TREASURY COMMITTEE GRILLS SEVERAL BANK CHIEFS ON BONUSES,

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

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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
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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
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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.


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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
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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