UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 548-iiHouse of COMMONSMINUTES OF EVIDENCETAKEN BEFORESCOTTISH AFFAIRS COMMITTEE
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This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.
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Transcribed by the Official Shorthand Writers to the Houses of Parliament: W B Gurney & Sons LLP, Hope House, Telephone Number: 020 7233 1935
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Oral Evidence
Taken before the Scottish Affairs Committee
on
Members present
Mr Mohammad Sarwar, in the Chair
Mr Alistair Carmichael
Mr Ian Davidson
Lindsay Roy
Pete Wishart
________________
Witnesses: Mr Graeme Dalziel, former Chief Executive, Mr Jim Faulds, former Chairman, and Mr Jim Willens, former Chief Executive, Dunfermline Building Society, gave evidence.
Q125 Chairman: Good afternoon, I would like to welcome our witnesses to today's evidence session. Perhaps you could introduce yourselves for the record.
Mr Faulds: Thank you, Chairman. My name
is Jim Faulds and I was Chairman of the Dunfermline Building Society from April
2007 until the end of March 2009. On my
right is Graham Dalziel, who was appointed Chief Executive of the Society in
2001 and retired in December 2008. On my
left is Jim Willens, who joined us in October last year as Chief Operating
Officer and took over the post of Chief Executive on
Chairman: Just give me one second, Lindsay has to say something.
Lindsay Roy: Chairman, I am not sure if this is a proper declaration but I think it is important that I acknowledge that I have known Graeme for ten years as the Chief Executive of Dunfermline Building Society. I worked with him on the executive of Lauder College Board of Management and I worked very closely with him as a school head in terms of sponsorship and work experience.
Q126 Chairman: Before we start detailed questions would you like to say anything in opening remarks?
Mr Faulds: Yes I would, thank you, Chairman.
I would like to say first of all thank you for giving us this
opportunity of providing evidence for the Committee's work. We have provided in advance written evidence
too and any and all written evidence will be made available to you should you
wish it. I would also like to make clear
right from the start that I consider, and the board of Dunfermline Building
Society considers that the responsibility for the plight that
Q127 Chairman:
Mr Faulds: Well, I believe that we were responsible up until October last year
for the position we found ourselves in.
Thereafter it is a different story so there are two stories here really,
Chairman. Why these events came around,
if I may take you back to the beginning of this century,
Q128 Chairman: You mentioned commercial property lending and one of the factors in the failure of DBS was probably commercial lending. Why did you decide to diversify into commercial lending?
Mr Faulds: By the way we were not alone, Chairman, it was perfectly legitimate and legal for societies to do that, in fact there is a 25 per cent nature limit placed on us by the FSA and we could take it up to that. However, we had to find other sources of income because our core business, savings and mortgages, were being squeezed by the retail competition in the private sector. Would you like to add to that?
Mr Dalziel: It was essentially to grow value for our members and, as the Chairman said, because of the competition in the market-place we saw a need to diversify, and commercial lending was one of the things that we did, but essentially it was to grow value for members, enhancing income so that we could then provide our members with competitive products in the retail market. The other angle that we had in setting it up is that we saw opportunities in the market-place for lending in some areas where it was allied to the mutual status that we had, to do with community regeneration or lending attached to housing associations for example, which became a major part of our business as well. So it was to enhance income for our members, to provide a return in excess of what of that which we could earn in residential lending, but also to add some value to the Scottish community at the same time. I should also say that in the years up to the end of 2007 that commercial lending operation added about £25 million in terms of contribution to overall member value during that period of over 100 million. As a percentage of assets, you asked the question at the last hearing two weeks ago about the percentage. At the end of 2007 it was 16 per cent against a nature limit of 25 per cent. That figure was disclosed in the accounts as part of the annual business statement that is produced by every single building society and it is clear in the accounts that it is there to be seen in terms of the lending limit. In comparison with other societies at the end of 2007 that just over 16 per cent compares to another four or five societies with ratios around about the same level; one was higher at nearer 19 per cent, and the rest were all round about 15 or 16 per cent.
Q129 Chairman: What steps did you take to ensure that members of the society were aware of your dramatic change to commercial lending?
Mr Faulds: We came to the last session when the Tripartite gave evidence and we noticed that there was a short debate on whether these facts were in our annual report and I think the FSA said they were not. They are in our annual report. Each year we detailed non-retail loans and mortgages.
Mr Dalziel: The other area too that we tackled in our annual members' review that goes out to all members, and the Chairman at the time highlighted this, I think it is either at the end of 2005 or 2006 review, is the successes that we had had in the commercial lending market and he actually identified one or two of the loans that we had actually lent during the year. At the AGM each year we also did our best to bring our members up-to-date with the strategy as it unfolded, and I had on average each year about eight member panels around the country in which I engaged with members about strategy and what we were doing and asked them their views on what we were doing and took their views into account in coming back to report to the board.
Q130 Chairman: When we took evidence from the Financial Services Authority, Jon Pain told us that repeated warnings were given to you in your building society and this is what he said: "Its previous management had made some poor management decisions that substantially weakened the outlook for the firm in a more difficult market condition environment, but in particular its diversification into commercial property lending, its purchase of non-core lending/mortgage portfolios from third parties and its inability to adequately control its cost base, particularly its IT investment." Do you agree with that assessment?
Mr Faulds: Not at all and I am delighted to get the opportunity to refute that. Certainly they did these round-robin letters to chief executives and the board of the society saw them all and certainly we read and were given copies of speeches they made where they touched on commercial lending. In the two ARROW visits while I was Chairman, commercial lending came up in the first one and that was about the process controls where they suggested some areas of improvement, which we implemented and they said they were happy with. In the second ARROW visit, and we have letters from the FSA to us following both visits, and we would like to submit them after the meeting ---
Q131 Chairman: That would be very helpful if you could do that.
Mr Faulds: And in the meeting at the end of 2007, November 2007 I think it was, they listed five areas that they felt were the key risks facing the society, and commercial lending was not mentioned. Do you want to read them out?
Mr Dalziel: Basically if I could go back, you mentioned the words "repeated warnings". That is not the case. If I can tell you that in 2005 when we had the ARROW risk assessment, this risk assessment that the FSA carry out is looking at risks to their statutory objectives under the Financial Services and Markets Act, and what they actually said in 2005 in the letter was that our commercial lending operation was well controlled. It also identified in the letter.
Q132 Chairman: You have copies of those letters?
Mr Dalziel: I could read
the actual section out to you. I have
got the actual letter here from the FSA: "The Society's commercial lending
operation has been very successful to date.
At the same time it has been well controlled. We are aware of the society's plans to
increase its exposure in this area and that you [meaning the society] have
recognised that the portfolio has now grown to a large enough size to warrant
risk analysis across the portfolio rather than solely at the individual
exposure level. We would ask that you
keep us informed of your progress in this area", which we did through
correspondence and a commercial director meeting with the FSA at
Mr Faulds: Can I add we were very disappointed with Jon Pain's evidence. However I do not want this to sound like we are blaming the FSA for what happened.
Q133 Chairman: They had a responsibility and you had too.
Mr Faulds: They have as a regulator and it is entirely your responsibility to judge them on that, but we were running the business and whatever happened in the business up to October was our fault, not the FSA's, but why we are disappointed in the evidence is that it painted a picture that we did not recognise whatsoever.
Q134 Mr Carmichael: I am glad you said that, Mr Faulds, you have obviously read the evidence if you did not actually see it at the time ---
Mr Faulds: I was here, yes.
Q135 Mr Carmichael: And you will have perhaps gleaned from that that I was less than impressed by the evidence that was given by the FSA, but the analogy, at the risk of being pejorative - and I apologise if you think it is - is it is a bit like people who blame the police for rising crime because it is not the police who are committing the crime, it is the criminals. I am not saying that what you did here was criminal but I want to just focus on how you got to the point where you did in 2008. I have a lot of sympathy for the position that you describe at the turn of the century. I think you said that it was an uncompetitive business and it was in danger of getting out-of-date. You saw opportunities and you wanted to enhance income and add value. I think probably in retrospect we would have to say that you were not ultimately successful in that.
Mr Faulds: Clearly we were not successful. I would argue that, given a fair chance, that strategy - and we had to change our strategy because, as any business knows, you have to change your strategy according to the environment and the circumstances in which you find yourself and the circumstances in 2008 were entirely different from 2000, would have succeeded, I believe.
Q136 Mr Carmichael: We can come back to that because I think those are different issues and for the purposes of the Committee in actually drilling down into the history of this they need to be dealt with separately. You say the circumstances were different. I do not actually know that they were. I think what was different was the perception of the circumstances, and I think there was perhaps a more realistic perception of the circumstances in 2008 than there was in 2000. We can come back to that. It is how we get to the point in 2008. The information that I have heard, and we have heard as a Committee alluded to perhaps without having direct evidence on it (but you are the people who can give us the direct evidence) is that the procedures of due diligence were effectively overridden in making some of the decisions on what we now regard as being the riskier, more toxic lendings that you took on. Was that the case and was that done with the knowledge and consent of the board?
Mr Faulds: I would quite like Graeme to reply to the process of the loan
approvals, but I would like to say here and now, and I know you do not mean it
in a pejorative way, I am tired of listening to the media talking about "toxic"
assets. We had no toxic assets, we had
no sub prime loans, we had no
Q137 Mr Carmichael: Can I just drill down on that a second, was it not in fact the case that you did have self-certified mortgages on your books?
Mr Faulds: Yes we did have.
Q138 Mr Carmichael: That cannot now be regarded as best practice.
Mr Faulds: At the time we were able to analyse those. With retrospect, no, I would give you that. At the time they were looked upon as prime; they were not sub prime. Just last week a journalist I have great admiration for, Alex Brummer, in the main feature column on the City page of the Daily Mail talked about us having £900 million of toxic assets in buy-to-let books that we bought. When the society ceased as an independent society that was down to 180 million and it was performing. There were some difficulties in it but it was performing. Going back to the £665million commercial book, at the time the society was broken up the customers were repaying the interest on those loans. We were perfectly happy with the provision that we had put aside with that book and yet it is all lumped together, including social housing by the way. This business of £1.5 billion of toxic assets that you read about in the press, what they were taking is social housing, which is the safest possible lending you can do in this sector, and they lump that in. The Government will get all its money back on that. They lump in the commercial. The Government should get all its money back on that or they are not doing their job right. They lump in the buy-to-let books which we have taken down from £500 or £600 million to £185 million, and all of this is deemed to be toxic assets. One of other figures you hear today, probably, because I am fed up hearing it in the paper, is a £150 million provision needed to be put against the commercial book. Where did that come from? I will tell you where that came from: a society who wanted to merge with us and clearly wanted the assets discounted so that it would get a bargain. If you hear 150 million again, give me a ring and I will tell you exactly where it came from.
Q139 Mr Carmichael: So you do not like toxic assets. What about due diligence?
Mr Dalziel: In terms of commercial lending, we did a number of things. We appointed a team of people from different banks with different experiences in the commercial lending area. We recruited in 2002 two different teams, a group of people who could go out and develop relationships in the market-place and a team of underwriting specialists who had experience in that sector. We also appointed to the board a commercial property expert.
Mr Faulds: Who is here today by the way.
Mr Dalziel: We also in terms of the process made sure before we lent that there were proper controls in place and the policy was reviewed by the board annually. That policy also went to the FSA. The diligence that was done in terms of each loan was deemed to be best practice.
Q140 Mr Carmichael: By whom?
Mr Dalziel: We had external auditors over the years both Ernst & Young and Deloitte's. We had quality assurance reviews from KPMG and then when we put it out to tender that changed to PricewaterhouseCoopers.
Q141 Mr Carmichael: Did your due diligence process change over the years?
Mr Dalziel: We made improvements as the years went on, of course.
Q142 Mr Carmichael: You made improvements?
Mr Dalziel: We made improvements across all areas of the business. That was our whole way of existence; learning from experience.
Q143 Mr Carmichael: When you said you made improvements that is a qualitative rather than a quantitative assessment. You will understand that. Let me put it in this way then: were there loans that were taken under the latter due diligence procedures that would not have been taken under the former ones?
Mr Dalziel: I do not think so. None that I can think of, to be honest.
Q144 Mr Carmichael: The point that I put to you and I have suggested to you was that due diligence procedures were actually overridden. Did that happen?
Mr Dalziel: Not to my knowledge.
Mr Faulds: Could I answer that, Mr Carmichael. I heard Vince Cable saying in Parliament that we had lent to an insolvent company. We cannot comment on individual customers, as you will understand, but can I give you an assurance that we did not lend any money to an insolvent company.
Q145 Mr Carmichael: I do not doubt that. I cannot think of the reference but if you have got an issue with Vince I am sure he will be more than happy and better informed than I am in terms of talking to you about it.
Mr Faulds: I wondered if that was where you were coming from.
Q146 Mr Carmichael: No.
Mr Dalziel: Could I also go back to the acquisition of the books, the point you made about the self-certified loans. That process that we undertook was the mortgage portfolio. We spent a lot of time looking at detailed cases and the particular books that we bought we spent at least a week or so down with the people that we were buying the books from looking at 25 per cent of the cases. We also did retrospective credit scoring analysis, making sure that the quality of the mortgage that we were taking on to our balance sheet was in line with what we wanted to have, so we had a policy of no sub prime. That gave us the opportunity to assess where we came across any cases that we did not want to have because we were worried about affordability or we were worried generally about the quality of the property, so for self-certified loans we did a lot of work to satisfy ourselves that those people could actually afford to repay the loan by looking at other aspects of their credit history, which you could do by modelling.
Q147 Chairman: Did you satisfy yourselves that when they put in the claim, "I earn £50,000 or £100,000", that was legitimate and that was valid? That is the main question.
Mr Dalziel: It was looking at does this look reasonable and actually does that person's credit score reflect what we would expect of that particular person's ability to repay.
Q148 Chairman: I think the most important thing is that somebody is self-certifying, and I think the industry knew then that the people who were self-certifying their income were not being truthful but building societies and others did not challenge those self-certified assessments.
Mr Dalziel: We challenged it looking at the overall credit score of the applicant concerned.
Q149 Chairman: That was the credit score.
Mr Dalziel: That actually does give a very good handle on that person's ability to repay given previous experience, so we satisfied ourselves there. Those self-certified loans were actually a very small part of the overall books.
Q150 Chairman: If you consider overall, I am not talking about just one building society, if you take all the lending institutions put together, I think that was one of the big factors in the failure of the whole system because people were declaring their income and the financial institutions were granting loans on the basis that whatever they wrote on the paper they accepted.
Mr Faulds: In retrospect, personally, I cannot speak for my colleagues, I would rather we had not taken on self-certified loans. As it happened they were performing but not as well as loans we found ourselves.
Q151 Mr Davidson: It sounds to me as if you are now saying that you did everything right. It is almost as if the operation was a success but the patient died! Can I just go back to the beginning. One of the local Members did say: "Let's face facts: the Dunfermline Building Society is the author of its own mistakes: mistaken judgments, mistaken investments, mistaken policies." Is that correct; yes or no?
Mr Faulds: No, not entirely.
Q152 Mr Davidson: It is not correct? What part of that is not correct? Three points: are you the author of your own mistakes?
Mr Faulds: Yes we are.
Q153 Mr Davidson: Mistaken judgments?
Mr Faulds: We made bad judgments and we made good judgments, lots of good judgments.
Q154 Mr Davidson: Okay.
Mr Faulds: And could I just add, Mr Davidson, we made a lot of judgments over those years and all of them were taken at the time in the best interests of the members and ---
Q155 Mr Davidson: But some of them were mistaken?
Mr Faulds: Of course they were. Have you not made any mistakes in your life, Mr Davidson?
Q156 Chairman: The way this works is that I ask you the questions, you see. Can I just come on then to the mistaken investments, there were mistaken investments as well, were there not?
Mr Faulds: Every financial services organisation ---
Q157 Mr Davidson: Is that a "Yes" then?
Mr Dalziel: What is a mistaken investment?
Mr Faulds: Are you trying to cross-examine me and trying to trip me up or do you want an answer to your question?
Q158 Mr Davidson: I just want to be clear ---
Mr Faulds: It is not a yes or a no. Chairman, am I allowed to answer in the way I want rather than a yes or no?
Q159 Mr Davidson: Within reason. We are pretty used in this Committee and other committees to people trying to spin their way out of things.
Mr Faulds: I am not spinning. I am here
and you can tell I am angry at what happened.
I started off, and I am genuine about this, by saying yes, we were to
blame for what happened up to October 2008.
Yes, we made mistakes and, yes, there are areas that we regret and if,
like any business person, we had our time again, we would not do it again. But I am not going to sit here and be cross-examined
like some
Q160 Mr Davidson: We run these sessions the way that we wish. I will just come back to this, you agree that you are the author of your own mistakes, mistaken judgments, mistaken investments, mistaken policies, which I think you pretty well do accept. Can I come to the question of why as a mutual, which is meant to be safe, secure, stable, you felt you had to actually go into these other areas? Would you have been able to just potter on perhaps not as large as you would want to be but just exist without going into commercial lending and buying up commercial mortgage books?
Mr Faulds: We do not believe that we would have. Our net interest margin, basically our gross and net profit, was reducing year-on-year because of the competition that we were facing and we were unable to compete effectively. In order to protect the independence of the society and to protect the branches and the jobs we had, we believed that we had to strengthen the business. That is what business people try and do: strengthen the structure and fabric of the business, and that is why we did that.
Q161 Mr Davidson: But strengthening the business by going into much higher risk? These areas were higher risk than the areas you were already in, were they not, commercial lending is by definition higher risk?
Mr Faulds: Yes they are, higher margin and higher risk, yes.
Q162 Mr Davidson: Then buying up the mortgage book from Lehman Brothers and others was much higher risk as well?
Mr Faulds: Higher risk and higher margin.
Q163 Mr Davidson: So you had no choice you are saying to us but to go down that road?
Mr Faulds: We also went into social housing which was lower risk and lower margin, so we had a balanced portfolio.
Q164 Mr Davidson: Just coming back to this, would you have collapsed had you not gone into commercial lending or acquiring the mortgage books?
Mr Faulds: I do not believe so. I believe this society would still be independent today if post October things had been handled differently.
Q165 Mr Davidson: I am not asking about post October; I am asking initially. What I am not clear about is why you went bust and others did not and then what the alternatives were that were available to you.
Mr Faulds: Excuse me, we did not go bust.
Q166 Mr Davidson: We will come on to that later on.
Mr Faulds: No, I am not having it, we did not go bust. I want that struck from the record.
Q167 Mr Davidson: That is not quite the way the system works.
Mr Faulds: Right, I thought I was in a courtroom.
Q168 Mr Davidson: That is American courtroom style; we do not do that here! The fact is that you went into commercial lending, high-risk stuff, when you could have done without it; is that correct?
Mr Faulds: You always have choices in business and we took those choices. If we had not taken those choices the society's margin would have continued to go down and it probably would have merged with someone else.
Mr Dalziel: That was the view of the board at the time. The view of the board at the time was that in view of the market-place unless we diversified the income to provide the members with those competitive products that they really deserved and wanted, then the only other alternative was to merge with somebody else or be swallowed up by somebody bigger. It was a view that unless we were dynamic in diversifying there was that risk.
Q169 Mr Davidson: Right. What would have been the downside to your mutual members of being taken over by someone else? Would they have suffered in any way?
Mr Faulds: It is not what they wanted. We know that from the research we did.
Q170 Mr Davidson: The difficulty is that we have had correspondence and contact from some of your members saying that they did not feel they were adequately consulted about the moves that led to the disaster.
Mr Faulds: Yes.
Q171 Mr Davidson: And therefore whether or not they agreed with that is a moot point.
Mr Faulds: That is an entirely different point, if I may say so, a point I have great sympathy with. May I address that because we felt terrible at the time. Because we were in discussion with the FSA and the Tripartite and because we were worried about any leak getting out about the society needing this extra capital which may lead to a run on the bank, if you will, we could not say anything. Also we were told by the FSA that we must not say anything so we could not communicate with our customers and then when the society was broken up we had no power to do so. I know the Nationwide sent out a letter immediately after. I have every sympathy with the members who felt they were cut out of it but we could not do anything other.
Q172 Mr Davidson: But going back to the strategic decision that was taken to move into buying up the mortgage books of people like Lehman Brothers and so on and commercial lending, you did have alternatives at the time. One of the alternatives would have been to accept a merger with somebody larger and more financially viable?
Mr Faulds: Yes, you always have choices.
Q173 Mr Davidson: Can I just clarify why that was rejected?
Mr Faulds: Because it was the view of the board at the time that we wished to
remain as a strong and independent society in
Q174 Mr Davidson: Even though the route that you were taking was much riskier?
Mr Faulds: The members did not know that at the time. We knew that but we believed that we managed those risks reasonably well.
Q175 Lindsay Roy: Can I just clarify that up until mid-2008, am I right that you had external validation that your self-evaluation and regulation was robust and vigorous within the society?
Mr Dalziel: I would say so, yes. There were no concerns.
Q176 Lindsay Roy: Fine, and is it the case that before 2007 you do not feel that the FSA could have done any more? From what I have seen, the advice was indirect, non-specific and became specific later in 2008. Would that be accurate as well?
Mr Dalziel: I think that is accurate, yes. Capital for example was not an issue at all. Capital adequacy was not an issue at all with the FSA until the end of September and then definitely in October, so that was certainly the case.
Mr Faulds: I really want to underline the point you made that I never got to come back to, Mr Davidson, we are not blaming the FSA or anyone else. We were responsible for running the business, they are the regulator, and I do not have any beef with them up until October 2008 at all. Can I refer you to Lord Turner's letter to the Chancellor, which I think actually was a rather fair letter, all in all, and in that you will see that they were perfectly relaxed and he makes the point that we did not breach any regulatory rules at any time.
Lindsay Roy: Can I move on then because ---
Chairman: Just before you move on.
Q177 Mr Carmichael: Can I finish the boring
stuff because even
Mr Dalziel: Not to my knowledge, no, there was nothing that has ever been brought to my attention or identified.
Q178 Mr Carmichael: What scrutiny was carried out by the FSA of your procedures for taking on self-certified mortgages and were they happy with that?
Mr Dalziel: In terms of
the acquisition of the mortgage portfolios, bearing in mind, as I have said,
the self-certified portion of one particular book, it was only one particular
book and it was a small proportion, the vast majority were normal prime
residential loans or buy-to-let loans.
The FSA got copies of all our board papers for example and all detailed
credit assessments that we did which were put at our credit risk committee, so
the FSA had access to that and were given copies of that at the time. We also discussed with the FSA at various
points during the period how the book acquisitions were going and what we were
planning to do next. The last book that
we purchased was at the beginning of 2006 and the Lehmans book that you
referred to was from a subsidiary of Lehmans and that was purchased in late
2005 and it was all buy-to-let business.
I want to say this again: despite what government ministers have said
live on British television, that was no sub prime lending; there was no
exposure to the
Q179 Mr Carmichael: Full status lending?
Mr Dalziel: Full status
lending and it certainly was not any exposure to the Lehman Brothers who then
obviously collapsed. These were
residential loans in the
Q180 Mr Carmichael: Your evidence then is that there was no concern expressed by the FSA beyond these "Dear CEO" letters?
Mr Dalziel: None at all, none whatsoever.
Q181 Mr Davidson: Can I just ask before we move off that, when you led the company into this much riskier area of work in terms of commercial lending and buying up of loan books, did you yourselves benefit by more than you would have had you not done so in terms of either salary or bonus?
Mr Faulds: Absolutely certainly not, from a non-executive point of view, not from Graeme's point of view either.
Q182 Mr Davidson: So it made no difference to either you personally or to anybody else on the board the fact that you moved into a much riskier area? It is the balance of risk and reward.
Mr Faulds: I assure you that is not the case, absolutely not.
Q183 Mr Davidson: Thank you.
Mr Faulds: And I can give you detailed chapter and verse separately.
Mr Davidson: That would be helpful to have that in writing for the Committee.
Q184 Lindsay Roy: We have had a clear view from you about the position before 2008 and
acknowledgement from yourselves about your own roles and responsibilities. Post October 2008 though you are saying that you
are far from happy about the way things went and one of the things that is
reported in the press was you said: "We failed because we cannot get the
faceless mandarins in
Mr Faulds: Of course. Can I do that in the context of the work that you are doing to look forward because what has happened to us has happened, and I know I am bleating on about it because I do feel angry about it but the experience we had may be able to be improved for those who might follow us.
Q185 Lindsay Roy: I think that is one of the purposes of this initiative.
Mr Faulds: Indeed. Our biggest frustration with the FSA, and we could feel their frustration too, is that we felt we were not dealing with the decision maker. We still do not know but we think the decision maker was the Treasury, and therefore I made attempts to meet the Treasury. Jim Murphy facilitated a meeting with Lord Myners who basically gave me tea and sympathy and he told me I had to convince the FSA of our case. We had good reason to believe many times we had convinced the FSA although, as they are perfectly entitled to do, they did change their opinion. You got evidence from the Tripartite and you saw the dynamics: the man from the Treasury Hugh Maxwell (and I would have had more chance of meeting Robert Maxwell than Hugh Maxwell by the way) hardly said anything, Jon Pain did it all, and that was basically what we were dealing with too. It was always the FSA and they could never tell us yes, no or maybe, nothing. I asked for a meeting with Jon Pain and got one. That was the only time I had any involvement with Jon Pain and he promised to get us a meeting with the Treasury, which he did not. You know what it is like in business, if you are not dealing with the decision maker you are in the dark. I think going forward it would help if there were a more open dialogue. We felt, to be perfectly honest, we were treated, sorry to keep the criminal court analogy going, like the accused. We were denied information and we were shut out. If we were being brought in, for instance the big issue about how much capital was required, the first time we heard a figure of £60 million was from the Chancellor of the Exchequer on the Sunday after they broke us up, the day after they broke us up. If they had just sat down and said it is £60 million we could have worked together but we were kept at arm's length, and that for me would be one telling lesson going forward: do not exclude the society, we are not the accused, we are not criminals. We were doing everything with the best of intentions and we were working very hard for our members and our staff.
Mr Dalziel: It is worth also just highlighting - and Mr Willens might want to come in on this too - at the time I handed over the reins on 3 or 4 December, at that particular point in time, we thought we had an offer on the table from the Treasury of £20 million of capital. We had a business plan that not only had been approved by the FSA, it was actively encouraged by the FSA as this was a society that had a business plan to remain independent, providing the people of Scotland with alternative access to financial services. As the Chairman said, up until a particular point in October when we were advised in a telephone conference call on a Thursday at 1 o'clock that they had done some additional stress tests for the whole sector and in order for us to get into the Government Guarantee Scheme we needed to raise £20 million-worth of capital to cope with the most extreme stress. This is after we had done our own stress testing earlier in the year and submitted it to the FSA. We were happy as a team and as a board and as an executive team that we had the capital to survive what the capital adequacy directives call an "extreme but plausible event" a one-in-25-year event. This came as a complete shock to us at the end of October that we were needing to raise £20 million-worth of capital. We were given until the Tuesday to say how we were going to raise the capital and if we did not raise the capital who did we want to merge with. At that point in time we had already done some business planning as an on-going part of the business, we had been doing that anyway, and the business plan for remaining independent was subsequently approved by the board and the FSA was comfortable with that. It was clear at that time in the market-place - and bear in mind you are looking at a very, very fast-moving environment in September and October, things were changing daily, the financial world was collapsing about our ears - it was becoming apparent, and the Finance Director and I went round the City looking at ways that we could raise the capital, the advice that we got was the only way we could really raise it was if the Treasury was willing to support it in some way. I did actually manage to meet the Treasury and an offer of £20 million was put on the table, subject to some conditions, though. One of the big conditions that subsequently came from the FSA was that they had to be satisfied with the level of provision in the commercial mortgage portfolio. We felt those conditions were met following external work that was done by KPMG in November. The story then unfolds and it is a complete shock to me, having retired at the end of the year, to find in March that the speculation was such, because it was clear that we had a plan approved and capital that appeared to me anyway at that time to be in the bag from the Treasury, that that was put on hold until we were able to explore a building society option. That was important at that time because the building society sector as a whole was looking to avoid, if we could, anybody going to the Treasury for capital because we wanted to be seen to be protecting our own sector, if you like, and that is what then led to the building society route being followed. Thereafter the rest took over.
Mr Faulds: Jim, do you want to add anything to that?
Mr Willens: Just to comment I certainly had very regular contact with the FSA throughout the period October 2008 all the way through to the end of March 2009. My impression is one that the FSA were working extremely hard but were working under extreme pressure and that they did everything that they could do within their powers to assist during that set of circumstances. At no time did I have any contact with the Treasury and at no time did I have any contact with the Bank of England until the weekend 28/29 March 2009. I would concur wholeheartedly with the view put forward that increased dialogue with the decision maker would be enormously helpful to both parties/both sides and would potentially lead to a different solution.
Q186 Mr Carmichael: Why did you not get that dialogue?
Mr Willens: We made efforts to meet with the Treasury and that was done, as Jim Faulds has just described, through a meeting with Jon Pain at the FSA. We subsequently did have a meeting with Lord Myners on February 13 and it was explained very clearly to us at that stage that the gateway to the Tripartite for a building society was via the FSA and that all our communications had to be funnelled through the FSA. That really was spelt out very clearly.
Q187 Mr Davidson: I am slightly confused by that then. If you were being told the people to speak to were the FSA and you had lots of meetings with the FSA and you had a meeting with Lord Myners as well, and he was essentially saying to you to deal with the FSA, I am not quite sure who you did not meet then.
Mr Faulds: The Lord Myners meeting came via Jim Murphy. Subsequently I wanted to meet the people who were day-to-day doing the work, like the chap you met two weeks ago. By the way, there was no great desire to meet the Treasury. We just wanted someone to give us some information and some decisions and some guidance.
Q188 Mr Davidson: Surely you were getting clear guidance. It is this question of not meeting various people. I get people writing to me who have already written to the Queen or they tell me if I do not deal with it they are going to write to the President of the United States and all the rest of it, so people saying that they want to meet somebody else is often because they do not like the answer they have had from the people who they have met.
Mr Faulds: I would not have minded if I had got any answers. When you get no answers, when you are getting stonewalled, then what do you do? Sit on your hands.
Q189 Mr Davidson: Were you not being told by the FSA and Lord Myners what it was necessary for you to achieve?
Mr Faulds: No.
Q190 Mr Davidson: You were left totally in the dark?
Mr Faulds: That is the whole point. We were told at the beginning that we had to raise £20 million which we subsequently did. We felt subsequently, looking at it, that with a bit more headroom we could raise £30 million which we did. They then told us that events had moved on and we needed to raise more money. How much more? No idea. We were told at one point that this mythical £150 million had come in from a competitive bidder and the £60 million popped up when the Chancellor was on. The First Minister told me that he had spoken to the Chancellor and the Chancellor had said to him that the figure was somewhere between £60 and £150 million but probably at the lower end. We were getting our information second-hand and that is no way to do business.
Mr Willens: If I could just add to that, the view that was expressed regularly from the FSA in the on-going dialogue which was daily was that the decision maker was not them; it was somebody else (ie the Treasury we think) and therefore they had to refer matters to that party or that body before being able to come back to us. That is where the frustration lay. It was not that we just wanted to see people.
Q191 Chairman: Can you tell us how much was the value of your deposits?
Mr Faulds: Sorry, Chairman, I did not hear that.
Q192 Chairman: How much in deposits did you have and how much more was the lending on commercial property?
Mr Faulds: Retail lending was 1.1 billion.
Mr Dalziel: Total assets of 3 billion.
Mr Faulds: Commercial 650, the buy-to-let ---
Q193 Chairman: The ratio to your deposits?
Mr Faulds: Sorry, I beg your pardon.
Mr Dalziel: 75 per cent of our funding came from retail deposits.
Mr Willens: It was 70 per cent funding from retail deposits and 30 per cent from wholesale markets. The lending ratio of commercial assets to overall assets was 16.7 per cent at the end of 2007, comparable to other societies, which has already been covered.
Q194 Mr Davidson: Can I pick up the next question that we have got down here. A couple of times you have referred to the fact that the building society sector likes to look after its own, so to speak. The fact that nobody came forward to help you at that stage and the fact that the Building Society Association was not prepared to put up the full 60 million that was said at one stage to be necessary to save you is obviously a cause for concern. Why did other building societies not step in to help you? Was that because you were seen to be - and I know you do not like the term toxic - so toxic that that was not going to be sufficient?
Mr Faulds: Clearly, and we would need to speculate because we have never been told, a couple of things: one, eventually, to be fair to them, they did come up with 30 million but they wanted Treasury to stand beside that with another 30, so they did come in to support us. They did have concerns. What we did not know at the time but has subsequently been revealed is that all these societies bar none had their own problems. I will give you one fascinating fact. We were denied access to this special lending scheme. This is what this whole issue is about. If the wholesale markets had not have closed down we would still have been pressing on. A good number of those societies who qualified for that SLS scheme who are in it, if they had to qualify now would not get in it. In a sense timing was against us too.
Q195 Mr Carmichael: Are you telling us then that basically you were small enough to be allowed to fail?
Mr Faulds: I would not say that. I actually think that at the time, the context of the times were pressured, and I do not know what was going through the minds of the FSA and the Tripartite, but here they had a problem: everyone else got in, we did not get in; you want to tidy up the problem and it is gone forever.
Q196 Mr Carmichael: Does anybody else have a different view on that?
Mr Faulds: What then happened is all the other societies faced similar problems to those we faced.
Q197 Mr Carmichael: Does anybody else have a different view on that?
Mr Willens: I think that the authorities were looking at challenges such as they had probably never seen before and they were looking to make sure that they protected the stability of financial markets to the best of their ability, and in doing that it may well be that if hindsight is applied, which is always terribly easy, that it may have been different.
Mr Faulds: I agree.
Q198 Mr Carmichael: If building societies release you, Mr Willens, you could have a wonderful future as a civil servant. That was worthy of Sir Humphrey.
Mr Willens: Thank you.
Q199 Mr Davidson: It was not a compliment!
Mr Dalziel: The other comment I would make is I was not there after December but before December, prior to the Banking Act being implemented, there were several societies that had been rescued already, so we were coming along, if you like, fourth in line as being an issue for the FSA to resolve.
Mr Faulds: And the first one where the Banking Act could be applied.
Mr Dalziel: So in answer to your direct question about were we small enough to be allowed to fail, Lord Turner makes that clear in his letter, that, yes, we were small enough, and that is what is most disappointing for me, and it is so sad that Dunfermline Building Society has provided services for all those years and the fact that the board at the time were not allowed the opportunity to look at what they could do differently to change their plans or whatever to meet the capital requirements that the Tripartite laid down, that is shocking and very sad.
Mr Faulds: On the point of Lord Turner's letter, Chairman, could I just correct one other thing. The FSA said that pressure was put on the board to remove executives. That is categorically 100 per cent not true. No pressure was put on. In fact when I rang a Mr Eric Enstrom at the FSA to tell him that Graeme was moving on and we were going to appoint Jim Willens as Chief Executive, and this was mid December - he had a canary fit when I told him that. He said, "You cannot appoint someone full time," and I thought, "I can see some writing on the wall here."
Q200 Mr Carmichael: I think the range of questions that we were wanting to drill down was the role of the Tripartite, but I think probably we have already covered that. Can I just distil down what I think you are telling us today, and we will then decide whether we agree with it or not. What you are almost telling us is that there was a conspiracy to exclude you amongst the Tripartite, or at least if not among the Tripartite between the Treasury and the FSA. Is that your honest view?
Mr Faulds: I would not use the word conspiracy. I think we were excluded deliberately.
Q201 Mr Carmichael: So when two people decide together to do something, does that not make it a conspiracy?
Mr Faulds: It sounds a bit sinister.
Q202 Mr Carmichael: A bit
Mr Faulds: A bit political.
Mr Carmichael: A bit political? Heaven help us.
Q203 Chairman: With profits of £5-£6 million a year would DBS have been able to pay the interest on a capital injection of £60 million?
Mr Faulds: By the way, we did a business plan and the business plan we put in was a much simplified business plan, but to answer your question.
Q204 Chairman: You do not agree then there was a need for a £60 million capital injection?
Mr Faulds: No, we do not agree with that. We believed we needed 30. However, our business plans going forward, depending upon what interest rate you charged - I do not know if you know what interest rates they are charging on this government money but it is penal - we had an offer of £30 million from the Scottish Government which was at very favourable interest rates because the offer was conditional. If we could have matched that with the building society club offer that would be 60, which we did not really need, so it is too simplistic to say that we could not pay the interest on 60 million. It depends on the interest rate. On the penal rate that would have been challenging.
Q205 Mr Carmichael: You could have afforded it on the SLS payments?
Mr Willens: The business plan was stressed to look at capital injections ranging from initially 20, but subsequently increased up to 30, up to £60 million. That business plan would have supported a £60 million pound capital injection at the rates that were being charged.
Q206 Mr Carmichael: With a £5-£6 million profit a year?
Mr Willens: But the business plan also included looking at ways to improve the organisation's efficiency by removing cost and simplifying the business over a period of time to take out that additional cost that sat within it, so a combination of factors would have allowed that to have happened.
Q207 Mr Carmichael: And you have the elephant in the room as well which is Dunfermline Solutions.
Mr Willens: I would not quite describe it as that but there was certainly a need to manage through the costs that had been built up by Dunfermline Solutions on the IT system. Again that would have been run over a period of eight to ten years and the business plan again took account of that.
Q208 Chairman: If you put aside the interests of the building society, do you accept that it was not in the public's interest to save DBS?
Mr Faulds: I passionately believe that the society should have been given a fair chance to remain independent. The board examined all options. If it could not the next best solution would be to merge with a stronger partner. I have to say that I am delighted that that partner is Nationwide. It could not have found a better home.
Q209 Mr Davidson: Can I turn to the question of the IT system, why did you decide to build your own IT system rather than seeking to buy something that was already in operation elsewhere?
Mr Dalziel: We did evaluate the market several times in fact and we did actually choose an existing software provider with software that was already being used. The reason we did it was so that we could provide our customers with a flexible range of products and be open for business anytime anywhere. We were alive to the fact that whilst face-to-face service through branches was vitally important to a lot of our members we also recognised that having the systems and technology capable of dealing with things over the internet was important so that is why we went into it. The reason for the 9.5 million exceptional item in the 2007 accounts - and that was explained at the time and we explained to members and we apologised to members for that at the time - was down to the fact that in order to implement it we had decided to try and go for a big bang approach and taking everything out and putting the entire new software suite at the one time. As we got into the project we realised that was not the thing to do and we needed to put it into bite-sized chunks. Putting it into bite-sized chunks at that time in 2007, we took the view that because of the way the market was going we really needed to focus on the members. 80 per cent, or even higher than that, 90 per cent of our members were savings members, investors in the society, and we felt that we needed to get the savings part of the system in before mortgages, and there were other things we wanted to do with mortgages in the meantime, so we parked our mortgage software on the side to leave that for another day to implement. Because we did not have a concrete action plan as to when we wanted to implement that particular mortgage suite, the auditors would not allow us to keep the value of that particular bit of software on the balance sheet, which then led to the £9.5 million. Had we remained going forward, as Mr Willens has described, the business plan allowed for bringing that mortgage system into production at some time in the future.
Q210 Mr Davidson: How many other building societies of similar size suffered a similar loss through the adoption of a new computer system?
Mr Dalziel: Well, there is one other; Derbyshire aborted their product. There have been a number of aborted attempts. We were all in the same boat. Certainly a number of us were looking for this Holy Grail of better technology to provide a better service for our customers. Ours went live in 2008. In previous years some other societies with different products had aborted their development, so figures of £10 million or £20 million were being written off in one year.
Q211 Mr Davidson: So there is a whole group of you doing pretty much the same thing and all making pretty much the same mistakes? I am trying to make clear whether or not this mess with the computer was unique to yourself.
Mr Dalziel: I have yet to meet anybody in the world of business who has been trying to implement IT who has not experienced some kind of problem, to be honest.
Q212 Mr Davidson: Indeed, absolutely, I sit on the Public Accounts Committee and we get them all the time, but what I am not clear about here is whether or not yours was as bad as or was uniquely bad in the sense of a screw up.
Mr Faulds: We went for a system that we thought would make us extremely competitive. It was too challenging, it took too long, it took too much money and we made a mistake.
Q213 Mr Carmichael: At what point did you start to realise that?
Mr Faulds: Unfortunately with these systems if you have ever been involved in them, it is not black and white, but I would say about the year 2004-05 we started to get concerned. We made changes down the years in the project management, bringing in different suppliers. Eventually we got a team - and this is the irony - where the product that went in worked terrifically well and given time the other part would go in, so we ran out of time.
Q214 Mr Carmichael: What were your front-line staff telling you about this?
Mr Dalziel: The front-line team is one of the things that encouraged us to implement this because they were looking for something different. The staff out in the branches were desperate to get their hands on this new system. We were doing simulation techniques to show them what the system would look like in real life for training purposes.
Q215 Mr Carmichael: I have seen it suggested, particularly in press reports, that some staff were raising concerns and they did it to their own personal detriment in that they were encouraged to leave.
Mr Dalziel: Not to my knowledge.
Q216 Mr Carmichael: So criticism was quite welcome?
Mr Dalziel: At all times in the society anywhere.
Q217 Mr Carmichael: You just did not get it; you only got encouragement?
Mr Dalziel: We had staff opinion surveys where people could identify areas that they were concerned about. We had lots of these mechanisms in place through the period.
Mr Faulds: Jim, you worked with the system when it was in.
Mr Willens: Yes, the system went live in November 2008 and there is no doubt that there was anticipation amongst the employee base for a new system because, not surprisingly, having waited for it for a number of years, they were looking forward to the benefits of it. The system and the management information portal both went live and both went well and it is not an insignificant thing to launch a new core system for savings in a financial institution, so I think that in itself was to everyone's credit. Was the system perfect? No. Were there still things about it that you would look to improve on an on-going basis? Yes, and there was feedback coming in on a regular basis from employees and indeed from customers. Was it ideal against what was originally planned? Then the answer has got to be no. Was it as it was first laid out? Because of the time-frame involved in getting it to implementation quite clearly that was not as it should have been, but the main part of it worked extremely well.
Q218 Mr Carmichael: So where did the failure for the lack of control lie?
Mr Willens: I am not in a position to be able to answer.
Mr Faulds: It lay with the executive and the board.
Q219 Mr Carmichael: The executive?
Mr Faulds: And the board.
Q220 Mr Carmichael: The executive being the executive who was employed by Dunfermline Solutions or ---
Mr Faulds: I beg your pardon, the management.
Q221 Lindsay Roy: Was the objective to make it highly customised to give you a market edge and now you have this is there interest from any other building society or bank in terms of what you have done?
Mr Dalziel: In terms of the original intention in terms of market edge, absolutely, yes. That is why it was in Dunfermline Solutions because we saw an opportunity in the market-place based on research. As I said earlier to Mr Davidson, everybody was looking for this Holy Grail and a lot of other building societies were very interested. We had the idea of providing services to other building societies with the technology in place.
Q222 Lindsay Roy: Has anybody picked it up since it has gone live?
Mr Dalziel: No, it is too soon.
Mr Carmichael: Can I ask will we have an opportunity at a later stage as things stand at the moment to take evidence from staff associations and former employees?
Chairman: It is always possible.
Mr Carmichael: Thank you.
Q223 Mr Davidson: One of the suggestions that we have got here is the PricewaterhouseCoopers report which had indicated that pure project management was to blame. You accept that?
Mr Faulds: Yes and I would add that that report was commissioned spontaneously by the board. Not by the FSA as you may have been led to believe.
Q224 Mr Davidson: I understand that. Can I clarify what has happened to Dunfermline Solutions now? Is it freestanding?
Mr Faulds: It is freestanding. The shareholder is the government, I believe?
Mr Willens: It is with the administrators.
Mr Faulds: It is with the administrators and the directors of that company, including myself, are currently in conversation with Nationwide, who wants the rights to use the software, and we are just tidying that up.
Q225 Mr Davidson: Is it a viable operation or is it just a question of picking up the wreckage?
Mr Faulds: It is difficult to say because although we are on the board we are not involved but I believe it is tidying it up.
Q226 Mr Carmichael: So what happened to the people who were responsible?
Mr Faulds: The management of the society and the directors?
Q227 Mr Carmichael: I mean the specific project managers for this.
Mr Faulds: There was a change of project manager in 2007.
Q228 Mr Carmichael: Who was it up to that point?
Mr Dalziel: KPMG project management.
Mr Faulds: And then a chap call Stuart Cooper ran it.
Mr Dalziel: Prior to that.
Chairman: Lindsay, communications with customers.
Q229 Lindsay Roy: There was some disquiet, and I can understand why, and apparently there are issues about communication, that neither from Nationwide nor from DBS was there direct contact with customers when things came to a head. How did that come about? Was it just because of the situation that occurred?
Mr Faulds: I feel terrible about that because it is fundamental to communicate with your customers, but for two weeks we were under pressure with media commenting on speculation but we were under a three-line whip from the FSA, and rightly so, that we could not say anything and we were nervous about running the bank. Then on the Saturday when it all came to a head we were stood down so ---
Q230 Chairman: We have received an email from a customer of DBS who was concerned that he had received no official communication to him from either DBS or Nationwide about the transfer: he was forced to rely on press releases for information. Why did DBS not communicate directly with customers about the transfer?
Mr Faulds: We as a board were unable to do so until that Saturday 28 March and thereafter the power to do so was taken out of our hands. I do believe Nationwide did write to customers. I have seen a letter that went to customers but you would need to ask Nationwide about that.
Q231 Chairman: I think there is another issue here. The Committee received an email on 20 May from a customer of DBS who said that when his wife visited an Edinburgh branch of DBS on 14 April and asked why they had not received any information, she was told that the staff had not received any information either. That is quite serious.
Mr Faulds: Well, we were stood down on 28 March and we had no power thereafter to do anything.
Mr Willens: If I could just add, I have been in place (but not with executive accountability) since 28 March and I have seen communications that have gone out from the Nationwide management team to employees, and several of them. I also have had contact with many employees who have been very positive about the communications that they have received since that time, so I have to say I am a little surprised at that particular comment.
Q232 Chairman: So you do not think it is the situation, it is just some report?
Mr Willens: It may well be that there has been either a misinterpretation or some miscommunication there. I have certainly seen many communications from the Nationwide to the employee base.
Q233 Chairman: Jim, you told us that DBS made available for commercial loans about 16 per cent of your assets. Some building societies have up to 25 per cent. Do you accept that under the Building Society Act of 1986 you were only allowed to have commercial loans of ten per cent and is that the right balance?
Mr Faulds: I think clearly there are lessons to be learned. Graeme and I were discussing this yesterday. We do not think that the 25 per cent is really an issue. There are some things that perhaps more regulation should be applied to, like development finance, like, as we discussed earlier, self-certified loans, but I do not think - and you may like to add to that - that 25 per cent is a problem, but maybe the nature of the lending within that.
Mr Dalziel: I think in the overall concept of learning for the future there are two elements of it. There is a macro element where a large part of the issues that we have got here are to do with capital and the stress testing that was applied. The second part of that is commercial lending and the limit of 25 per cent. If you close up too much in terms of capital then it does not allow banks and building societies to offer innovation in the market-place and move forward. In terms of the 25 per cent limit, as long as the capital is controlled then that should be fine, but I think there are some areas of lending that, if you look at the history across a number of societies, could be ruled out or restricted.
Mr Faulds: Could I add to that, Chairman. The commercial lending issue could easily be misleading here. Lord Turner's letter says that the decision was taken based on potential future losses on the commercial book, not existing losses. We were all looking at commercial property suffering large cuts in value, and we still are, but there is some evidence that came out recently that it is not going to be as deep as we feared. In fact I saw yesterday one report which says that it has stabilised, so these potential future losses may not occur, so let us not beat up commercial lending as if it is the problem. Commercial lending done properly and managed properly need not be the problem.
Q234 Mr Carmichael: Does this not come though actually just to the very heart of the present situation? If you were to say that, then what is there to stop us finding ourselves in this situation again in ten, 15 or 20 years' time? Do we not actually have to have a much more rigorous and perhaps, yes, much more risk-averse structure for the future because surely it is your responsibility in a position like yours to take account and make provision for potential future losses?
Mr Dalziel: We did, we did.
Mr Faulds: We did. We put aside £32 million and that provision was looked at deal- by-deal loan-by-loan and then the FSA appointed KPMG to sense test that and they suggested that the maximum we should put aside is 40 million. We were putting aside 32 million. We believed that we would bring that book home profitably without that full provision we needed. You are absolutely right, Mr Carmichael, if I am wrong about this, if these potential future losses do occur, then yes.
Q235 Mr Carmichael: You have to make provision.
Mr Dalziel: If what Lord Turner is saying is he had to break down the society because he is scared of these potential future losses - and let us say they do come, you are absolutely right, you could not go on like that, but we do not accept necessarily that those losses would be more than £32 million.
Q236 Chairman: Those potential losses are not going to come; they are already
there. I know banks who have lent £10
million on a property and they are lucky if they are recovering 25 per cent of
that. Properties in
Mr Faulds: If you sell at the moment, absolutely.
Q237 Chairman: How can you hold on to it?
Mr Faulds: Our customers were paying the interest so why would you sell?
Q238 Chairman: If the banks are selling those assets then the customers have failed to pay that interest.
Mr Dalziel: In our case the customers were paying the interest. We have only had three cases in arrears of interest.
Mr Faulds: Three cases.
Mr Dalziel: We had arrears
of interest of 100,000 in the commercial loan portfolio. To go back to the point, the key thing is the
stress test. We allowed stress tests in
the capital base of a fall in the commercial property market in the
Q239 Chairman: A final question, if you could reverse the clock tell us three mistakes that you would not repeat?
Mr Faulds: Speaking personally, clearly we would have approached the IT project differently. On commercial lending we might have been tighter on the lending. We were perfectly content with what we did in commercial but clearly with hindsight maybe tighter on that. For me, frankly, we should have moved faster on the strategy we had in place because it was the right strategy; we just were too slow for our own good.
Q240 Chairman: Thank you very much. Can I thank the witnesses for their attendance. Before I declare the meeting closed would you like to say anything in conclusion, perhaps something we have not covered in the questions?
Mr Dalziel: Maybe I could just say that as Chief Executive for eight years and having spent 24 hours a day putting my whole soul into the society trying to grow value for members, I am very saddened by what has happened and disappointed and shocked actually by what has happened.
Mr Willens: Likewise, everything that was done was done
with the very best interests in mind for the membership and employees, and it
was a very sad outturn for
Mr Faulds: I would like to say we have talked a lot about members who were always in our minds, but we have fought very, very hard in the last six months to protect our staff and it is them I really feel for.
Q241 Mr Carmichael: A lot of your staff are very bruised and very financially hurt. Is that an apology to them?
Mr Faulds: Absolutely. I am sorry if anyone has suffered for this. That is an absolute unreserved apology. A lot of staff have spoken to us and they were very supportive of the fight that we were putting up.
Chairman: Thank you once again.
Witnesses: Ms Liz Kelly, Group Counsel, Mr Tony Prestedge, Group Development Director, and Ms Alison Robb, Divisional Director, Group Strategy and Planning, Nationwide Building Society, gave evidence.
Q242 Chairman: Good afternoon. I would like to welcome our witnesses to today's evidence session. Perhaps you could introduce yourselves for the record?
Mr Prestedge: Mr Chairman, could I first say that we are pleased to be here on
behalf of Nationwide to help you with your business today? My name is Tony Prestedge. I am one of the executive directors for the
Nationwide Building Society. With me
today is Alison Robb, our Director of Strategy and Planning. Alison is with me because she was heavily
involved in the transaction and the discussions with the Bank of England, and
indeed the Treasury and the FSA during the process of the acquisition of parts
of
Q243 Alistair
Carmichael: And partly because you thought
you were coming to a
Mr Prestedge: Indeed I am looking forward to the process!
Q244 Chairman: Before we start on the detailed questions, do you have any opening remarks?
Mr Prestedge: Very briefly, Mr Chairman. The one thing I would ask the Committee to remember is that I am conscious that the evidence, both from the previous panel and also from the Tripartite members, was very much about the history of the organisation. Given that Nationwide only acquired a subset of the business on 30 March, I hope you will appreciate that we feel it would be wrong for us to speculate around the process that was adopted by any part of the regulator or indeed the past decisions that were made, and that we can focus part of this evidence on the running of the business, moving forward - albeit we accept that there may be questions that you do want to ask, based on the parts of the business that we have inherited.
Lindsay Roy: Before we proceed any further, it is important that I declare an interest here. Mr Geoffrey Howe, the Chairman of Nationwide Building Society is my cousin.
Q245 Mr Davidson: So you had better answer his questions!
Mr Prestedge: Now that is worse than in a
Q246 Chairman: Could you tell us why did DBS fail?
Mr Prestedge: I did say that I think it would have been wrong for us to speculate, and we have already heard the evidence ---
Q247 Chairman: We are not asking for speculation; we are asking the reason.
Mr Prestedge: In our view there was insufficient capital, or in the view of the Tripartite, who ultimately made the decision, there was insufficient capital for the business to continue to trade independently.
Q248 Chairman: Did the Tripartite authorities make the right decision in refusing to provide DBS with a capital injection of £30 million?
Mr Prestedge: In my view it was the right decision, partly because this is not
just about capital; it is also about profitability. To inject capital would have required the
Tripartite, or any other member who decided to inject capital, to seek some
form of repayment and interest on that.
The business within
Q249 Chairman: So you think £30 million capital injection was not sufficient?
Mr Prestedge: In our view it would have been insufficient, yes.
Q250 Chairman: What figure would you put on it then?
Mr Prestedge: In fairness, we never completed all of our due diligence on parts of the assets that subsequently never came to us. The acquired portfolio within the residential lending book never came to us; the commercial book, as well as the RSL portfolios; so it would be hard for us to predict. Certainly our view is that the numbers that were quoted earlier, which I believe were attributed to the Chancellor of being between 60 to 150, would be the range; but we never finished full due diligence in order to be more precise.
Q251 Chairman: Would any other building society have been able to take on the transfer from DBS?
Mr Prestedge: It would be wrong for us to talk on behalf of other building societies. In our view, however, given the limited due diligence we would have been able to undertake, we do not believe that there would have been others in the sector in any different position than us in concluding that a normal merger would have been right for their members.
Q252 Chairman: What have you discovered about DBS since the transfer, about the business?
Mr Prestedge: We have discovered a fantastic workforce who, I have to say, I
would absolutely commend in terms of their performance and their behaviour,
given the very significant uncertainty that they must have lived through. We have discovered a membership through the
branch network who clearly value the brand of
Q253 Lindsay Roy: According to the information I have, a one-off loan from HMT was rejected as an option, as was a reported offer from the Scottish Executive. In your view, why was it that these options were not seen as desirable or taken up?
Mr Prestedge: In fairness, I do not know the details of those potential
offers. It was a discussion between
members of the Tripartite and
Q254 Lindsay
Roy: From the information you have, who
decided not to invest the taxpayers' money in
Mr Prestedge: I do not know the basis upon which that decision was made. The only information I have is that I heard from the Tripartite within your last hearing, which is that that decision was made by the Treasury and ultimately the Chancellor.
Q255 Lindsay Roy: Nationwide did not feel that they should pursue that and make an enquiry about that?
Mr Prestedge: We do not feel that it is for Nationwide to do so. There was an open-market transaction for a business that went into temporary public ownership. The decision-making was by the authorities and not by any commercial organisation within the sector.
Q256 Lindsay
Roy: How competitive was the tender for
Mr Prestedge: Clearly we do not know that. We indeed found out ourselves that there were four people who supposedly put forward a bid, because we heard that from Mr Bailey from the Bank of England, but we do not know the details of those bids. They were details, I guess, only supplied to the Tripartite itself, and therefore it is difficult for us to comment.
Q257 Lindsay Roy: But you were happy to take on what you were asked to take on?
Mr Prestedge: We were very clear that there were parts of the organisation that we would not bid for under any circumstances. We would never, and did not, bid for the acquired portfolios of residential lending, because Nationwide has never acquired residential lending which we have not originated for ourselves. We did not bid, and never would under any circumstances, for the commercial portfolio, for similar reasons. For the purposes of the business that we did acquire, the billion pounds' worth of primary tail portfolio residential lending as well as the liabilities, i.e. the savings side of the business, the head office and the branch network, we are very happy with what we have acquired.
Q258 Lindsay Roy: In effect, you had the crème de la crème?
Mr Prestedge: We have the parts of the business which, for us, we felt we were able to take on board without creating risk for our own membership.
Q259 Alistair
Carmichael: You have just outlined there a
very different corporate history to the one which we heard described by Mr
Faulds, when you were sitting in the audience here. He identified a situation where the
Mr Prestedge: That is true.
Q260 Alistair Carmichael: Why not?
Mr Prestedge: In fairness, I think it is important to remember there are two very
different businesses we are discussing here.
Nationwide has a balance sheet at the end of last year of
£200 billion; we have 800 branches and 15 million members, and a much more
diversified business, including current account banking as well as credit card
operations and, at points in the past, a life business and, now, a full
regulated sales operation. So it would
be wrong to compare apples with pears.
What I would say, however, is that the board of Nationwide has had a
policy over time that it would not use members' capital to acquire assets that
it had not self-originated; i.e. it
would not pass accountability for the credit decision into a third party, and
that we would use the capital within the business to originate assets where we
believe we had oversight for the credit quality within our own
organisation. That is not to say that
there are not very good assets within acquired portfolios within the
Q261 Alistair Carmichael: You would not pass comment, apart from the fact that you did not want to buy them.
Mr Prestedge: On the basis that it is not an asset class that we choose to have on our own balance sheet.
Q262 Mr Davidson: Can I pick up the point about staffing and compulsory redundancies and related matters? As I understand it, you have promised that no branch staff will be made redundant in the first three years.
Mr Prestedge: We have.
Q263 Mr Davidson: What does that mean, though, for staff in the headquarters and any other back office staff?
Mr Prestedge: At this moment in time, if you consider the majority of merger transactions - if we were to take something like the Portman, which was one of our earlier transactions, it took 12 months to complete, and Derbyshire and Cheshire, because it was a different nature of transaction, took 12 weeks to complete, and therefore we had a much longer period of time to assess the operations - with Dunfermline, in reality, the transaction was completed within 48 hours. The reason why we felt able to give 100% guarantee for three years for the branch high street employees is because we were clear that we wanted to commit to the branch network for that period of time, to prove that it had value. What we have said to all of their head office employees - and I have said this personally and I have been with colleagues when they have said it - is that we are now going to go through a process of reviewing what operations within the head office environment within Dunfermline will remain, and how could that site be used, moving forward, in order to mitigate any potential job losses. What we were not prepared to do, and it would have been wrong to do, was to mislead employees at the point of the transaction or even today, when those final decisions have not been made.
Q264 Mr Davidson: Within what sort of timescale do you believe a decision on the plan would be taken about the future of the back office staff in their headquarters?
Mr Prestedge: My expectation is that we would be able to have a clearer picture
on the roles that will exist within
Q265 Mr Davidson: I understand that. It is three to six months, you say. Is that three to six months from now?
Mr Prestedge: I think I said six to nine months. My expectation was that we would be able to be clear around the direction for that site towards the back end of this year, when we have completed the assessment of all that work.
Q266 Mr
Davidson: Can I just clarify about pension
arrangements for existing
Mr Prestedge: There were two pension schemes that operated within
Q267 Mr Davidson: So the final salary scheme has been closed, effectively?
Mr Prestedge: The final salary scheme has been closed and the liability for that scheme resides with the administrator.
Q268 Chairman:
What
will happen to the Dunfermline Building Society brand in the long term? Will it remain intact? It is a popular brand in
Mr Prestedge: We have made clear our intention, not just with the
Q269 Chairman: Obviously there are cultural differences within the organisations - DBS and Nationwide. How does DBS exist within Nationwide?
Mr Prestedge: First, I would say there is much less cultural difference than you
might imagine. My experience is that
both businesses hold their heritage of mutuality very strongly. Both businesses' employees feel very strongly
about the service ethic and the right thing to do on behalf of the
membership. My personal experience - and
I have been to
Q270 Chairman:
What
presence did Nationwide have in
Mr Prestedge: Prior to the transaction, we already had just over 40 branches in
the
Q271 Chairman: What practical problems are there with taking on the business of DBS?
Mr Prestedge: If I am honest with you, there are always operational challenges
when you go through a transaction, about how you manage your cash; how you
ensure you reconcile your own balance sheet; how you determine your risk
profiles. We have not, however, at this
time, experienced any significant difficulties that are giving us any concerns
around the merger with
Q272 Chairman: We see this IT system cost DBS a lot of money, a loss of over £9 million. Are the IT systems compatible?
Mr Prestedge: We genuinely have not yet concluded whether or not the IT solution
within
Q273 Chairman: We have received an email from a customer of DBS who was concerned that he had received no official communication to him from either DBS or Nationwide about the transfer. He was forced to rely on press releases for information. Have you now explained the situation in writing to your customers?
Mr Prestedge: What I would say, Mr Chairman, is that I am very disappointed about
that, because we have actually written to all of the different consumers within
Q274 Chairman: When you take on a new business there are always mountains of problems but, from your evidence, it appears that the structure, priorities and culture of the DBS were reasonably functioning well. So what went wrong, for the failure of DBS?
Mr Prestedge: As I said earlier, my observation from the outside looking in is
that we are in a very severe economic downturn.
The shape of the balance sheet within
Q275 Chairman: Do you believe that it was a wise decision of Nationwide to take over?
Mr Prestedge: I do believe it is a wise decision, for two reasons. First, I think that, in the parts of the
business that we were able to acquire through the process, there is a business
there that, over time, we will prove there is value in. Secondly, because we believe it was the right
thing to do on behalf of the mutual sector.
Whilst we could not step in and do a voluntary merger because of the
risk it would have posed to our own business, we were clear that, if we were
able to do so, we would seek to find a solution to help
Q276 Lindsay Roy: Am I right that, given the speed of events, due diligence was not as comprehensive as might otherwise have been the case?
Mr Prestedge: That is very true. However, as part of the transaction that we were able to complete post-announcement on merger due diligence, with the agreement of the Bank - maybe I could ask Ms Robb to comment on that.
Ms Robb: We did complete a limited amount of due diligence prior to the actual execution of the transaction over the weekend, but we then had a four-week period in which to complete our in-depth due diligence, which we did. We confirmed to the Treasury that we had completed that and the findings were satisfactory within the premises which we had expected.
Q277 Lindsay Roy: Was there anything you found that was surprising?
Ms Robb: No.
Q278 Mr Davidson: So this was a cherry-picking, shotgun wedding. There was nothing that you found that was untoward at all; you are perfectly happy with everything; and the process has all run smoothly since, has it?
Ms Robb: It is fair to say that everything was executed so quickly, and we were using legislation for the first time; so certainly, as events unfolded, there was some issue in terms of the transfer order and that has been corrected; but I would say that was an administrative procedure that needed to be completed, as opposed to a substantive issue with the transaction itself.
Q279 Mr
Davidson: I am sorry if this was dealt with
while I was out of the room, dealing with a practical issue. The IT systems - can I just ask about
that? There is compatibility between the
two, is there? Before we get on to Dunfermline
Solutions, you were able to operate with the system that
Mr Prestedge: Perhaps I could answer that.
Because we have chosen to continue to run the business independently,
the only point of integration that we need is at a balance sheet and an
accounting level. We have not sought to
deploy
Q280 Mr Davidson: What is your view of the technology systems that they are using?
Mr Prestedge: There have clearly been, since deployment last October, a number of ongoing developments that have been required, and there would need to be on an ongoing basis. It is a solution that, as with any technology solution, will take a period of time to bed down, and has been live for only six months. What I would say is that it is operating; it is fit for purpose for the way in which the organisation is currently operating. Whether or not we retain that, however, in the medium and longer term is a debate that we are as yet still to conclude, because we will do that across the entire Nationwide estate.
Q281 Mr
Davidson: Do you think that the system that
Mr Prestedge: I clearly was not part of the choice of that supplier and I am unclear what price you would pay for a similar solution in the marketplace.
Q282 Mr Davidson: That was delightful! You should certainly be in the Civil Service! That told us absolutely nothing at all.
Mr Prestedge: In fairness, I am not trying to be evasive. In many respects I cannot answer the question because, without going out to the market and tendering for a common solution with multiple suppliers to determine the price, without having done that, it is a question that I cannot answer.
Q283 Mr
Davidson: You are not in a position where
you are aware of the way in which
Mr Prestedge: I certainly am not able to say the former, partly because it would not be an appropriate solution for the Nationwide Group, because we operate services and products beyond savings and mortgages. Therefore, it is not a current account banking solution and would not be able to service the full suite of product offering that we offer within the Nationwide Group. What I would say is, as with any solution that is deployed and is now only six months old, there is ongoing development work required. The IT function within Dunfermline are working incredibly hard to understand the IT solution they are now operating and, over time, we will evaluate that. In terms of value for money, because I have not had the privilege of going out to the market to determine what else is out there and at what cost, it is not a question I feel able to answer - but I am really not trying to be evasive.
Q284 Mr Davidson: Can I clarify what has happened to Dunfermline Solutions, the IT business? You were not involved with taking that over; that remains with the administrators, does it not?
Ms Robb:
Q285 Mr Davidson: And you took a conscious decision that you did not want to take that over?
Ms Robb: Yes.
Q286 Chairman: Is there a case for restricting commercial loans to 10 per cent of a building society's total assets, as it used to be before the Building Societies Act 1986?
Mr Prestedge: My own personal view would be not. I do not believe that straightforward limits in terms of extent of exposure is an appropriate way to regulate a business. The appropriate way to regulate a business is to determine its competence, its capability and its capital level. If a business has sufficient capital in order to allow it to take risk and not disproportionate risk, and to create sufficient return for that to be the right commercial thing to do, then I believe that businesses should be able to do so.
Q287 Chairman: You think that this is a matter for the judgment of the management board?
Mr Prestedge: I think it is for the judgment of the management board. I do however agree that, with some organisations it is right - and I believe we heard this from the regulator - moving forward, there does need to be some closer supervision to ensure that the business is operating in specific markets; that they have the right skill, they have the right competence and, particularly, they have the right risk management capability to understand and assess the risk they are taking onto their balance sheet, and to ensure that they can manage those responses it originated.
Q288 Chairman: This might be a difficult question for you to answer. What responsibility does the FSA and Government hold for the failure of DBS?
Mr Prestedge: As I was not a director of DBS, I cannot comment on the way in which business was supervised or the way in which the regulator engaged. What I would say, and I think that Mr Pain said this himself, is the regulator has learnt lessons and the way that they are supervising firms is clearly going to change over time; and, given the experience that we have all observed within the marketplace, that clearly is right.
Q289 Chairman: How can you say that the regulator has learnt lessons? The regulator told us repeatedly that warnings were given to DBS about their commercial loans; we have noticed that there is a letter there, appreciating their decisions.
Mr Prestedge: I have not seen either the correspondence from the regulator to
Q290 Lindsay Roy: From your enquiries and investigations since you have taken over DBS, do you have evidence that there was proper external validation and robust internal self‑evaluation procedures prior to 2008?
Mr Prestedge: We do not have evidence of that, simply because the parts of the organisation that we did not acquire we have not acquired, and therefore we have no information associated with that. What I would say is that, for the parts of the organisation that we did acquire, and principally the prime residential book, it is a good-quality book which is performing well and the risk assessments within that book itself would be very comparable to that of our own and one that we are very comfortable to have on our balance sheet. Beyond that, I am afraid I cannot comment.
Ms Robb: Perhaps I could add that, as part of the due diligence process, we sampled a significant number of cases manually and validated the information that we had been provided over the course of the weekend; so the evidence was there.
Q291 Chairman: A final question. In your view, what lessons can be learned by other building societies about the position DBS found itself in?
Mr Prestedge: I think that there would be three things that I would observe, and
I believe we heard this earlier from the ex-board members from
Q292 Chairman: I would like to thank the witnesses for their attendance. Before I declare the meeting closed, would you like to say anything in conclusion, perhaps on areas that we have not covered in our questions?
Mr Prestedge: Nothing at all, thank you.
Chairman: Thank you very much.