Friday, September 14, 2007

Northern Rock Gets Emergency Bank of England Funding (Update5)

By Ben Livesey and Jon Menon

Sept. 14 (Bloomberg) -- Northern Rock Plc got emergency funding from the Bank of England, the biggest bailout of a British lender in 30 years, after rising credit costs left the mortgage provider unable to make loans.

Northern Rock shares plunged as much as 26 percent to a six- year low after the company said today the central bank will provide an unspecified amount of credit. The Newcastle, England- based bank, whose roots date back to 1850, is the U.K.'s third- biggest lender by gross mortgages with loans worth 17.4 billion pounds ($35 billion) as of June 30.

The rescue stoked concern among investors and depositors that other financial firms relying on short-term credit rather than deposits may be vulnerable because the rate they borrow at exceeds the amount they earn from lending. The Chancellor of the Exchequer Alistair Darling authorized the move, saying the Bank of England will step in as the lender of last resort ``where institutions face short-term liquidity difficulties.''

``This is a set of circumstances that I've not seen in 25 years,'' Chief Executive Officer Adam Applegarth said on a call with journalists. ``It's a substantial program, it is at a penalty rate. The facility will provide a solid ground base.''

The Bank of England hasn't had to bankroll a U.K. lender since the 1973 collapse of Cedar Holdings, which pioneered second mortgages, triggered a crisis of confidence that threatened to unravel the banking system.

Bank `Solvent'

The assistance will ``help Northern Rock to fund its operations during the current period of turbulence in financial markets,'' the Bank of England, U.K. Treasury and Financial Services Authority said in a joint statement. ``Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book.''

The move is the U.K. bank's biggest step to help financial markets after credit costs soared last month amid commercial banks' reluctance to lend to each other. By comparison, the European Central Bank has loaned cash to banks in seven special auctions since Aug. 9. The U.S. Federal Reserve cut its discount interest rate and abandoned its bias toward fighting inflation.

At least 16 U.S. lenders have been forced into bankruptcy since investors shunned adjustable-rate and subprime mortgages. Germany's Landesbank Sachsen Girozentrale and IKB Deutsche Industriebank AG are getting emergency bailouts after losses from asset-backed securities. Bear Stearns & Co., Goldman Sachs Group Inc. and Barclays Plc are among firms that have stepped in to prop up investment funds in the past three months.

`Severe Liquidity Squeeze'

Pretax earnings at Northern Rock will be between 500 million pounds and 540 million pounds, missing analysts' estimates of 647 million pounds, the company said today. It blamed a ``severe liquidity squeeze'' and rising short-term interest rates, saying it won't make new loans that are unprofitable in current markets.

Northern Rock suffered from ``a classic case of overtrading,'' Royal Bank of Scotland Group Plc analysts wrote today. Net lending surged 43 percent in the first eight months of the year, ``faster than the bank's balance sheet could sustain.''

``It leaves Northern Rock desperately hoping that something comes along to restore confidence,'' said Colin Morton, who helps manage 14.4 billion pounds including Northern Rock shares at Rensburg Sheppards Plc in Leeds. ``At the moment their funding costs are higher than what they get from people who are buying a house from them.''

Credit-default swaps based on Northern Rock's debt rose 22.5 basis points to 152.5 basis points, according to Deutsche Bank AG prices.

Bank Shares Tumble

Northern Rock is the U.K.'s worst-performing bank stock this year. Its shares fell 46 percent through yesterday, compared with the 12 percent drop of the nine-member FTSE All Share Banks Index. The stock fell 155 pence to 484 pence as of 12:45 p.m. in London, valuing the lender at 2 billion pounds.

Bradford & Bingley Plc, which makes one in five loans to U.K. landlords, lost 8.8 percent to 326 pence. Alliance & Leicester Plc, another U.K. commercial and consumer bank, sank 7.5 percent to 867 pence. HBOS Plc, Britain's biggest mortgage bank, fell 5.6 percent to 842.5 pence.

``The outlook for Northern Rock as an independent entity does not look good,'' said Sandy Chen, a London-based analyst at Panmure Gordon & Co., who has a ``sell'' rating on the stock.

The bank is an ``increasingly likely'' takeover target, Credit Suisse Group analysts wrote today. The decline in the stock price already made it ``attractive,'' MF Global Securities Ltd. analysts said earlier this week.

`Only Viable Alternative'

``Northern Rock will struggle to fund any new growth without the backing of a larger financial partner,'' Merrill Lynch & Co. analyst John-Paul Crutchley wrote in a note to clients today. He has a ``buy'' rating on the stock. A partnership or acquisition is ``the only viable alternative if Northern Rock is to return to writing significant new business volumes,'' he wrote.

The shares were downgraded to ``underperform'' by analysts at Cazenove and to ``hold'' by Landsbanki Islands hf.

Northern Rock was formed from a merger between two building societies and the initial public offering of Northern Rock Building Society in October 1997. The company has relied on borrowing in the money markets to control costs and grow faster than it would if it relied on its deposit base.

The ``substantial'' amount that Northern Rock can borrow is capped by the collateral it is able to provide, CEO Applegarth told reporters, without giving details of the quantity or the penalty rate that the bank will pay.

The interim dividend will be paid as planned on Oct. 26. The bank, which has 6,000 employees, this year won't replace all of the 15 percent of employees who typically leave annually, he said.

`Freeze, Thaw'

``Looking forward, I can't see when the global liquidity freeze is going to end,'' Applegarth said. ``The thaw will only come when banks make it clear what they hold on their balance sheets.''

The Bank of England yesterday relaxed restrictions on financial institutions, encouraging them to lend more to each other as it tries to reduce overnight borrowing costs that are threatening to crimp economic growth.

Yesterday's action by the U.K. central bank was its first to help credit markets since the subprime market collapsed. Governor Mervyn King has indicated the bank won't go as far as the ECB and the Fed because policy makers can't afford to ``encourage excessive risk taking.''

Commercial banks, which agree to hold a specific amount of money at the Bank of England at the end of each monthlong maintenance period, can now undershoot that target by 37.5 percent to free up cash if needed. That compares with the usual limit of 1 percent.

Hundreds of Northern Rock customers crowded into branches to pull out their savings. William Gough, queuing with about 30 people outside the Maddox Street branch in London's West End, said he was ``horrified'' to hear about the request for funding.

``I am going to take out the lot, every penny,'' said Gough, 75, from Belfast, Northern Ireland.

Last Updated: September 14, 2007 08:14 EDT

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