bank management team at Northern Rock—perhaps that is Northern Rock—were not particularly good was that a question for Keith Morgan—or of the timing of the it has become clear, over the last year, that interest sale and the lack of competition around it. All that rates would remain very low for, potentially, a long leaves me with the question: did we get best value for period to come. Banks make money in all sorts of the taxpayer? ways, and it is fair to say that low interest rates may Another question concerns your assumption that, at be good for the consumer, but they make it more the end of the day, we will get our money back, which difficult for banks to make a turn. is based on everything being rosy over the next 10 or The third point I would make about whether I accept 15 years. There is a big question mark over that. All that we made a loss of £2 billion. On the face of it, that we can look at is how things stand now. What Northern Rock Asset Management—the bad bank— makes you confident that we will get the money back is, so far, profitable. It is one of those paradoxes: the over time? good bank was making a loss and the bad bank has Ev 2 Committee of Public Accounts: Evidence

17 September 2012 UK Financial Investments and HM Treasury been making profits. That is likely to persist, partly Actually, in financial terms those two options were because the Government can borrow reasonably always likely to come up with a fairly similar answer, cheaply, and therefore ultimately the bad bank can because the big money was associated with the bad fund itself reasonably cheaply. bank and the bad bank was common to both of them. The other thing is that a lot of the bad news is in the Again, coming back to our thinking, the other thing at past. I recognise that the property market is not taking that time was that mortgage lending was declining. It off and that house prices are not growing rapidly, but, was quite a big risk to take out a whole load of on the face of it, the big falls in house prices are mortgage capacity. Had we done so, it may be that behind us. So, although the bad bank is carrying a new entrants would have taken up the slack, but even degree of bad debt, actually the performance of the subsequently, when, as the Report mentions, the mortgages shows that these people—Ms Hillier being Government tried to make the good bank lend more, one of them—are generally paying their mortgages; the good bank had a good try at it, but it failed to hit the money is coming in, and that makes life better. the target. Ultimately, the question that you are raising is: what Even in failing to hit the target, Northern Rock during discount rate do you use to discount the future? On that time accounted for, I think, 22% of net lending the one hand—when I left the office, at least—the into the mortgage market, which is a reminder of how Government can, at present, borrow over a 10-year little the other banks were lending at that time. So period at a rate of 2%, but I think the UKFI’s keeping Northern Rock as a mortgage institution estimates were based on a Government cost of during that period provided quite a good underpinning funding of 3% to 4%. You are right to look also at to the market. It is a pity that it didn’t lend more, in what would happen if you looked at the long-run one sense, but on the other hand you cannot subsidise discount rate, which the Treasury would use. The lending so much that the Government would have Treasury would use 3.5% real, which you could argue taken a big loss on that lending. translates to 6% or 5.5%, and that is how you get the So I think the lesson was that we should have £2 billion. So, as I say, the losses on this go back to nationalised earlier and we should have contemplated the past. The Report confirms that the sale of Northern closure, although that was likely to be rejected. If we Rock was conducted well, but that was obviously at had nationalised earlier, we probably would have the end of the process and reflects all the intervening faced up earlier to the choice between good bank-bad information. bank or selling the deposit book—not much earlier, because there were a lot of other things going on, but I think there are important lessons there, and I think Q2 Chair: Before the others come in, just to pursue we would learn from them next time. that point a bit: would you have wished to nationalise it quicker or split it quicker? Is that really where you Q5 Chair: are coming to? What would be the lesson learned for That is a helpful start. I am going to ask Keith Morgan, as you were around at the time—not next time? being disrespectful to Robin, just because Keith were Sir Nick Macpherson: The first thing is that I would the person there—to pick up from there. have wanted to nationalise it quicker. We spent a long Okay, we nationalised too late and we have lost, so time trying to find ever more sophisticated devices, in far, £500 million. What should you or could you have effect, to bribe private companies to buy it. That done differently, either in overseeing the management failed. We should have nationalised it. capability within Northern Rock, or getting the decision on the timing of the sale, or encouraging Q3 Chair: And divided it up? Would you have done competition for the sale, which might have minimised that? the loss to the taxpayer? Sir Nick Macpherson: The big choice was whether Keith Morgan: Maybe I should talk about you just closed it down immediately— profitability, which is one of the issues you raised. Could the bank have lost less money along the way? Q4 Chair: Which they did in Iceland, and they are There is the point about lending that Sir Nick has just now growing. mentioned, and there is the £2 billion. It might be Sir Nick Macpherson: We could have done, but there helpful if I explain a little bit of this from the were two things that even an organisation as hard- layperson’s point of view, starting from 1 January hearted as the Treasury would have thought twice 2010 when the UKFI became responsible for about. One was that, at that time, when the economy Northern Rock. was going into a downturn, Northern Rock was a very If you look at what happened, in the first year of important employer in the north-east of England, so operation of Northern Rock—the good bank—the there was the effect on the north-east of closure. bank was slightly ahead of its profit target. That target The other factor about closure, which had just escaped was a loss of £224 million. In the second year, the me temporarily, was that it would at that time have profitability started to deteriorate below what was cost quite a lot more—our estimate was £5 billion to expected in the original plan. The NAO Report very £6 billion—because it would have been a fire sale. helpfully shows, on page 24, the interest rate That took you on to two options. One was doing what environment that was being referred to— we did with Bradford and Bingley, which was effectively selling the deposit book, taking on the bad Q6 Chair: But what we don’t understand is why they bank and dealing with that. The other was trying to didn’t buy gilts. Presumably everybody else did. Why carve out a good bank but also taking on a bad bank. didn’t you tell them to buy gilts? Committee of Public Accounts: Evidence Ev 3

17 September 2012 UK Financial Investments and HM Treasury

Keith Morgan: What you have to do as a bank is Q10 Chair: That’s not what it says here. hold liquidity. Keith Morgan: It was adopted after we challenged the business plan at the end of 2010. Q7 Mr Bacon: Are you saying gilts aren’t liquid any more? Q11 Chair: Why didn’t you challenge them earlier? Keith Morgan: You’ve got to hold safe liquidity. If Keith Morgan: I think it was pretty good timing, interest rates are low, you earn a very small interest actually. We were monitoring the business from 1 rate on billions of pounds. The Report shows that, January 2010, and by December 2010 we were asking when the plan was put together, everybody was them to come up with a better business plan. That expecting interest rates, at this point in time, to be was as we monitored and saw that the environment back at 4%. was changing. The difference between 0.5% short-term interest rates The other thing to mention on the lending, if I can and 4% interest rates is quite significant—it is just finish that one point, is that there is this trade-off measured in tens of millions of pounds. As the between profitability and volume. It was a competitive environment was deteriorating in terms of interest market in terms of lending, and there were decisions rates, it was very clear that the company was not that had to be made. Would you try to lend more and going to make the forecast profitability going forward. lose more money, or would you tailor your lending to So the UKFI board asked the company to reiterate, match the profitability targets? That, I think, is what renew, refresh and come up with a better business was going on throughout 2010 and why we ended up plan. with a £9 billion— That was done at the end of 2010, as we went into that period. We challenged all aspects of the business Q12 Chair: But the purpose of the split was to ensure plan. In particular, we were interested in growth that money continued to be lent to keep the mortgage forecasts, in the Treasury income—where they were market going, so if that is your purpose— investing their money—and in the cost base. The Keith Morgan: The objective that we have to result was that we went through various iterations understand is the lending objective, but also the with the business from December 2010 to May 2011. profitability objective. It is a balance between the two. During that period, we came up with a better business plan than before, but still one that could not resist this Q13 Meg Hillier: I am not a finance expert, but I do environmental change, which is that interest rates are know that when I put money into savings accounts, if lower for longer. it is not performing, I will move it and I will move it On the lending point, which is clearly another point pretty quickly. You can use your intelligence on that. referred to in the Report, the original target was £15 Now, you said it was pretty good that from January billion. Just over £9 billion was lent—clearly not the 2010 to December 2010 you went back and pushed original target, and some way off it. One important Northern Rock to move that money, that liquidity— fact is that the marketplace was significantly £9 billion in liquid form—into gilts. That seems quite a long time to me. Was it because you didn’t want to subdued—that word is mentioned in the Report. In be having your finger in, managing it day to day? Can fact, the market was close to £40 billion lower for you explain that a little more? those two periods than when the original plan was put Keith Morgan: During this period, the company was together. The company still missed its targets. Sir Nick also releasing the guarantee on deposits. There was a mentioned that, in fact, Northern Rock accounted for guarantee on £19 billion of deposits, and of course in 22%—more than one fifth—of the growth of the the back of everyone’s mind was the fact that we mortgage market. needed to manage that very prudently—we needed to make sure we had money available. In that situation, Q8 Chair: I am going to interrupt you because that you are more prone to keep money available short is all in the Report. We’ve got two questions. First, term than to have it locked up longer term. As that let’s kill this 22%, because if you shoved the two bits passed, there was the opportunity to reconsider the of the bank together—somewhere in the Report it says Treasury investments, and we pressed on that point as this—the bank as a whole, or the old Northern Rock, we approached the end of 2010, as I mentioned. was taking £5.6 billion out. Keith Morgan: Absolutely. Q14 Meg Hillier: Could they have done that quicker, do you think? Do you think there was any fault in Q9 Chair: So the good bank bit looked good only Northern Rock’s management not moving quicker on because, at the bad bank, people were closing on their that? mortgages and paying them back early. So it was not Keith Morgan: That is very difficult to answer, but I a good story. That is the first thing. think the answer is that maybe, within the question, The second thing—you haven’t answered this—is that in terms of months—but then you would have taken their management of the resources seems poor. If they the judgment as to what the right timing was to move hadn’t done the 0.5%, and they had shoved money it in any event. The point about the losses is that the into gilts, they might not have had the quarter of a losses here are not really associated with whether or billion of extra losses that they did. not they moved into gilts at a certain point in time. Keith Morgan: No, they did have a policy of The £224 million of losses was locked in in the investing across the spectrum of gilts, short-term to business plan at the beginning. Then the balance of long-term. that was really forward looking. Our problem with the Ev 4 Committee of Public Accounts: Evidence

17 September 2012 UK Financial Investments and HM Treasury future for Northern Rock is that as you see the interest up the expertise you needed to deal with that kind of rate environment going out lower and lower for situation once those warnings had come through? longer, the break-even point on the business goes out Sir Nick Macpherson: I think we did start to build up longer and longer, so whereas you had a business the expertise from late 2007, but, again with the which looked like it could break even in 2012, you benefit of hindsight, we did not build it up quickly start to find that it is possibly not going to break even enough. Reflecting a recommendation of this in 2013. Then you have a deadline to sell the business Committee, I commissioned a report on the Treasury’s by the end of 2013. So it’s really a forward-looking management response to the financial crisis. It is a concern, which was our concern, which was why we very good report, produced by Sharon White—now of moved quite quickly to press for the better plan and the Treasury—and I wrote to the Chairperson of the then to assess the strategic options for the business. Committee before the summer, setting out our response. Q15 Mr Bacon: On that point, you have said that if I think there were big lessons for the Treasury. This you want to keep it short term, you obviously want it is a difficult issue, because you cannot staff the to be very liquid, and then you might move to Treasury on the basis that a bank is going to collapse something that is longer term. You make it sound like tomorrow. If you did, we would have this investment gilts really aren’t liquid. The point was it was the banking arm which, for a lot of the time, would be Bank of England—[Interruption.] It could have been twiddling its thumbs. The issue about the challenge in gilts and something else. You do not have to hold which you are setting is: how do you build up enough the gilts to maturity. There is a market and there is a capacity so that you do not waste money on external price. You could have put it into gilts and you would advisers? We have been through this with the have got a better return, wouldn’t you? Committee in the past— Keith Morgan: There are things other than gilts, other corporate bonds, which might qualify for liquidity, so Q18 Mr Bacon: If the Bank of England had not been yes. But on the spectrum of liquidity management, it denuded of most of its expertise, you would not have was operating at a very conservative position at the had the problem in the first place, would you? beginning of the period when the deposit guarantee Sir Nick Macpherson: You can argue that, and no was going to be lifted. Then we were encouraging it, doubt the next time a bank collapses, as they do with as the year went by, to invest in higher yields. unerring regularity—usually, once every 10, 20 years—we will see where the expertise is then. But Q16 Mr Bacon: Are you saying there is a difference the point is the Treasury needs enough capacity to in liquidity between the Bank of England and owning do a lot of the leg work which, if you are paying an a gilt, or not? I don’t think there is. investment bank to do, becomes very expensive Sir Nick Macpherson: There is in one respect. indeed. I think we have benefited from building up in- Obviously, if you are holding a one-year gilt or a two- house expertise and Tom Scholar here, who is a living year gilt, then the actual price of that gilt in the market example of that expertise, can speak eloquently is going to be pretty close to par. The problem if you about that. have a 10-year gilt, say—the ones that at that time What we also learned was that having an arm’s length would have been yielding more—is that you are at the body that could actively manage our shareholdings mercy of movements in long-term interest rates. For has been hugely advantageous. Keith has recently left example, if you bought a gilt now and it had a yield the UKFI, but he has very kindly come back here for of 2%, and yields double to 4%, you would be sitting free today to give you the benefit of his wisdom. on a capital loss in the short run of anything up to half Robin is now chairman of it. The UKFI is a very small the value of that gilt. In the case of Northern Rock, it outfit: it comes very cheap indeed. These guys have needed to be liquid, because there were concerns agreed to work for us at way below their market rate. about money being withdrawn as the guarantee came I think that that demonstrates that you can build up off. You really did not want to be holding long-dated expertise, you can build up capacity and you can hang gilts in those circumstances. I recognise the point on to it. about investing in gilts, but you want to be a bit careful. Q19 Austin Mitchell: That is very good, but it is a small outfit facing a big problem. The Report makes Q17 Austin Mitchell: The Treasury has clearly been the point that all the predictions, both from the old on a steep learning curve here. The Report makes Applegarth management—which seems to have got recommendation that “the Treasury lacked sufficient off scot-free, without penalty or fine or anything—and in-house capacity to make the best use of external from the new management, were over-optimistic. The advice and challenge Northern Rock management Treasury must have shared that over-optimism about effectively.” It goes on that “Departments need the way the economy was going to develop. Why did sufficient capacity and expertise to be available within you not, for instance, ask for due diligence when you government to detect and make effective challenges nationalised it in February 2008? to over-optimism in business” circles. Sir Nick Macpherson: I think we did ask for due The first warnings of disaster came in 2007. How did diligence. the Treasury interpret what happened in 2007—as an Austin Mitchell: Was it because you were over- augury of things to come, which would next year hit optimistic? Bradford & Bingley and HBOS, or as a blip which Sir Nick Macpherson: The problem was that the could be countered? Why did you not begin to build whole market at that point was in decline, and later Committee of Public Accounts: Evidence Ev 5

17 September 2012 UK Financial Investments and HM Treasury that year it went into freefall. So, at each point, we or something, where you ended up in ’73 having a 7% were making pretty pessimistic assumptions about growth rate. In 2006–07, the economy was growing at how much house prices would fall, and how much 2% to 3%, so it seemed that this could continue. You commercial property prices would fall, but we turned could also argue that the asset price rises were a out to be too optimistic. One of the lessons of that is response to a low-interest, low-inflation environment. that actually you need to have pretty serious stress It turns out that we were wrong—I accept that. You tests. There is always a risk about— were right and there are probably lessons for us, too. We should have had you inside the Treasury. The Q20 Austin Mitchell: But you had stress tests in critical point is to learn from these things, and that is 2007, ordered by the FSA. what we have been seeking to do. You have Sir Nick Macpherson: We did, and it turned out that demonstrated that in 2007–08 we were slow off the things happened that were off the scale, in terms of mark. I plead guilty to the fact that I thought—not “I the pressure on the banking system. Tom managed a thought”; we all thought—that Northern Rock was a lot of this; do you want to comment, Tom? particularly extreme example. Even in late 2007, I Tom Scholar: May I add one thing? It is correct to cannot remember anybody—the Governor of the Bank say that through the autumn of 2007 and much of of England, the chairman of the FSA, the Leader of 2008 not just the Treasury, but many commentators the Opposition—saying, “You’d better watch out, and forecasters in general were constantly revising because the whole of the banking system is going to down their expectations of the economy. An example collapse next year.” It was very much focused on of that was house prices, which started to fall during Northern Rock’s management at that time, and its 2008. We found, looking at Northern Rock, that business model, but within a year the whole system successive business plans had underestimated the fall was collapsing. in house prices. We eventually did manage to catch up and make the opposite mistake, which is always a Q24 Chair: I know that looking back is much easier, risk in these circumstances. So, if you look at the but, given what has happened to interest rates, it might business plan that underlay the case for the split, it have been better never to have split the bank. had, as a central assumption, a fall in house prices of Sir Nick Macpherson: I still think splitting the bank 37% from the peak to the trough—again, reflecting made perfectly good sense. very much the consensus at the time. In the event, the fall was more like 20%, so that element of the Q25 Chair: Because? business plan proved to be over-cautious, which Sir Nick Macpherson: Because, on any basis, it helped to offset some other elements where we had capped the losses at a point that would have been very been over-optimistic. similar to just selling the deposit book. The two things Unfortunately, forecasting is not a science, and you are ultimately related. If the good bank was going to always make an error one way or another. I recognise make a loss, we probably would not have got a very that we, at least in the early stages, were catching up good price for those deposits in the market at the time. with the way the market was evolving, but that is one Indeed, one of the problems that we have had example where we took a hard look at it and thought, throughout this period is getting anybody to bid for “Let’s make a very prudent assumption, in order to these assets, because the market is very subdued give us some protection against the downside.” indeed. To come back to the positives, it is striking that once Q21 Austin Mitchell: I am mystified by the way that we got Northern Rock back into the private sector, the Treasury was carried along. You say it was under Virgin’s management, they seem to be modified optimism by 2008—well, it was, but up to expanding. I think they had 4 million customers to that point you were carried along by the kind of start off with. They are well on target to get an extra general euphoria. Here was in fact an enormous 1 million customers this year, and they are, by all bubble, which was based on ever-inflating asset accounts, lending actively, so having a private prices. I would have thought a basic view of the company back running this bank and being Treasury should be that if a thing cannot go on for competitive can only be good for consumers and ever, it probably won’t. depositors. Sir Nick Macpherson: There was a monumental, Chair: At which point, I will bring in the local MP. collective failure, of which the Treasury was part. Q26 James Wharton: One of the north-east MPs. Q22 Austin Mitchell: So you were part. Listening to your answers to Austin’s questions Sir Nick Macpherson: Yes, I was part. I suppose, reminds me of one particular colleague, whom I will looking back on it, that the period of 2006–07 was not name, who famously saw it all coming and quite interesting. A lot of people now who say yes, predicted nine out of the last one recessions. My they saw it coming and who made speeches saying— concern would be—listening to some of the answers—that some of the conclusions that you are Q23 Austin Mitchell: I did. drawing may be because we were lucky and it worked Chair: You and Vince. out okay this time, rather than because the underlying Sir Nick Macpherson: But at the time, it was not as premise of the action that the Treasury took or the if the economy was growing very rapidly, or as if route by which we got to it was actually correct. inflation was picking up. We had been through this In particular, on the lack of due diligence, you say that long upswing, where it was not like the Barber boom you should have nationalised the bank more quickly, Ev 6 Committee of Public Accounts: Evidence

17 September 2012 UK Financial Investments and HM Treasury but within that five-month gap, would you look at Sir Nick Macpherson: Very much so. The Chancellor putting in mechanisms for advancing a process of due has made it clear that our interest as a shareholder is diligence and looking into things? Not necessarily not just about making a quick turn for the shareholder; taking the step of nationalising the bank, but could the it is about looking at the broader impact. Things such due diligence not have been started earlier—quietly— as lending are important, and even employment is and then not necessarily deployed in a purchase if important. There is a balance of risks here, in effect, events had transpired differently? for the Treasury between its classic Finance Ministry Sir Nick Macpherson: You would certainly accelerate function, which is about protecting the taxpayer that process. I would not claim that in those five versus its other, Economics Ministry function, which months the Treasury was just sitting idly doing is about creating conditions in which the economy nothing. It was using that period to get a far deeper grows. In a sense, we must internalise that within the understanding of the issues in relation to Northern Treasury, and when we look at things such as RBS Rock. The other point I would make, and I am sure options, we continually try to assess whether the the Governor of the Bank of England would make it, intervention will increase lending and lending was that one of the problems in 2007 was that we did capacity, and help the economy, versus the impact on not actually have at that point the powers to resolve a our shareholding. bank in the way that we subsequently had. For Perhaps reflecting my Finance Ministry background, I example, when Bradford and Bingley came under think it is important to attach a degree of scepticism pressure in September 2008, we could resolve that around the state getting into the banking business. over the weekend using the powers we had acquired History suggests that when the Government own in early 2008. On that basis, we could sell the deposits businesses, whether in banking or manufacturing, they of Bradford and Bingley, which we did to what is now tend not to run things very well. That is not called Santander, and run off the bad bank, in effect. necessarily about the quality of management; it is just We have at our disposal far stronger powers to that Governments have conflicting objectives and intervene. We have far greater expertise. You are right. generally will put off making decisions that will have There is always an element of luck in these things. I an impact on one set of citizens—for example, think the Treasury has probably had more than its fair employment in the north-east. We ended up owning share of bad luck over the last few years. Northern Rock and the vast majority of the Royal Bank of Scotland, but I would be quite cautious about Coming back to learning the lessons, we should lending to all comers. If you do, you can destroy value remember that we still own a very large bank indeed at quite a rapid rate. There is a trade-off here. in the shape of the Royal Bank of Scotland. We have Chair: There is clearly a trade-off, but before you get a very big shareholding in another bank—Lloyds. All away with that, I must say that if you look at the points you are making are highly relevant today, something like the electricity market, it is difficult for which is why the money at stake is far bigger. Our in- us to think that the private sector is working in the price on our shareholdings is of the order of £50 interests of consumers all the time. We are having to billion, so this is very serious, and you will be glad to intervene, so it is not always the case. hear that we are trying to ensure that whatever decisions we need to make in the coming period will Q28 James Wharton: Not all Government be based on a far more professional approach to asset interventions are in the interests of consumers and management than existed in Government in 2007. taxpayers. I have one last question on the sale decision. It says Q27 James Wharton: I think that when the in bold letters in the Report that a delayed sale would Government stray into what is effectively a new not have been better value, and the sale seems to have area—running banks is not something that worked quite well from the Treasury’s point of view. Governments in this country have done very much One would assume, therefore, that it has not worked throughout our history—there is a danger that their necessarily as well as it might have from Virgin’s role becomes something that is viewed through the point of view—if it had come along a bit later it might prism of people who work in the private sector, which have got a better deal. Has the sale worked well is to say it is about asset management and getting the because you knew it would, or have you been lucky? best value from what we are doing. I suggest that what Sir Nick Macpherson: It was clear to us that if the we need to look at is the broader impact of bank stayed in the public sector its losses would Government involvement. When you are assessing the continue and value would be eroded, so perhaps we effectiveness of the journey you have been on with have been lucky. Perhaps if interest rates had taken a Northern Rock and where you are going with other different course, Virgin would now be making even assets that the Government have acquired, do you take more profits than it is and you would be criticising us into account things like the number of job losses and for having sold it. There is a degree of luck; it goes the impact on the broader economy? There has been back to the issue of forecasting. This is a forecast that, some talk of net mortgage lending at 22%, which is a at least at this stage, we have got right. There is positive, but how many jobs have been lost in the another issue, which is why it is important to get north-east because of the steps that have been taken, businesses in a competitive market into the private and could that have been avoided? Do your models sector. take into account more than just the cash return on the Having a new entrant in banking in the shape of Government’s investment—the impact on the Virgin can only be good for the market. The state, not economy, jobs and people? least because of Brussels rules around state aids, is a Committee of Public Accounts: Evidence Ev 7

17 September 2012 UK Financial Investments and HM Treasury pretty poor competitor in this sort of market. There Sir Nick Macpherson: One of the problems is that the is a difference with electricity. Electricity is a highly British banking market is very mature. With all these regulated market; it is basically a utility model. I agree transactions over the past few years it has been that banks have some things in common with utilities, difficult to attract new interest. but it is easier to enter the market when it comes to providing banking services than providing electricity, Q37 Chair: The interesting thing with Lloyds is that but I may be wrong. we did not sell it to the highest bidder. Robin Budenberg: I think we would argue that they Q29 Mr Bacon: In that case, why didn’t you break did sell it to the highest bidder. I am sure that the up all the banks—the Royal Bank of Scotland, Lloyds board of Lloyds would have made sure that they did TSB—big time, into lots of small pieces, keep lots of the best possible deal for shareholders. That is golden shares, stay out of it and let them compete? something we discussed with them to ensure that was What is lacking in the banking market is competition. the case. That is why there isn’t lending. Chair: I don’t think those who lost would argue that, Sir Nick Macpherson: That is indeed a possibility, but maybe that is for another time. but you would lose— Q38 Ian Swales: I would like to explore a bit more Q30 Mr Bacon: Not necessarily, once they started to this good bank-bad bank situation, referring to figure make money. 3 on page 19. You put only £10 billion of the Sir Nick Macpherson: You would lose quite a lot of mortgage book into the so-called good bank and kept shareholder value in the process. £54 billion in the so-called bad bank. I am sure Ms Hillier would be mortified to find that her mortgage Q31 Mr Bacon: You don’t know. As I said, you was regarded as appropriate for a bad bank. I am would keep golden shares. If they did well, you would intrigued as to how you came up with that sizing. I do do well as well. understand balance sheets and I can see how it works. Sir Nick Macpherson: We rely on the UKFI to advise Why did you not make the Northern Rock plc larger, us in these matters and hitherto they have not come so that its cost base would be better covered and it up with that option, but it may be that Robin has it on would be more likely to be successful? Looking at his mind. these numbers, I can see why the bad bank is likely to be more successful than the so-called good bank. Q32 Chair: Robin, do you want to comment on that? Why was that decision taken? Then I am going to Ian and Stewart. Sir Nick Macpherson: Since it was before the UKFI’s Robin Budenberg: I think breaking up banks is a very time, I will pass this one to Tom. complex thing to do. We have seen in the sale of a Tom Scholar: The reason why we felt that it would small number of branches by RBS how complex that make sense to separate the bank and to create a is. It is very expensive— smaller vehicle was that, first of all, we had already established that there were no buyers for the entire Q33 Mr Bacon: Putting them together doesn’t seem bank, so we would need to create a smaller vehicle in to be too difficult. Mr Goodwin went round putting order to find a buyer who was eventually prepared to large numbers of banks together at very high speed take it back into private ownership. Secondly, because without a lot of regulatory oversight, didn’t he? of the way that the financial regulation system works, Robin Budenberg: He did. the greater the assets of a bank, including mortgages, the more regulatory capital it has to hold against those Q34 Mr Bacon: I mean, like 15 banks in three years, assets in order to protect the depositors. Given that or whatever it was. Everyone was sitting there, going, Northern Rock was entirely owned by the state, the “Oh, this is interesting.” The FSA said, “Mm, should only place that that capital was going to come from, you really be doing that?” But nobody stopped him. realistically speaking, was the Government and, as the Why is it so much more difficult to break them up Report clearly sets out, we were very keen to than to put them together? minimise any additional equity injection by the Robin Budenberg: I think you would lose a lot of Government. value. For both of those reasons, we felt that, to minimise the cash call on the Government and to maximise the Q35 Mr Bacon: We lost a lot of value putting them chances of creating a new bank that could be sold, we together, as it turned out. should be looking to have a rather small Northern Robin Budenberg: As it turned out. Rock plc. It had £20 billion or so of liabilities in the form of cash deposits, so it clearly needed an asset Q36 Mr Jackson: What do you mean by that? That book to match that, and because of the way that the you would lose a lot of value by freeing up the numbers stacked up—the tables set them out—a market? mortgage book of something like £10 billion seemed Robin Budenberg: If you look, for example, at like the best way to achieve that. Lloyds’ disposal of what we call the Verde, the European Union-mandated sale of 500 branches, that Q39 Ian Swales: So are you saying that this could was a very value-destructive process, because you had not have been structured differently to make the good to create a new entity, new overheads, and there bank pick up more of the assets and liabilities of the weren’t many people who wanted to buy. total—to make an even better bank, if you like? Ev 8 Committee of Public Accounts: Evidence

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Tom Scholar: First of all, I should say that people Q43 Ian Swales: I am really teasing out the idea of often use the terms “good bank” and “bad bank” whether there was an even more saleable and valuable because it is a simple way of describing it, but it was bank had we structured it a bit differently. For not the case that good mortgages got put into Northern example, if Ms Hillier’s name had been one of the Rock plc and bad mortgages got put customers on the list of Northern Rock plc, would into Northern Rock (Asset Management). On the Virgin have paid a little bit more because they had a contrary—not least because the state aid rules required more expensive customer relationship with all these us to—we put a very similar mixture of mortgages people who actually only have a relationship with into both vehicles, so it is really about the overall total NRAM? rather than the composition of those mortgages. Tom Scholar: Perhaps I could ask Robin to comment Certainly we could have decided that, instead of on the attractiveness and what the buyers were putting £10 billion of mortgages into Northern Rock looking for. plc, we could have put in £15 billion or £20 billion. Robin Budenberg: To have an attractive business, it We would then have had to put in some matching is important to have a portfolio of mortgages in there liabilities, and that would almost certainly have meant to create a real business, so you had to split the a bigger Government loan and a bigger Government mortgages between the two new entities. On the way equity injection. We could not really see the case for in which it was done, clearly, if you put all the, as doing either of those things and, in addition, we felt Keith says, really poor-quality mortgages into Northern Rock, you would have spent two years that it would create a bigger bank that would therefore convincing people that they weren’t really poor have been more difficult to sell on. quality. As it was, they were of reasonable quality and broadly balanced across the credit spectrum, but with Q40 Ian Swales: So you are saying that the good mortgages in there, and that meant— mortgages in NRAM are no higher risk than the ones in Northern Rock plc? Q44 Ian Swales: Was any consideration given to, in Tom Scholar: I will look to Keith. I think it is very effect, selling part of NRAM alongside Northern much of a muchness. Rock? Once you had the hindsight 18 months to two Keith Morgan: You will find that there are similar years later and you had £50-odd billion of mortgages mortgages inside NRAM as there are inside Northern and customer relationships in NRAM, was any Rock plc. The worst end of the credit spectrum is still consideration given to packaging that with Northern in NRAM, but I think the point that you are making Rock? My big worry is whether Northern Rock is is that, for more than 90% of the mortgages inside sustainable. Are the jobs going to continue? I am a NRAM, people are making their mortgage north-east MP, and one of the big advantages that we repayments—they have no problem making their had with Northern Rock was the huge charitable mortgage repayments. It is just not correct to call it a foundation that they used to run, but I guess that has bad bank in that sense. either gone or is going. Those are the considerations. We have something that is relatively emasculated Q41 Ian Swales: So was it right to split it at all, with compared with what it used to be. hindsight? If that is the case, what was the logic? Keith Morgan: One of the things to mention about Now, looking at it with hindsight—I respect the fact the combination of Northern Rock and the buyer, that you did not have hindsight at the time—was it Virgin, is that they are complementary businesses. The still right to do the split? Northern Rock business was very simple. It was Tom Scholar: I think it was, and the NAO also mortgages and it was savings. As we have mentioned, concluded that in its Report, because had we not done that was then prone to some of the very sensitive the split we would have had to put in £6 billion of movements in the economic environment. When we looked at and did our due diligence on Virgin and capital to support the mortgages and we would have what the combination would offer, one of the things had to make an additional loan of, I think, £20 we saw was that they are complementary. It is 1 billion— million mortgage and savings customers with 3 million Virgin customers, which actually has different Q42 Ian Swales: But you have put in £23 billion of products, so there is the opportunity to cross-sell loans and £1.5 billion of capital, as I understand it. In products more between the customer bases. The the end, you cannot make something out of nothing, distribution is complementary. The combination of the can you? You have had to give taxpayer support to business overhead is complementary, so it is a two vehicles instead of one, haven’t you? stronger proposition, being part of— Tom Scholar: You are of course right; you cannot create something out of nothing. The other thing that Q45 Ian Swales: I can see that. How many mortgage I would say is about the eventual sale back to the customers does NRAM still have then? private sector. This, of course, was in the UKFI’s Keith Morgan: It is about 350,000 pure mortgage domain, and it might want to comment on this, but I customers. think that what it found when it got to the sale process Sir Nick Macpherson: Can I very briefly add to that? last year was that there were not that many people What is quite interesting is that, even since this wishing to buy anyway and, certainly, it was already Report, Virgin has bought £465 million extra of of a size that was presenting quite a challenge to the mortgages from NRAM, and UKAR has also sold its buyers. Gosforth site and two smaller properties to Virgin Committee of Public Accounts: Evidence Ev 9

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Money, which suggests, actually, that Virgin are kind the whole of Northern Rock was effectively on one of of interested in sticking with the north-east and with quite considerable Government support of the sort that wider mortgage delivery. I suspect this Committee would have been uncomfortable with. As Robin said, the view on the Q46 Ian Swales: We have had a letter about that. size of the sale was that this was the right structure, Thank you for reminding me. but we are still managing these assets. If there is To go back to my question, was any consideration anybody out there who wants to come in and pay at given to expanding the size of Northern Rock plc, par for those mortgages, I am sure that the UKFI using NRAM assets, as part of the sale process—in would be keen to talk to them. other words, making a bigger Northern Rock plc— because Northern Rock plc is only roughly a quarter Q54 Ian Swales: I have one last point. As I of what Northern Rock used to be? understand it from the Report, there were three other Robin Budenberg: I think when the split happened potential buyers: two from one name and another the decision was to allocate the mortgages on the basis outfit. I guess I know what you will say, but I want to of what created a viable business, and— hear you say it. Do you think that it would have made any difference if there had been a bigger mortgage Q47 Chair: So is the answer no or yes? book offered with Northern Rock at the time of the Robin Budenberg: The answer is that it was sale process, as opposed to selling it separately or considered at the time of the split. later? Obviously, those other players do not now have the infrastructure to come and bid for those Q48 Ian Swales: But not at the time of sale process? mortgages. Virgin does, but you now have only one Robin Budenberg: No, because I do not think that game in town. Would a bigger bank, in other words, there was any reason at that point to suggest that the have made any difference to the other players? shape of Northern Rock plc was in any way sub- Robin Budenberg: No. I think that size would have optimal from the point of view of a sale. been an issue. If you increase the size, you probably reduce the number of people that might be interested. Q49 Ian Swales: We have had some evidence Chair: Well, you had hardly anybody interested since—that if Virgin has bought half a billion of anyway. Of your 50 whatever it is, you only had one mortgages, it would have liked it to be bigger. Would and a bit. any of the other buyers have been interested? Robin Budenberg: I think that was a particular issue Q55 Mr Jackson: Can I ask Sir Nicholas a question? for Virgin, because they were short on mortgages You mentioned earlier the importance of using this because it wasn’t a product that they offered. Report to inform future policy and learn lessons. Can I ask whether you will or have changed your Q50 Ian Swales: How were those mortgages econometric modelling as a result of the lessons selected? This figure of £54 billion was at the time. I learned from this particular situation, with regard to don’t know what the figure is now. How were Virgin’s the fact that you, as you concede, were significantly half a billion of mortgages selected to sell to them? out on profitability and lending targets? You sort of Keith Morgan: They asked for market representative implied that that was a function of the unique set of loan-to-value mortgages, so it is a very similar circumstances between 2007 and 2009, which is a fair composition to what was built up inside Northern point, but there is speculation about the break-up of Rock plc and what was put in there in the first place. the euro, whether orderly or disorderly, and I am just trying to understand why you were not able to foresee Q51 Ian Swales: I can’t believe that it was random. some of the market conditions. Was it that you did not There must have been some process, by which you have correct data collection or there was not said— information available? How have your models Keith Morgan: Yes. For example, it did not include changed so that if this or a similar situation were to anyone in arrears. happen again, you would be better placed to make a Chair: The interesting thing with this line of decision on value for money for the taxpayer? questioning from Ian is, why did you not think of Sir Nick Macpherson: It is a good question. In one adding some more in? sense, in macro terms, it is no longer my responsibility. The new Government have contracted Q52 Ian Swales: If 90% of the mortgages are out the macroeconomic forecast to the Office for performing well, surely there was an option— Budget Responsibility, which, like all forecasters, is Chair: So you get the state out and back to your struggling to produce persistently accurate forecasts. thing quicker. The problem with all macroeconomic forecasting is Sir Nick Macpherson: We still have that option, spotting turning points and then spotting the extent of and— the change when there has been a turning point. The Treasury’s forecasting record was extremely good Q53 Chair: But you chose not to pursue it. Why? All through most of the period of 2000 to 2010 simply we are trying to understand is why. because the economy was growing pretty much in a Sir Nick Macpherson: Going back to the good bank, straight line. On getting better models, you can only bad bank split, we had extensive discussions with make so much progress. Virgin in 2007, 2008—prior to nationalisation. At that I would identify two other things that we need to do. point, the only basis on which it would have taken on One is that you need to have a better approach to Ev 10 Committee of Public Accounts: Evidence

17 September 2012 UK Financial Investments and HM Treasury managing risk. The Treasury has put in a lot of effort Q58 Mr Bacon: It is very nice of you to come back, over the last few years continually to look at risks— but where are you now? for example, in relation to the eurozone and the fiscal Keith Morgan: I am not doing anything at the situation. Looking at risk does not mean that you are moment. I am between jobs—I think that is the suddenly going to produce better forecasts, but it phrase. makes you better prepared institutionally when things go off track. For example, in relation to the euro over Q59 Mr Bacon: You are a man of leisure, but you the last couple of years, we have continually looked are expecting to get another job? You are not going to at the implications for the public finances and the be a burden on the state? banking system. We have had all sorts of contingency Keith Morgan: I am looking forward to getting plans in relation to the banks, which fortunately, so another job. far, we have not had to use. I think trying to address the organisation and culture of the organisation is Q60 Mr Bacon: Mr Budenberg, you have a hole— probably a better investment than endlessly trying to you do not have a head of wholly owned investments refine the macroeconomic model. for the UKFI at the moment. You are its chairman. The final point I would make is the one that has come Are you taking responsibility for filling this hole? up several times during the course of the discussion: Robin Budenberg: No. I think when Keith joined us, if you are in the business of selling banks, you really he and I agreed that his objective should be to manage need to ensure that that sale is done on the basis of the separation of Northern Rock plc from Northern Rock (Asset Management), then combine Northern very high-quality analysis. I think that the UKFI, as Rock (Asset Management) into Bradford and Bingley, the Report indicates, did a very good job once the and then sell Northern Rock plc, and that at that point decision to sell the bank had been made, but if in the his objectives would be fulfilled. We now obviously future the Government were, say, to sell Royal Bank have a much simpler structure, which is UK Asset of Scotland, it is going to be incredibly important that Resolution. It combines Bradford and Bingley with that is done on the basis of really good analysis—that Northern Rock (Asset Management). Our chief there is all sorts of due diligence and that we conduct executive—who is with us here because he is formally lots of different scenario analysis to ensure that we the accounting officer now, whereas I was during the can persuade this Committee that we have done a whole period that is under debate today—has good job. That, I think, is one of the biggest effectively assumed responsibility for that, in addition challenges the Treasury faces in the coming years. to Lloyds and RBS, because we feel that it is simpler. We are effectively now pushing the wind-down of that Q56 Mr Jackson: Do you think this particular case balance sheet in the way that was described earlier— has fed into this narrative of feast or famine? In other sales and mortgages; some of the things that the NAO words, before the crash there was too much lending has already reported on, such as debt exchanges; and to the wrong people—120%, and we’ll throw in a a range of things to try to speed up the recovery of kitchen as well—and now we have the FSA the cash and to maximise the recovery of the cash. historically, within the last two or three years, saying, “We don’t want to lend to anyone, hardly.” There has Q61 Mr Bacon: So he has taken on the roles of both been a fight on about saying we need the right lending partially-owned investments and what is left of to kick-start the economy. The construction industry wholly-owned investments? is an important facet of that. Robin Budenberg: Exactly. It is a big job. Sir Nick Macpherson: One of the risks, if you are a policy maker, is that you spend the next few years Q62 Mr Bacon: Good, so you will not be replacing trying to re-fight the last war, and if you are not him. You are slimming down the UKFI. That is good careful, that can compound the problems you have. to hear. Sir Nick, or perhaps Mr Scholar, I gather Mr There is a balance to be struck. Clearly, we do not Kingman is returning to the Treasury as Second want to be in a situation in the future where the state Permanent Secretary. Is that right? We miss him. He was a great witness when we had him. has to intervene and the taxpayer has to pick up the Sir Nick Macpherson: I am looking forward to you bill for the mistakes of the banks. That all points to calling him before the Committee to account for the banks holding more capital and more liquidity, but events when he was not there. it carries a cost in terms of lending into the economy. Chair: We will get the right person back, don’t worry. There is a balance to be struck. You identify an Sir Nick Macpherson: It would be a pleasure. I look important risk, and it is one that we are very focused forward to coming here for many, many years to on. come.

Q57 Mr Bacon: I just want to clear up a couple of Q63 Mr Bacon: If Mr Scholar is Second Permanent things. Mr Morgan, it says in the CV we have that Secretary and Mr Kingman is coming back, what are you are responsible for managing the Government’s you going to do, Mr Scholar? shareholding in NRAM and Bradford and Bingley. As Sir Nick Macpherson: Tom can explain what he is I understand it, from what Sir Nick was saying earlier, going to do, but the critical point is this. You have that is strictly no longer the case because as of today talked about Treasury capacity, and this is about you have left the UKFI, is that right? strengthening Treasury capacity. I can assure you that Keith Morgan: At the end of August, yes. if there were to be another financial crisis, having Committee of Public Accounts: Evidence Ev 11

17 September 2012 UK Financial Investments and HM Treasury

Messrs Scholar and Kingman around would be Commission to do anything about that deadline if we hugely advantageous. had not shown any positive intent to actually do something. Q64 Mr Bacon: Is it in anticipation of another big If we had tried to do the process this year rather than crisis? One hopes not, but one has this sense with the last year, I think the first half of this year was a more euro—Mr Jackson, who is not here at the moment, difficult time than last year. What was clear was that mentioned the euro earlier—and no one really knows Virgin was pretty keen to move forward. As you have what is going to happen for sure. There seem to be pointed out, Virgin was one of a relatively small lots of indications that they will do whatever is number of people who we thought were naturally required, but there is an expectation in the market that interested in it. If we had delayed much longer, there there could be another explosion that would make is every prospect that they would have got frustrated Lehman Brothers look rather small. That is one of the and gone off and done their own thing, which would reasons why everyone is sitting on trillions of cash have meant that we would have been without them. and not doing anything with it, isn’t it? Sir Nick Macpherson: One of Tom’s many Q67 Chair: Done their own thing? What—started responsibilities, which he will continue to be their own network of banks? responsible for, is the international side of the Robin Budenberg: They were determined to expand Treasury, including the eurozone, so perhaps he would Virgin Money. They had a choice of either doing it like to make a statement. internally, or externally using Northern Rock, which Tom Scholar: With permission! You are, of course, was their preferred option. absolutely right. There is a huge amount of uncertainty, and for that reason we are doing, and we Q68 Chair: The other side of the coin is that I don’t have been doing for some time, a very great deal of think there was much of a competition. I think you contingency planning so that we are ready to deal with would accept that. Really there was Virgin and whatever happens. In doing that, I should say that we possibly the ex-guy from Northern Rock. are building on many of the recommendations of the Robin Budenberg: J.C. Flowers. Committee and the NAO over recent years. A lot of that is set out in the letter that we sent to the Q69 Chair: Yes, but there was not much around. As Committee in July, and we have invited the NAO to we come to looking at the other assets, that is a worry. have a look at our implementation of all these findings How are you going to ensure that we divest ourselves next year as part of our regular discussions. I am sure in a competitive way? the Committee will want to talk to us about that next Robin Budenberg: The other assets are more likely to year, and I will be very happy to come and do that. be divested—

Q65 Mr Bacon: I remember Sir Nick saying some Q70 Chair: Why? time ago that you were doing a great deal of Robin Budenberg: In the form of a flotation of some contingency planning. As of today, you would say that form, rather than a sale to a single party. The you were prepared for whatever happens in terms of conditions that will be favourable for that sort of event if, for the sake of argument, the euro were either to are somewhat different, and it is all about the have the exit of one member or if it were completely economic outlook, the regulatory outlook and the to unwind. You have planned for all eventualities? strength of the stock market. Tom Scholar: It would be tempting fate to say anything completely categorical, but we have looked Q71 Chair: So you would not do it again this way? at everything we can think of and we have a very wide Robin Budenberg: We looked at a flotation of range of plans for all kinds of event. Northern Rock and it was clear that a flotation would, one, be a very difficult thing to do because it was not Q66 Chair: Okay. Getting back to the sale of a profitable bank, and two, the markets simply were Northern Rock, two of the questions that interest me not there at the time—and I don’t think there was any are, first, the timing. You decided to get out early. The confidence that they would certainly be there by the argument is that you were losing and therefore you time we had to sell in 2013. minimised the losses, but equally the other side of that coin is that you sold very much at the bottom of a Q72 Chair: My final question, before I go to Jackie, rotten old market so you had to take an extra loss is that you ended up giving £2 million in bonuses. I there. Had you hung on a bit, you might have got a accept that that was down from the £30 million you better price. European deadlines, as I think all of us originally agreed, but it was a business that was losing know, are pretty flexible. Although the bureaucrats money and performing worse than it had promised it might not say that, in effect they are. Looking back would perform on its own business plan, maybe for on it, did you get the timing right? extraneous reasons. How can you justify that to us? Robin Budenberg: One, I don’t think we could have Robin Budenberg: We had to create a senior sold it any earlier. Maybe if we could have sold it management team for Northern Rock in a situation earlier, we would have got more money for it, where they knew that the likelihood was that in a short because, if anything, as we have discussed, things period of time it would be sold and they would lose have probably got more difficult for an operation like their jobs, which is in fact what, on the whole, Northern Rock. We had a 2013 deadline, and our view happened to the senior management team. I think that was that it would be difficult to persuade the the incentives that were put in place were reasonable Ev 12 Committee of Public Accounts: Evidence

17 September 2012 UK Financial Investments and HM Treasury in that regard. We looked very carefully at a number enough money into a state-owned organisation, in the of criteria against which those incentives were hope that the problem will go away. measured, and while we completely recognise that this I wasn’t directly involved in the negotiations on business was sold at a loss to the taxpayer— Northern Rock. Tom might have something to add. I was more directly involved in relation to the Royal Q73 Chair: And performed less well than they said Bank of Scotland and Lloyds. The state aid regime it would perform. has come to a pretty sensible conclusion on them, in Robin Budenberg: Yes, and that was definitely taken the sense that it forced them to sell quite a lot of into account in arriving at the level of incentive that branches. We were discussing that earlier. Yes, it did was payable. result in a loss of value for Lloyds but, with the Co- op picking up those branches, it has created a potential Q74 Chair: It just seems odd to me that they had challenger bank. any. I hear what you say—that they would not have It comes back to what we have been discussing a lot come if they had not been promised a bonus. today: the trade-off between money for the taxpayer Robin Budenberg: I should say that I think they and a more competitive banking system. Just having worked incredibly hard, and actually successfully in a bit of pressure from the European Union on that terms of bringing about a sale in a very difficult front is on balance a good thing, I think. environment. We certainly could not have exited Northern Rock on the terms that we did without that Q77 Jackie Doyle-Price: So a short-term loss to the management team. I should also add that the chief taxpayer and a potential long-term gain to the executive left and did not get a bonus, and nor did consumer. Is that right? the chairman, Ron Sandler, who I think did a very Sir Nick Macpherson: Broadly. good job. Q78 Austin Mitchell: I have a couple of questions Q75 Mr Jackson: I am slightly unclear about for the UKFI—I keep thinking MFI. Following up on paragraph 1.27. There was a total of £4.5 million in the Chair’s questions, you could have hung on to it bonuses, of which you say £2 million went to more for much longer, of course. It could have continued to junior staff. Does that mean up to a manager in a be run as a state bank, apart from the fact that Sir branch? Nicholas does not like that idea. Keith Morgan: Essentially, each of the 2,000 people In insisting that the price would be lower if you sold in Northern Rock received close to £1,000. It was a later, weren’t you defying the economic predictions of bonus paid to junior staff across the board. the Office for Budget Responsibility and the Government—that all was going to be well in a couple Q76 Jackie Doyle-Price: Sir Nicholas, you opened of years’ time? They are desperately trying to your remarks with the observation that hindsight is encourage lending for affordable housing and so on. wonderful thing, but you were very candid about the So, you were defying that, as well. mistakes that could perhaps have been recognised. We Robin Budenberg: I think we were focused on value should all recognise that this is pretty uncharted on the sale. We knew we had to sell it by 2013. As territory. Given where we are, I think this is a good was said earlier, if you leave it until 2013, you might story. end up with a higher price, but if you didn’t you I would like to explore something further. Paragraph would be in a very difficult place. We did feel that 1.22 of the Report details the negotiations you had to delaying until 2013 would almost definitely lose undertake with the European Commission with regard Virgin as a potential bidder. Therefore, our view was to state aid guidelines. I would like some observations really based, I am afraid, more on value and tactics from you as to how difficult that made the job of around a sale process and on trying to maintain getting the right outcome for the taxpayer. As Robin whatever competition was available, rather than alluded to, the 2013 deadline brought another dynamic focusing too much on where the economy was going into it. The nearer you got to that, it would have over 10 years. become a fire sale. The guarantees to customer deposits obviously had to Q79 Austin Mitchell: Okay, but the taxpayer lost— be lifted, which then brought in another competitive what?—£728 million on the deal, which was the loss challenge, because of the FSA imposing additional on the price you paid: the loss was £248 million lost capital requirements. Could I have your observations in value before the sale and £232 million at the point as to whether, without that, we would actually have of sale. been able to secure a more favourable deal? The other assets, which remain with the UKFI, are not Sir Nick Macpherson: I do not know whether we the kind of tarnished assets that the Americans are would have secured a more favourable one. Without lumbered with—they look like viable assets—but why it, we may have been tempted just to hold for longer, should we believe you when you say those can be sold which might have resulted in more losses. I suppose I without a loss, when there has been such a loss on am ambivalent about the state aid regime. Britain was the bank? historically the great advocate of it. I genuinely think Robin Budenberg: Again, our remit is to focus on it often forces you to do things that are probably in value for money. We will look at the RBS and the the consumer’s interest, in terms of promoting Lloyds stakes, alongside our Treasury colleagues, and competition, and prevents you from taking what is give a view on when we think the right time is for a often the easy option—that is, to keep shovelling sale, on a value-for-money perspective. Committee of Public Accounts: Evidence Ev 13

17 September 2012 UK Financial Investments and HM Treasury

Q80 Chair: But you are not quite like that. Just let a number of ways. One way relevant to this is that, us be clear. You look at value for money having regard ultimately, the UKFI will have an approach to a to financial stability and competition. particular bank—in this case, Northern Rock—but it Robin Budenberg: Yes. is also the role of the Treasury to advise the Chancellor in pursuit of the wider national interest, Q81 Chair: So it is not entirely value for money. which is what you have been discussing. Those wider Robin Budenberg: No. There is definitely a balance issues are taken into account in terms of the role that that we need to take into account. the Chancellor plays.

Q82 Chair: Yes, because on Lloyds Bank—you keep Q87 Chair: And the remit that you give the UKFI? telling me; we will have to have a look at it in detail— Sir Nick Macpherson: We could change the UKFI’s I am told that it did not go to the highest bidder. I remit. Inevitably in a process such as this, the UKFI assume that there was another motivation, in selling don’t just turn up on the last day and say, “Here is a to the Co-op, around mutualisation, wasn’t there? fait accompli.” There will be opportunities along the Robin Budenberg: Again, that was an issue for the way to provide orientations, such as if we put a Lloyds board, because it is the Lloyds board that particularly high value on mutualisation, for example, decided who to sell it to. or if the issue of the Northern Rock Foundation was important or jobs or whatever, and that then becomes Q83 Chair: Don’t tell me—we are a major part of the negotiations. The UKFI do not at that point stakeholder, and I cannot believe there weren’t just say to us, “I’m sorry, but because of our remit we conversations between us and the Lloyds board. are not prepared to get involved in those discussions.” Robin Budenberg: Our role is to act as a commercial They have a clear remit, but they are also people of shareholder, and we try to do that. the world who are willing to take the odd instruction consistent with their remit. Q84 Chair: Yes, but a big institutional shareholder Chair: Final question from Ian and then I’m going to has a say. I hope my pension people have a say on my close the session. pension, because I want them to them to protect— Robin Budenberg: Absolutely. Q88 Ian Swales: Who is doing the administration for the NRAM part of the business at the moment? Q85 James Wharton: That ties in with the question Keith Morgan: The servicing of the mortgages? I asked earlier about the role of Government in doing Ian Swales: Yes. this. Are you acting purely as a commercial Keith Morgan: When we put together Bradford & shareholder, or are you acting in the broader public Bingley and Northern Rock (Asset Management), the interest when looking at some of the banks that we idea was to create an effective and efficient way of are talking about? doing it. It is now underneath a holding company Robin Budenberg: When we are looking at those called UK Asset Resolution and is now a common set sorts of decisions, which are decisions for the board of operations that is equal and based in both the north- of Lloyds, we look at it as a commercial shareholder. east and in Yorkshire, which is servicing those When we look at things such as the sale of Northern mortgages. Rock and, inevitably, the sale of RBS and Lloyds, we will take account of the other issues that we need to. Q89 Ian Swales: Are those people entirely separate from the people who are joining the Virgin Q86 James Wharton: Is there a danger that one pre- organisation? empts the other? A certain course of action may not Keith Morgan: Yes. They were separated actually at be the 100% purest way of getting the best the back end of 2010. commercial return, but it may have broader benefits. Is there not a danger that by the time you come to the Q90 Ian Swales: So there is no sense in going back point when you are making that decision and you on that arrangement in anyone’s interests. Do you decide to act in the broader interest, it is too late, think it is right to have them separate? because decisions have been made on purely Keith Morgan: Yes. It was a requirement actually. It commercial terms that may not be in the broader was a state-aid requirement that we separated the interest? What protection is there to ensure we get the operations. greatest possible public good out of the position that the Government have found themselves in? Q91 Ian Swales: Final question. The balance sheet Sir Nick Macpherson: I would be happy to answer shows other assets of £14 billion, as opposed to that. I think it is important to distinguish the role of mortgages. I just wondered what those actually were. the Treasury from the role of the UKFI. When we got Keith Morgan: There is a large amount of derivatives into the business of owning banks, we saw real merit that underlie some of the fixed-rate positions and in having an organisation which was at arm’s length some of the swap positions. In a sense, they are not from the Treasury and which had a clear remit. That real assets; they are just financial assets. is what the UKFI seeks to do and, in my view, it has done it well. Q92 Ian Swales: That is really my question. At the Clearly, the Treasury, in its role as the nation’s finance time, were they valued at par or have there been any and economics Ministry, is responsible for taking a write-downs since? We are talking about large sums broader view in the national interest. It does that in of money here. What has been the position? We all Ev 14 Committee of Public Accounts: Evidence

17 September 2012 UK Financial Investments and HM Treasury know that that was part of the problem in Northern think of the accountancy here. The value in the Rock. Was £14 billion the value in Northern Rock— Northern Rock balance sheet against this £14 sorry, £15.7 billion was the other assets in total. Was billion—what was the difference? How much was that the value in Northern Rock’s books or was that written down at the time? after some write-down? Keith Morgan: At nationalisation, I was not there. I Keith Morgan: At the point at which the Northern am not sure. Rock (Asset Management) business was formed, all of the write-downs had occurred as a result of the Q96 Ian Swales: Ballpark—is it £1 billion? £5 actions taken by or through nationalisation. What you billion? then get is some oscillation in the value of those Tom Scholar: The big picture is, in effect, at assets, but those are oscillations that we monitor week nationalisation the state took on all the assets, so they in, week out. took on the return, positive or negative, associated with that. As the Report says, the expectation is over Q93 Ian Swales: So in the £14.2 billion that NRAM the lifetime of the ownership for there to be a return had, that was after write-downs that had already of something like 4%, which is enough to cover all taken place? the costs, including the financing costs, but not, as Keith Morgan: Yes. the Report says, enough to satisfy the normal rules of Government investment. Of course, this was not a Q94 Ian Swales: So we do not expect, as taxpayers, normal Government investment; it was undertaken as loads of that further to go bad? They are already an emergency rescue mission. valued at a fair value. Chair: I shall conclude by saying it is a bit fingers in Keith Morgan: Yes. In fact, the main issue for the the air as to whether your prediction over what we get long-term future of Northern Rock (Asset in the next 10 or 12 years will be correct—real fingers Management) is the degree to which there are bad in the air stuff, so I don’t think we should take that debt losses on the mortgages themselves. too seriously. We or our successors will come before you or your successors to look at that. Thanks very Q95 Ian Swales: How much was that? In effect, did much indeed. That was very helpful—a very difficult the taxpayer take the hit there? I am just trying to subject.

Written evidence from UK Financial Investments Ltd

1. On 18 May 2012, the National Audit Office (“NAO”) published its report on the creation and sale of Northern Rock based on the information available at the time.

2. Subsequent to the publishing of the report, three further relevant transactions have taken place. Firstly, in accordance with the Northern Rock plc sale and purchase agreement, HM Treasury has received from Virgin Money Holdings (UK) Limited (“Virgin Money”), further cash consideration of £73 million. Secondly, UK Asset Resolution Ltd, (“UKAR”) the holding company for Northern Rock (Asset Management) plc, (“NRAM”) agreed to sell £465 million of mortgage assets to Virgin Money at par. Finally, UKAR agreed to sell its Gosforth site and two smaller properties to Virgin Money. The cash proceeds from all three transactions were paid to HM Treasury.

3. This note sets out the background and substance of these transactions in more detail.

Further Cash Consideration paid by Virgin Money for the Northern Rock Plc Sale

4. The sale and purchase agreement for Northern Rock plc signed by HM Treasury and Virgin Money on 17 November 2011 agreed a consideration comprising: — Cash of £747 million (paid on 1 January 2012); — Tier 1 Capital Notes of £150 million; — Additional cash consideration of £50 million to £80 million receivable upon a future profitable flotation or sale in the next five years; and — A further amount relating to the final calculation of the net asset value of Northern Rock plc at completion of the sale on 1 January 2012 (to be paid in the summer of 2012).

5. This last amount was originally expected by UKFI to be c.£50 million with the NAO report stating a range of £50 million to £74 million. Subsequent information on the movement of the net asset value of the company up to 31 December 2011 and negotiations between UKFI and Virgin Money led to a recent agreement that £73 million would be paid.

6. As such, a total of £820 million has been paid in cash to date by Virgin Money for its acquisition of Northern Rock plc. In keeping with UKFI’s announcement on the sale of Northern Rock plc on 17 November 2011, the Government has the potential to receive over £1 billion in total. Committee of Public Accounts: Evidence Ev 15

Sale of NRAM Mortgage Assets to Virgin Money 7. Separately, and subsequent to the signing of the sale and purchase agreement for Northern Rock plc, Virgin Money opened negotiations with UKAR and reached an agreement to acquire £465 million of NRAM mortgages (covering circa 3,700 customers) at a price of par (£ for £). These mortgages are secured on residential and buy-to-let property assets in the UK. 8. These loans will continue to be serviced by NRAM until transfer to Virgin Money, expected to be before the end of the year. The sale will not affect the terms and conditions of the mortgages in this portfolio and all customers who will be impacted by the sale will be contacted directly by NRAM and Virgin Money at a later date. 9. The sale forms part of UKAR’s on-going process to manage the run-down of the closed mortgage books of both Bradford & Bingley and NRAM whilst maximising value for the taxpayer.

Sale of UKAR’s Gosforth Site to Virgin Money 10. Separately, UKAR agreed to sell its Gosforth site to Virgin Money as part of its phased withdrawal from the site that will complete in 2013. UKAR originally announced its phased withdrawal from Gosforth in December 2011. This reduces and simplifies the number of properties under UKAR management and allows it to focus on its two main sites in Crossflatts in Yorkshire and Doxford in the North East. 11. UKAR received a £38 million payment from Virgin Money in settlement for the purchase of the Gosforth site and two much smaller North East properties known as Camperdown and Doxford 3. In addition, Virgin Money agreed to waive £2.9 million of rental costs that UKAR would have incurred for continuing to use parts of the Gosforth site up until the end of 2013. As such, the purchase consideration totalled £40.9 million. September 2012

Printed in the United Kingdom by The Stationery Office Limited 11/2012 023552 19585 PEFC/16-33-622