TUESDAY 4 DECEMBER 2007

MR RICHARD SEXTON AND MR JOHN HITCHINS

  Q1300  Mr Todd: Do you think this episode has enhanced your ability to win audit business in this particular sector?

  Mr Sexton: I think our ability to win business is dictated by our ability to deliver a quality audit in whatever market.

  Q1301  Mr Todd: Therefore, you think it has done no reputational damage at all?

  Mr Sexton: I believe that the audit process as judged by reference to the specifics of Northern Rock in the annual and interim reports—our opinion on the latter was signed on 25 July—discloses very accurate information about liquidity and other structures within Northern Rock.

  Q1302  Mr Todd: Financial institutions do not have to get their audit from you; there is a competitive marketplace here. You think it has made no difference and the market believes that you have performed a technical task to the best of our ability and you are a good provider of these services in future?

  Mr Sexton: I believe that to be the case.

  Q1303  Mr Todd: Good! I am glad you are so confident. I turn to events in April when the bank chose to alter its lending pattern, at least so it told us, to reduce the level of new loan activity. Did you have any role in suggesting that it might need to do that to reduce the level of risk?

  Mr Sexton: I am not involved in the detailed delivery of audit services to Northern Rock, but to the best of my knowledge, no.

  Q1304  Mr Todd: Mr Hitchins, do you have anything useful to add to that? Were you closer to this?

  Mr Hitchins: No.

  Q1305  Mr Todd: Looking at Granite, you have said that it is a small vehicle. To what extent did you audit the function of Granite? Did you see that as a material part of your audit of Northern Rock?

  Mr Sexton: The assets and liabilities that sit within the so-called Granite structure appear on the balance sheet of the group accounts and, therefore, they were subject to audit.

  Q1306  Mr Todd: Did you examine the risk that obviously was faced in the end by Northern Rock that it would not be able to securitise through the vehicle it chose and obviously that was a material factor in the eventual collapse of the bank? Was the scenario that securitisation opportunities would effectively dry up one that you examined?

  Mr Sexton: A specific requirement of auditing standards is to consider the work that management and the board have done in connection with their ability to continue as a going concern. The primary reason for that work is to ensure that the assets and liabilities are properly valued, but as part of that work we look at all the information available.

  Q1307  Mr Todd: You have not quite answered the question. Bearing in mind that the vehicle of Granite and the securitisation of loans were absolutely critical steps in the ongoing operation of Northern Rock, did you examine a circumstance in which this would cease to be a functioning alternative?

  Mr Sexton: The audit team would have considered the availability of continuing funding based on historical trends.

  Q1308  Mr Todd: Do you imply that because it had not happened before they did not think it was a risk worth considering, because it is an historical function looking back?

  Mr Sexton: That is not what I am implying or saying. I am saying that they would have considered many, many scenarios but they would have regard to historical performance and the ability to raise funds. It was in February that we issued our report.

  Q1309  Mr Todd: When eventually the Bank of England found itself having to support this institution, not surprisingly people wanted a clear picture of the assets and liabilities of the bank. It appeared that that picture was not readily available to any of the tripartite partners. Was the preparation of an appropriate picture of the assets and liabilities of Northern Rock at that point something in which you played any role?

  Mr Sexton: For the purposes of discussion with the Bank of England in September?

  Q1310  Mr Todd: Yes.

  Mr Sexton: I do not know the answer to that question.

  Q1311  Mr Todd: Could you ask your team? I am slightly surprised that you have not had more detailed conversations with the team involved in Northern Rock before coming here, because you have qualified a number of your responses by saying that you were not directly involved and you are not too sure exactly what happened.

  Mr Sexton: I believe I have said that I oversee the audit. I have spoken to the audit team about the key elements of our reporting dates, both the annual and interim reports. I cannot answer your very specific question in relation to that matter.

  Q1312  Mr Todd: Presumably, a critical issue in valuing the assets and liabilities of Northern Rock because it is a mortgage institution is the assumption about the future housing market in the UK. Is that reasonable?

  Mr Sexton: I would imagine that to be the case.

  Q1313  Mr Todd: Therefore, what assumptions did you have in place when you gave Northern Rock advice on valuing its loan book?

  Mr Sexton: I am slightly confused. The implication of your question is that we gave them advice on valuing their loan book.

  Q1314  Mr Todd: Presumably, you tested whatever its assumptions were to see whether or not they were reasonable?

  Mr Sexton: That is correct. In February as part of the going concern review for the annual report we would have looked at its forward-looking assumptions for the purposes of the balance sheet presentation, and for the purposes of our 25 July opinion we would have updated those again basically by reference to management discussion as required by the APB guidance notes.

  Mr Hitchins: It is important to bear in mind that the mortgages are in the balance sheet of Northern Rock at cost with the amortisation of relevant fees and expenses. The work that the auditors have to do is to assess whether or not the bank has made sufficient provision for impairment of the mortgages. In that context as one element we look at what assumptions management has made as to the future trend in UK house prices. Another element is the percentage of cover—the loan to value ratio—that the mortgage has. All of those factors are looked into. It is not really a valuation, but we are responsible for auditing management's impairment allowance.

  Q1315  Mr Todd: What was your take on that at the time you conducted it? Obviously, one of the current speculations is that Northern Rock's loan book may not be quite as resilient as it might have appeared in the past because of the expectations in the UK housing market.

  Mr Hitchins: I cannot comment on the details of it because, obviously, I did not do that piece of work myself, but in principle we signed a clean opinion in February and so we would have had a look at it and satisfied ourselves.

  Q1316  Mr Todd: I have been a bit frustrated by the absence of much detailed knowledge of what PwC actually did for Northern Rock during this audit process. Can you provide us with a summary of how you worked with Northern Rock on the assumptions of impairment that they produced?

  Mr Sexton: What we will more than happily do is provide you with a commentary on the nature of the information we sought that the company had put together in January for the purpose of its review.[5]

  Q1317  Mr Todd: The other aspect I am interested in is your role of the September process in trying to sort out the valuation of Northern Rock and its assets and liabilities at that particular time when, very understandably, public authorities were wondering quite what they were getting themselves into. You said you were not too sure what happened then.

  Mr Sexton: I said I was unaware of the precise work that we might or might not have done.

  Q1318  Mr Todd: Will you also provide a note on that?

  Mr Sexton: Yes.[6]

  Q1319  Mr Love: It has been reported that the big six accountancy firms, if I may call them that, have produced a report on valuing bank holdings. The getting together of the big six is unprecedented. Why is this being done?

  Mr Sexton: It is not unprecedented. From time to time the so-called big six do get together when there is a matter of public interest. We feel that we can be helpful to the markets in general in encouraging people to think about particular issues. A short paper has been produced which reiterates largely the existing accounting standards in connection with the calculation and presentation of value-based assets. That is the paper to which you are alluding and the one to which the Financial Times article referred.

6   Ev 341 Back