Wednesday, October 22, 2008

A look at Northern Rock one year in

Northern Rock was essentially the start of the credit crisis in the UK (though before they imploded the Germans had to rescue some banks, as did the Americans).

In August 2007 the credit markets froze, and Northern Rock, which funded itself through the money markets, found itself in trouble. They approached the BoE for a loan, and the bank disclosed this, causing a run on the bank as excitable TV coverage convinced savers their money was under threat. The government responded by guaranteeing the savers of Northern Rock, extending £26.9bn in loans to be repaid by 2010 at an interest rate of 6.75%, and then nationalising the bank in Feb 2008, injecting 3.5bn in capital into the organisation.

At the time, an enormous fuss was kicked up by the opposition to these sensible measures. The Telegraph scaremongered in Nov 2007 that the taxpayer would never get their money back after Alistair Darling refused to "guarantee" that the loans would be repaid (what reasonable person could give such a guarantee?) When the bank was nationalised in Feb 2008, George Osborne called Alistair Darling a "dead man walking" and said that "We will not back nationalisation. We will not help Gordon Brown take this country back to the 1970s."

Alistair Darling appointed Ron Sandler to sort the bank out. At the time the Rock had 1 million savers, 800,000 mortgages and 6000 staff. At the time of nationalisation the Rock received just 25% of it's funding through deposits. Nationalisation tasked it to get this up to 50%. Sandler made 1500 people redundant, but the Rock still employs 4500 staff and has 70 branches.

Sandler's strategy was to halve the mortgage book, and in order to incentify mortgagees to remortgage elsewhere, they have the highest standard variable mortgage on the market at 7.34%. Why so drastic? Because it was a race against time. If the property market tanked many people wouldn't be able to get remortgages elsewhere. They had to be incentivised to move quickly. They also had to cap the number of savers they could take on to 1.5% of the savings market to comply with EU rules on nationalised industries. But they are well on their way to achieving their target of 50% of funding through deposits.

So far the strategy has paid off. They've repaid £15.5bn of their loan so far, leaving them with £11.4 bn still outstanding. The scaremongering from earlier in the year that the taxpayer would lose the lot was unfounded.

Some charity groups have been accusing the Rock of harshness in their repossession strategy. They repossessed 4200 homes, compared to about 2200 the year before. But in the context of the total number of mortgages they held when this saga started, this is low.

Some Northern Rock mortgagees took out the now infamous "Together" mortgage which constituted a 95% mortgage, plus an unsecured loan, that took total lending to 125% of the purchase price. Most of the Rock's unsecured loan portfolio comes from these "Together" loans. Unsurprisingly, the mortgagees appear to have blown all the money advanced to them, and other lenders are reluctant to take them on. They represent the biggest threat to Northern Rock achieving normality. Once NR have repaid their loan to the govt, expect new mortgage rates to drop for very secure customers with low loans-to-value, as a way to attract good customers and dilute the number of risky mortgages on their books.

Still, Northern Rock is well on it's way to being mended. Once they have repaid the loan to the government, and sorted out their funding, they should be in a prime position to be floated on the market. I expect the government will wait a few years though. It's never sensible to float in a depressed stock market.

Two people come out well from this. Alistair Darling's actions in nationalising the bank and appointing Sandler to run it turn out to have been the right thing to do. Darling is going from strength to strength - no way can he be termed a "dead man walking". Ron Sandler appears to be an excellent trouble shooter. If we need troubleshooters again, his name will surely be on the top of the list.


Anonymous said...

No more boom or bust.

snowflake5 said...

I see the Conbots have turned up on the blog!

Anonymous said...

What a lot of rubbish. NR is being asset stripped and we will end up with the worthless dross at the end of this debacle.

snowflake5 said...

anonymous - nonsense. NR is being stabalised with increased funding from depositors, more prudent lending practices and is repaying it's loan to the government. That's a result.

Oh - and for the first anonymous person, I was tickled to find that Ken Clarke has proudly announced that he said "no more boom and bust" first!

Anonymous said...

The problem is that those mortgages that have left NRK's books (due to their eyewatering interest rates) are the one's who CAN move.

What's left are unwanted by any other lender which doesn't say much for their quality !

Anonymous said...

From today's Tele...

The Government will have to pump more capital into Northern Rock and Bradford & Bingley to reflect worsening conditions in the housing market, senior bankers believe.

By Katherine Griffiths and Philip Aldrick
Last Updated: 5:58AM GMT 03 Nov 2008

In August, the Government converted £3bn of its loan to Northern Rock into equity to bolster its core tier 1 capital ratio, which had slipped to the dangerously low level of 2.9pc.

The Government may have to inject "£2bn pounds to £3bn more," into Northern Rock, a source close to the Government has told The Daily Telegraph.

A new capital injection into B&B would be more modest because the business is smaller, but the buy-to-let specialist could still require a significant sum to offset rising bad debts.

The spotlight will be on B&B and Northern Rock over the next few weeks as Royal Bank of Scotland, Lloyds TSB and HBOS push forward with massive fundraisings , imposed on them by the Government in a bid to bolster the financial strength of the banking sector.

There is a view that the Government will have to apply the same standards particularly to Northern Rock, as it is still a deposit taking institution as well as a mortgage lender, and therefore needs to maintain customers' confidence.

The Treasury and Bank of England devised an "eight six four" rule which was the basis for forcing RBS, HBOS and Lloyds to raise £37bn between them, sources said. Barclays was also told it had to raise capital and on Friday unveiled a £7bn fundraising from strategic investors.

The major banks were told to raise capital so that they have 8pc core tier 1 ratios after the fund raising and in a very stressed situation still have 4pc. That would leave them with about 6pc after the spike in bad debts which is expected as the economy weakens.

"If the Government has applied that stress test to the big banks why has it not to Northern Rock and to B&B? It is going to need to put more money into those two and from a regulatory point of view, it needs to do it by the end of the year," a banker said.

B&B raised £400m in the summer in new capital after a string of failed attempts. The capital raising did not restore confidence in the business and the Government nationalised the bank's mortgage book in September and sold its deposits to Spain's Santander.

Analysts believe B&B's bad debts will spike up at a faster rate than other banks because the vast majority of its business is areas where defaults tend to be highest, including by-to-let and "self certification loans", where the customer does not have to provide proof of income.

Bad debts are also accelerating at Northern Rock because the bank is trying to shrink its balance sheet so that it can repay the billions loaned to it by the Government.

To reduce its size, as customers' mortgages come up for renewal, Northern Rock is encouraging customers to go elsewhere by only offering unfavourable deals.

This has meant that good customers are leaving, but those with poor credit histories who find it difficult to get a good deal elsewhere are remaining, leaving Northern Rock with a concentration of customers who are more likely to default on loans.

The impact of this "adverse selection" may mean Northern Rock needs more capital, said Alex Potter, an analyst at Collins Stewart.

A key issue will be how Northern Rock and B&B handle customers who are defaulting on loans. If there is an active repossession policy, banks will have to dramatically increase the capital they hold on their balance sheets as repossessed properties are often sold at a loss.

This is on top of a need under Basle II accounting rules to top up capital to support even loans which are being repaid but which, because of the worsening environment, are seen as more risky.

snowflake5 said...

big jock knew - not sure you should be copying and pasting entire articles from newspapers, for copyright reasons. In future place a link, and quote only an excerpt.

Regarding Northern Rock - the Telegraph is incorrect in believing that NR is one of the big eight that have been told to raise Tier 1 capital. NR is simply not big enough. Also, while it is shrinking it's mortgage book, it's saving book is increasing, as people seek the safety of a nationalised bank to place their money. NR is well on it's way to 50% funding from savers, and if it can increase this, it gets safer.

P.S. Telegraph's record is very poor on NR predictions. As pointed out in the main article, in Nov 2007 they were claiming that the govt would lose the entire loan it made to NR. As NR has repaid half the loan already, we can see the Telegraph was talking utter rubbish.

Anonymous said...

They also had to cap the number of savers they could take on to 1.5% of the savings market to comply with EU rules on nationalised industries.

Can someone explain to me how Nationalisation was such a good idea if it meant capping the number of savers? I understood that savers bring security to a bank, whereas borrowers bring risk.. but I'm not an economist or Chancellor of the Exchequer or anything so what do I know.

Once NR have repaid their loan to the govt, expect new mortgage rates to drop for very secure customers with low loans-to-value, as a way to attract good customers and dilute the number of risky mortgages on their books.

Does Northern Wreck even have any 'secure' customers left? It sold off it's best assets to JP Morgan and was left with the worst of it's portfolio.

What about it's liability to Granite? The off-shore tax-haven masquerading as a charity which owns half of the mortgages sold by Northern Wreck.

All this was allowed to go on under Chancellor Gordon Brown, and now Prime Minister, sorry, Dear Leader Gordon Brown.

How about bailing out some of us with student loans, rising fuel costs, bank charges or even those who rent, save sensibly and don't borrow stupid amounts of money, who now have no protection from Buy-2-Let landlords defaulting/repossession?

Anonymous said...

Snowflake, whats your opinion of the massive levels of private debt, public debt and massive PFI commitments incurrred under this Government? [Anonymous2]

Anonymous said...

We haven't even started to see the problems really unfold yet house prices heading for -30% to -40%, sterling heading to its knees, recession already underway, job losses increasing daily, no manufacturing base to trade our way out of it, once these things start to bite and the dross that is on NR's books starts defaulting then we shall see the nulabour miracle economy for what it is (borrowed from the future) and I have been a staunch labour man all my life, fought tooth and nail to get them in (how wrong I was) they should have been called the nu-conservatives. This muppet Brown will be exposed for what he is... a fake controlled by rich bankers

snowflake5 said...

Alex Fear - without nationalisation, NR would have collapsed. End of story. The idea that it could survive with the credit markets frozen and only 25% of it's funding from depositors is fantasy thinking that only Tories would be daft enough to indulge in.

However nationalisation brings restraints (so that there isn't unfair competition.) NR has to get it's funding from depositors up to 50%, and they are attracting savers within the rules. But the only way to achieve a full 50% funding from savers (or a higher percentage), is to shrink the mortgage book.

The alternative is the government continuing to supply 75% of the funding ad infinitum - not desirable.

The idea behind nationalisation was to fix the bank and then to float it - that can only happen if NR is able to function without government funding, which in turn can only happen if they are a smaller bank. NR overexpanded badly - not sure why people want that over expansion to continue. Not sure why all the Tories responding to this thread are so furious that the govt loan is being repaid and NR being weaned off public funds. Not sure why the Tories are so upset that NR is being restored to a bank that depends on savers for funding rather than money markets or the state.