Assignment:
Northern Rock plc
Northern Rock, originally a building society, became a bank in 1997 and floated on the Stock Exchange. It became a member of the FTSE100 in 2000 and was ranked in 2007 as the UK's fifth largest mortgage lender but was the seventh largest retail bank in terms of net assets. In September 2007 it experienced the first run on a bank (customers trying to get their money out en masse) since the 1850s in the UK.
PwC audited the 2006 accounts and gave a clean bill of health. This meant that there was no presumption that the company would stop trading and there were no concerns about accounting practices that were material enough to be reported. In the aftermath the House of Lords Economic Affairs Committee carried out a review and decided that the auditors had been ‘complacent' and their lack of liaison with the banking regulators had been a ‘dereliction of duty':
‘There was no single cause of the banking meltdown of 2008-09. First and foremost, the banks have themselves to blame. As our predecessor Committee found in its report on Banking Supervision and Regulation in 2009, the supervisory system put in place in 1997 proved unfit for purpose. But we conclude that the complacency of bank auditors was a significant contributory factor. Either they were culpably unaware of the mounting dangers, or, if they were aware of them, they equally culpably failed to alert the supervisory authority of their concerns. Our recommendations are designed to address these failings and thus make a repetition less likely.' (Quoted from the House of Lords report March 2011)
In July 2007 the Chief Executive, Adam Applegarth was published on the Northern Rock website (interim report for 2007) as saying:
"Operationally Northern Rock had a good first half in 2007. Mortgage lending has been particularly strong with a gross market share of 9.7% and a net market share of 18.9%, helped by improvements in retention of home moving customers, keeping customers coming to the end of their product deals and a strong mortgage market. Credit quality remains robust.
The outlook for the full year is being impacted by sharp increases in money market and swap rates seen in the first half. This has resulted in a negative impact on net interest income as mortgage pricing in the market generally has lagged behind increases in funding costs in the year to date. Action has been taken with changes in our swap transaction policies to minimise exposures in the future to significant changes in interest rates.
We are pleased to have achieved approval for use of our Basle II rating systems. This means that the benefits of Basle II enable us to increase our 2007 interim dividend by 30%. Going forward our dividend payout rate increases to 50% of underlying EPS from around 40%. Future capital planning, including the reduction of capital hungry assets, will allow us to return capital to shareholders through a share buyback programme.
The medium term outlook for the Company is very positive"
From BBC News website - Northern Rock Timeline:
4th September 2007
The rate at which British banks lend to each other - the London Interbank Offered Rate (Libor) - rises to its highest level in almost nine years.
13th September 2007
The BBC reveals that Northern Rock has been granted emergency financial support from the Bank of England.
14th September 2007
The firm's shares fall 32% as worries about its future increase. Savers line up outside branches intent on withdrawing their deposits. It is public knowledge that current legislation only protects deposits of up to £33,000 - with a maximum payout of £31,700 - should a bank become insolvent. Northern Rock's website breaks down and its phone lines are jammed.
17th September 2007
The shares fall 40% compared to the day before, queues at branches show no sign of going away. It is now feared that the rush to withdraw money will spread to the rest of the banking system.
Just before 6 pm, the Chancellor Alistair Darling intervenes and commits the government to guarantee all deposits held at the Northern Rock. He says his action was spurred on by the "importance I place on maintaining a stable banking system".
February 2008 Northern Rock is nationalised.
Business Model
Usually mortgage lenders borrow short term from depositors and lend longer term to people who want to buy property. It assumes the depositors will not want to withdraw their money suddenly as in the case of Northern Rock.
Northern Rock went further than this; it leveraged the model by using funds from the short term money market. This model is successful when funds are readily available and the cost is low. It was so successful that Northern Rock was able to expand rapidly compared to the competition.
Board and Committees
The Board had 12 members, six of whom were non executive directors and it had 4 supporting committees: Audit, Remuneration, Nominations and Risk.
The Chief Executive Adam Applegarth had risen through the ranks as a graduate trainee, there was a culture of internal promotion.
The Chairman of the Board and the Nominations Committee was Dr Hon Matthew Ridley, educated at Eton who had a doctorate in Zoology for Oxford and no prior financial services experience. He had been an independent director from 1994 and became chairman in 2004.
Other Independent Non Executive Directors (NED):
Adam Fenwick, 46 years old, Group MD of Fenwick Ltd and also NED of John Swire and Sons Ltd.
Sir Ian Gibson, 60, senior NED; background in senior management at Ford and Nissan; Chairman at the Mirror Group and NED at GKN and Greggs; and, formerly member of the Court of the Bank of England.
Nichola Pease, 46, Chief Executive of JO Hambros Capital Management; since 1983 she has held fund manager and senior management positions in the finance industry.
Michael Queen, 45, Director of 3i Group plc
Rosemary Radcliffe, 62, is Independent Complaints Commissioner for the Financial Services Authority (from 2001). She was a partner at PwC from 1982 to July 2001. Rosemary was a member of the Global Oversight Board which has responsibility for the governance of PwC world-wide and Chairman of its Governance Committee. Rosemary was awarded the CBE in January 2000 for services to business competitiveness.
Sir Derek Wanless, 59, King's College, Cambridge, MA first class honours in maths was former CEO of Natwest; paid off with £3m in 1999 after leading a disastrous acquisition strategy. Chairman of Northern Rock's Audit and Risk Committees. On 12th September 2007 he had just finished a wide ranging report on the NHS and the effects of the increased levels of funding for the Kings Fund health think tank (an update on his report in 2002).
In February 2007, the Audit Committee reviewed the effectiveness of the external auditors and made a recommendation that they be re-appointed for a further 12 months.
For the first 9 months of 2007 the Audit Committee comprised: Fenwick, Gibson, Pease, Queen, Radcliffe and Wanless. The Risk Committee comprised: Gibson, Radcliffe, Wanless and 5 Executive Directors including Applegarth. In 2007 Radcliffe only attended 2 out of 4 Audit Committees and 1 out of 3 Risk Committees before she retired in November 2007, the other NEDs attended all their Audit and Risk Committee meetings.
Task
Consider the corporate governance arrangements affecting Northern Rock up to the crisis in September as detailed above.
a) Write an objective report for the government detailing how and why the governance arrangements may have assisted in the failure of Northern Rock.
b) Describe the ways in which the governance arrangements noted above fulfil the current version of the UK Corporate Governance Code.
c) Comment, detailing your reasons, on whether such a major banking failure is likely to occur again.