Ex-Northern Rock boss fined for misrepresenting arrears data

Northern Rock’s former deputy chief executive was handed a record fine and banned for life today as the City regulator lifted the lid on staff manipulation of mortgage arrears figures at the lender.

David Baker was fined £504,000 (€571,000) by the UK's Financial Services Authority (FSA) and banned from working in any regulated activity after the watchdog found that he misled shareholders and analysts by quoting inaccurate data.

The fine is believed to be the highest ever for this type of offence and one of the largest handed to an individual.

The FSA also handed a £140,000 (€157,000) fine to Northern Rock’s former managing credit director Richard Barclay and banned him for failing to ensure the accuracy of the figures.

Newcastle-based Northern Rock collapsed into public ownership in early 2008 after it was forced to seek emergency funding from the Bank of England and suffered the first run on a UK bank for 150 years.

In its reports, the FSA said staff at the lender’s debt management unit (DMU) felt “under pressure to maintain the firm’s reported arrears and property possession figures” at half of the Council of Mortgage Lender (CML) average.

To do this the unit developed a practice of removing those loans that were subject to a possession order, but had not yet been repossessed, from both the arrears data and the possession numbers.

Another tactic to doctor the number of impaired loans “led to the mortgage arrears being misreported to be significantly less than they should have been”.

In January 2007, Mr Baker discovered that 1,917 loans had dropped out of the figures because of the possession order manipulation, but did not tell the firm’s chief executive, Adam Applegarth, or correct the numbers reported in the firm’s annual report.

At the time the company boasted that its rate of mortgage loans more than three months in arrears was 0.42%, under half the industry average.

However, the FSA found that had the omitted loans been added to these figures, it would have increased them by around 50%, to a rate of 0.68%

Had they been reported as possessions, those numbers would have risen from 662 to 2,579.

Mr Baker, who earned £900,000 in pay and bonuses in 2006, did not know about the other misrepresentation of arrears figures, which also emerged out of the FSA investigation.

This involved a mechanism at Northern Rock that allowed the bank to “rehabilitate previously poorly performing customer loans” by “capitalising” them – or adding the missed mortgage payments on to the loan total and letting the customer repay it over the term of the agreement.

Normally this would only be done under certain criteria, for example when accounts were one or two months in arrears and then a payment was made and direct debits set up.

But the FSA found DMU staff manually capitalised loans outside of the rules to “improperly reduce the number of reported arrears”.

An average of 6,870 manual capitalisation were made every month during the period under investigation, from January 2004 to March 2008.

The regulator said that while it was not possible to ascertain what percentage of the manual capitalisations were outside of the bank’s policy, “the evidence suggests that the proportions were significant”.

It said that had the correct figures been used they would have been “significantly worse” and closer to the CML average over an extended period of time.

Mr Barclay was managing credit director of the DMU and directly responsible for providing accurate information about loan arrears and property possessions.

The FSA said he knew the firm’s arrears position was an important tool for the lender’s senior management, analysts and the FSA to form a view of its asset quality, but did not ensure the figures reported were accurate “despite warning signs at an early stage”.

Mr Baker, who worked at Northern Rock for 34 years, was deputy chief executive between January 2004 and March 2008.

Today’s FSA report said that while he did not tell the chief executive or the board about the possession order loans he did seek advice “from a senior and suitably qualified colleague”.

The 56-year-old today said he took the decision “on compassionate grounds” to allow the DMU department to rectify the error over a six month period because Mr Barclay had suffered serious health problems.

Mr Baker, who is now entitled to draw an annual pension in the region of £300,000 (€340,000) a year, said his decision and its timing was “made with the best of intentions” and insisted the move was intended to “resolve and not hide” the error.

“I made an error of judgement and I regret it,” he said.

He added that financial provisions for the impaired loans had been made in the 2006 accounts.

“The decision I took also had no adverse impact on Northern Rock’s customers. It did not cause, or precipitate, the bank’s later liquidity difficulties.”

By the end of 2006 Northern Rock had grown to become the fifth largest UK mortgage lender with 8.3% of the residential lending market.

“Important to the firm’s rapid growth was the maintenance of its asset quality,” the FSA said. “The value of Northern Rock’s securities was in part derived from a market perception of how its loan book was performing.”

It added that the provision of accurate information concerning the number of loans in arrears or possession was “an important indicator in assessing the firm’s asset quality”.

In August 2007 Northern Rock’s house of cards came tumbling down in the credit crunch when the money markets that had fuelled its aggressive growth froze over.

Mr Baker left the firm in May 2008, after it had fallen into public hands, and the company informed the FSA of the misreporting the following month.

Margaret Cole, FSA director of enforcement and financial crime, said: “Baker and Barclay both failed to meet the standards we require of senior individuals within FSA-regulated firms.

“They both held senior positions of trust within the firm but they provided inaccurate information to the Northern Rock board and to the market.”

Both men admitted the misconduct and were given a 30% discount for early settlement.

Mr Baker would have been fined £720,000 (€815,000) without the discount, while Mr Barclay, whose fine was further reduced on the grounds of hardship, would have paid £300,000 (€340,000).

Northern Rock said today that it had fully co-operated with the investigation and would not face any sanction.

“As objectives of the business plan for temporary public ownership, the company’s leadership team and risk control environment have now been significantly strengthened,” it added.