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INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBL/AMCONSUL BELFAST PRIORITY 1487
RUEHED/AMCONSUL EDINBURGH PRIORITY 1244

UNCLAS SECTION 01 OF 02 LONDON 000071 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV UK
SUBJECT: TREASURY COMMITTEE GRILLS SEVERAL BANK CHIEFS ON BONUSES, 
LENDING, AND RE-PRIVATIZATION 
 
LONDON 00000071  001.3 OF 002 
 
 
¶1.  (U) Summary: The House of Commons' Treasury Select Committee 
held a one-off evidence session January 12 on the UK's fully and 
partially nationalized banks.  It heard evidence from Stephen 
Hester, chief executive of the Royal Bank of Scotland (RBS), Gary 
Hoffman, chief executive of Northern Rock, and Eric Daniels, group 
chief executive of Lloyds Banking Group.  The session was part of 
the Committee's ongoing work on the banking crisis and focused on 
compensation policy, lending policies towards small businesses and 
consumers, the government's asset protection scheme, and timeframes 
for a return to full private ownership.  End summary. 
 
Royal Bank of Scotland: 84 Percent State-Owned 
---------------------- ----------------------- 
 
¶2.  (U) Compensation: Stephen Hester, chief executive of RBS, 
acknowledged there had been significant instances of unjustified pay 
prior to the banking crisis.  Until the banking industry can 
demonstrate it can handle crises without government intervention, he 
said, it invites onto itself a high degree of scrutiny over issues 
such as compensation.  On the RBS bonus pool, Hester said the bank 
will not pay any discretionary cash bonuses for the 2009 performance 
year to anyone earning over GBP 39,000, per the bank's asset 
protection scheme agreement with HM Treasury.  However, Hester said 
the bank has become a prisoner of the market on compensation, with 
no choice but to pay bonuses in future years to attract and retain 
staff. 
 
¶3.  (U) Lending: RBS agreed to 2009 lending commitments totaling GBP 
25 billion in February 2009, when it made an agreement in principle 
with HM Treasury over the bank's participation in the asset 
protection scheme (APS).  Hester told Committee members that this 
was a realistic figure but creating the target required guess work 
as to the level of credit demand in 2009 and how many lenders would 
disappear from the UK market.  Of the GBP 25 billion, RBS committed 
to GBP 9 billion of mortgage lending.  Hester said the bank is 
likely to exceed this target, with 90 percent of all mortgage 
applications being approved.  RBS committed to GBP 16 billion of 
business lending.  Hester said the bank is less likely to meet this 
target, despite approving 85 percent of all business loan 
applications, because of a lack of demand.  He stressed that the 
bank's terms of lending are not prohibitive, with the average 
interest rate on a small business loan half of what it was three 
years ago. 
 
¶4.  (U) Asset Protection Scheme (APS): RBS formalized its 
participation in HMG's asset protection scheme in November 2009. 
Hester said the agreement signed in November was substantially 
different to the initial agreement proposed in February, because the 
world is "less gloomy" today.  He said the APS is now less 
protective, and therefore less expensive.  He believes it is 
unlikely RBS will call upon the scheme and now views it as a "rainy 
day" scheme that restores confidence in the bank.  He expected the 
bank to exit the scheme in two-to-three years.  The bank is, he 
said, well capitalized against one more year of losses.  Its tier 
one capital ratio is currently 10 percent, above the bank's eight 
percent target.  As a result, Hester believes there is some cushion 
against the Basel Committee's increased capital requirements. 
 
¶5.  (U) Regulatory Reform: Hester was critical of calls for a 
re-introduction of Glass-Steagall-type legislation that would 
formally separate retail banks from investment banks.  He said there 
is no evidence to support this separation, with the preponderance of 
failures throughout the crisis coming from "narrow - retail - 
banks."  The least number of failures, he said, came from "universal 
banks." 
 
¶6.  (U) Re-privatization: The re-privatization of RBS will be 
dependent on restoring shareholder value.  Shareholder value is 
expected to improve because the remaining problems the bank may 
encounter, Hester said, were likely to be just "small set-backs," 
instead of big "blow-ups."  RBS's experience with UK Financial 
Investments (UKFI), which manages the government's stake in the 
bank, has been very positive.  Hester said UKFI has been an engaged, 
commercially-oriented shareholder.  The bank and UKFI have a 
fundamental alignment of interests, both looking to improve the 
bank's share price. 
 
Northern Rock: Fully Nationalized 
-------------- ------------------ 
 
¶7.  (U) Compensation: Gary Hoffman, chief executive of 
fully-nationalized Northern Rock, said the bank did not award any 
pay rises or bonuses to executives in 2009.  For 2010, the bank will 
introduce an incentive scheme that will make pay awards for 
executives if the bank meets various financial targets.  Senior 
executive bonuses will be subject to claw-back.  He said HMG's bonus 
tax would be influential on its compensation decisions. 
 
 
LONDON 00000071  002.3 OF 002 
 
 
¶8.  (U) Bank Restructuring: On October 28, the European Commission 
approved HMG's restructuring plans and state aid package for the 
bank.  The bank is in the process of splitting into two separate 
companies: a "good" bank - Northern Rock Plc - and a "bad" bank - 
Northern Rock (Asset Management) Plc (NRAM).  The good bank will 
keep the bank's savings accounts and some existing mortgage 
accounts.  It will offer new savings products and new mortgage 
lending.  The bad bank will hold the riskier part of the bank's 
residential mortgage book, will not take deposits and will not offer 
new mortgages.  During the Committee hearing, Hoffman said NRAM has 
been inappropriately labeled a "bad bank."  He said it will hold 
400,000 mortgages, over 90 percent of which are performing.  As of 
the end of September, 4.1 percent of mortgages allocated to NRAM 
were in arrears (compared to the national average of approximately 
2.5 percent) but that number is beginning to stabilize.  NRAM, he 
said, will repay the government loan through the natural maturity of 
its mortgage book.  He expected 50 percent of the government's loan 
to be repaid within the next three to four years, but it could take 
up to 20 years before the entire debt is repaid. 
 
¶9.  (U) Re-privatization: Hoffman stressed he had not been given a 
deadline for Northern Rock's return to the private sector.  He said 
the government will determine this timescale.  While some informal 
discussions have taken place regarding the re-privatization, he said 
there is no good reason to rush to a sale.  Hoffman said HMG is 
reviewing its 100 percent guarantee of all Northern Rock deposits, 
which was introduced following the retail run on the bank in 
September 2007.  Currently though, the full guarantee remains in 
place. 
 
Lloyds Banking Group: 43 Percent State-Owned 
--------------------- ---------------------- 
 
¶10.  (U) Compensation: Lloyds Banking Group fully embraces G20 
compensation principles, according to Eric Daniels, the group's 
chief executive.  He told the Treasury Committee the bank is trying 
to better align risk and the tenor of bonuses.  The bank's 
compensation program for senior executives consists of three 
separate strings: base salary, bonuses which are deferred and have a 
claw-back element, and a long-term compensation piece where payment 
will be dependent on long-term profitability, earnings per share, 
and a successful integration of Lloyds and HBOS (Lloyds TSB and HBOS 
merged in September 2008).  Daniels said the bank's compensation 
committee, which is independent of management, will decide whether 
the targets have been met and will determine whether this long-term 
compensation should be paid. 
 
¶11.  (U) Asset Protection Scheme: Lloyds Banking Group signed an 
agreement in principle with HM Treasury to participate in its asset 
protection scheme in March 2009.  However, an agreement was 
subsequently reached with HM Treasury to instead allow the bank to 
raise GBP 21 billion of private sector capital.  Commenting on 
Lloyds' decision to opt out of the scheme, Daniels said it had 
originally signed an agreement because few other options were 
available.  However, as markets opened, the bank searched for a 
market-based solution.  He told the Committee that Lloyds' 
subsequent rights issue took into consideration potential changes to 
capital requirements made by the Basel Committee. 
 
¶12.  (U) Lending: In March 2009, Lloyds committed to increasing 
lending by GBP 14 billion over twelve months (to March 2010).  Of 
this, GBP 3 billion would consist of mortgage lending and GBP 11 
billion of business lending.  Daniels told the Committee Lloyds 
expected to exceed its mortgage target.  Lloyds also expected to 
exceed its new lending to businesses. However, Daniels said 
repayments of business loans have increased dramatically; so on a 
net basis, Lloyds will have difficulty meeting its target.  He 
stressed that credit availability "absolutely exists" and noted that 
Lloyds' loan application approval rates are approximately 80 
percent.  The bank, he said, passes on all Bank of England interest 
rate reductions and does not change the terms of lending agreements 
unless there is a material change in risk.  He was unsure whether 
there would be any sanctions for missing the targets (though Lord 
Myners, Financial Services Secretary to the Treasury, has previously 
hinted there would be none). 
 
¶13.  (U) Re-privatization: Lloyds will exit state ownership when its 
share price has increased and it has convinced investors the price 
increase is sustainable.  During a previous evidence session in 
front of the Committee in February 2009, Daniels said he expected 
the bank to have exited state ownership and to have repaid all 
public money within three years (by the beginning of 2012).  In the 
January 12 hearing, Daniels refused to recommit to this timeframe, 
saying the exact timescale was a question for UK Financial 
Investments. 
 
SUSMAN