Northern Rock Bail-Out

Financial Times (UK) 14sep2007

[Several more articles below]

“Share buybacks are off the agenda” replied Adam Applegarth, Northern Rock’s chief executive, to an analyst’s inquiry on Friday. No kidding. The UK’s fifth biggest mortgage lender had just announced a profits warning and the previous evening had gone cap in hand to the Bank of England – unable to refinance its maturing liabilities in the money markets. The share price fell 31.5 per cent on Friday. The chances of Northern Rock remaining independent are slim.

Should the end come, the rise and fall of Northern Rock will become a case study in failed alternative banking models. Compared with the UK banking average of 7 per cent, Northern Rock used wholesale market securitisation for 43 per cent of its funding. Eschewing customer deposits kept down costs – the bank has just 72 branches – and facilitated a rapid expansion of the loan book. But this over-reliance on one form of funding now looks foolish, irrespective of exceptional credit market conditions.

New lending activity will plummet. But potential buyers of the bank – Lloyds TSB for instance – will be more interested in determining whether Northern Rock is solvent. Already, its current market capitalisation barely exceeds core tier one capital. And at the end of June, total interest and similar income divided by outstanding loans suggested a return on assets of about 6 per cent. Given that is below current funding rates, the sustainability of the business is questionable.

The bailing out of Countrywide in the US by Bank of America shows that these vulnerabilities are global. In the UK, Bradford & Bingley uses the wholesale markets for just less than a fifth of its funding, but the sector is well capitalised. Continental Europe is more conservative, with higher deposit-to-loan ratios than the UK. More at risk may be some hedge funds and investment bank vehicles that look scarily similar to Northern Rock. Worse, they are geared.

source: 15sep2007

Dilemma Confronts Ex-Banking Trailblazer

CHRIS HUGHES / Financial Times (UK) 15seo2007

Northern Rock still had some stock market value on Friday – £1.8bn – but the lender’s franchise and business model have been severely damaged. And that limits the options facing this former trailblazer of the banking world.

Its only reliable source of funding – customer deposits – is walking out of the door of branches from Gallowgate to Moorgate. The bank’s use of emergency funding from the Bank of England has evidently weakened the value of the Northern Rock brand name.

Meanwhile, the capital markets remain closed to business.

Thanks to the Bank’s intervention, Northern Rock should be able to meet debts to institutional lenders that fall due in the coming months. But its ability to continue new lending is in doubt.

Adam Applegarth, the chief executive, is confident the business has a future, saying his request for Bank funding was granted on the basis that Northern Rock has a “sound business plan”.

“The media coverage makes it look as if the Bank has pulled up a dumper truck and dumped cash in,” he said, stressing that he approached the Bank and not vice versa. “In time, with good customer service, customers who leave us will come back.”

He anticipates that one day Northern Rock will be able to tap the capital markets again, and will be capable of being a competitive element in the mortgage market. “We would expect Northern Rock to be a lower growth business with higher margins,” he said.

But as things stand this weekend, that seems a long way off. And assuming there is no dramatic and immediate thawing in the capital markets, that leaves Northern Rock facing only two options.

First, it can shut doors to new customers and let the business go into “run-off”. As existing customers paid off their mortgages, so the company would pay off its debts to the Bank in an orderly way. Second, it can try to find a buyer. Neither is an attractive way forward.

Going into run-off would see the mighty Rock quietly wither away. And a sale to a stronger parent – the option likely to be favoured by the regulator – looks hard to pull off, say investment bankers.

People familiar with the Northern Rock situation say buyers have been sniffing around in recent weeks. But no one was willing to put an acceptable price on the table.

HSBC is large enough to gobble up the company. However, it is coming under fire for not devoting more energy to its Asian roots. Lloyds TSB might be interested, although it already has a standalone mortgage business in the form of Cheltenham & Gloucester.

Overseas, Citi looks like a contender. Indeed, the US bank bought Egg earlier this year.

But the strategic benefits of buying Rock are probably not large enough to impel a conventional lender to move.

Bankers say alternative buyers may be found among Wall Street investment banks such as Lehman Brothers and Morgan Stanley, or private equity and hedge fund firms such as Cerberus and Fortress. Yet with Northern Rock so weakened, and its share price and market value continuing to fall, it is hard to see why even these buyers – traditionally fond of taking a risk – would want to move in a hurry.

Home-grown chief with youthful air Adam Applegarth, Northern Rock’s chief executive, has, like many of its senior people, moved up by promotion through the company ranks. He is also – again typically of the Rock – a product of the company’s home region, to which he has retained a strong allegiance.

He became chief executive in 2001 while still in his late thirties, having joined Northern Rock in 1983 as a graduate. Born in Sunderland in August 1962, he studied pure maths and economics at Durham University. He lives with his family in Tyneside.

Mr Applegarth, now 45, has an energetic and youthful air, doubtless helped by his passion for sport. He is particularly fond of cricket, which he plays to a high level, and rugby. Regarded within Northern Rock as dynamic and astute, he is intimately involved with the company’s operations, tending to leave the job of appearing on platforms within the region to foster Northern Rock’s public role to other directors, including the chairman Matt Ridley.

source: 15sep2007

Hedge Funds Cash In After ‘Shorting’

JAMES MACKINTOSH / Financial Times 15sep2007

Hedge funds made big profits from the collapsing share price of Northern Rock on Friday after aggressively “shorting” the stock for more than a month.

The mortgage lender’s shares had been the most heavily shorted in the blue-chip FTSE 100 index, as hedge funds borrowed the bank’s shares to sell in the hope of profiting from a price fall. “Short-sellers” attempt to make money by borrowing shares and selling them, profiting from them when the price goes down.

On Friday the shares fell 31.5 per cent after the Bank of England bailed out the lender, leaving them trading at 438p, just over a third of their £12.58 February peak.

One London hedge fund manager who has been shorting the stock said: “There are a lot of people in our community who are short and I guess they feel even more validated now and think it could fall further.” He said the big risk to those hoping for further price falls was that another bank would step in to buy Northern Rock. But he believed such a move was unlikely until the “storm” had settled down.

source: 15sep2007

Drama Ends After Weeks of Upheaval

PETER THAL LARSEN & CHRIS GILES / Financial Times (UK) 14sep2007

For Northern Rock, the drama that ended early on Friday, when the Bank of England dotted the ‘i’s and crossed the ‘t’s on an emergency cash injection, began more than a month earlier.

The Newcastle-based lender’s world changed for ever on August 9, the day when a crisis of confidence hit the money markets, causing liquidity to dry up in the banking system. It was also the day that Northern Rock’s executives realised their 10-year run in the capital markets was over. For a month, they tried to weather the storm. But a week ago, the bank’s directors accepted the inevitable and formally asked the Bank of England for an emergency line of credit. With that, the first bail-out of a British bank for 15 years was under way.

The bank, one of the UK’s biggest mortgage lenders, slowed its new lending and encouraged redemptions in order to hoard cash. Executives hoped the end of the summer holidays would ease the paralysis in the markets. But by the start of September it was becoming clear that conditions were not going to become any easier.

Northern Rock, which has been a pioneer among European banks in using the world’s capital markets to fund its business, found that all its traditional sources of funding – the investors who had queued up to buy commercial paper, mortgage-backed securities and bonds backed by Northern Rock mortgages – had dried up.

By early September, it was relying almost entirely on overnight money markets to finance its commitments.

“I can’t see any time when it has happened before – every single market froze,” Adam Applegarth, Northern Rock’s chief executive, said on Friday. “It’s an astonishing thing to see the sterling three-month interbank market effectively not exist.”

Even before the crisis, all was not well. Northern Rock had issued a profits warning at the end of June, suggesting that the increase in short-term interest rates was undermining its growth. But as the crisis deepened, Northern Rock’s share price went into free-fall, fuelled by a wave of short selling by hedge funds. Throughout August, the bank was in touch with its supervisors at the Financial Services Authority. Executives at the Bank of England were also kept informed. As the share price plunged, speculation mounted that a bank with a larger balance sheet and access to more retail deposits would step in and buy Northern Rock.

Encouraged by regulators, several institutions, including Lloyds TSB, are said to have looked at its books. But the banking liquidity crisis and uncertainty about Northern Rock’s true value made a deal hard to agree.

By the start of this week the authorities knew the game was up. It was a question of when not whether Northern Rock would formally seek emergency funding from the Bank. Meanwhile, its governor, Mervyn King, had been drafting a letter to the Treasury select committee, explaining his thinking on the credit squeeze. Minutes before it was due to be released, the document was held back. When it was published the next day, a paragraph had been inserted, stressing the Bank’s role as lender of last resort. Mr King wanted to ensure the Bank did not appear to have been blindsided by Northern Rock’s appeal for a lifeline.

The lender made its formal request for funds on Thursday, and discussions intensified through the day between the Bank, the FSA and the Treasury. In the afternoon, the FSA judged the lender solvent, and the Bank – concerned about confidence in the system – argued that if Northern Rock failed, a widespread bank run would loom.

With this advice, Alistair Darling, the chancellor, took the decision on Thursday evening to authorise a lending facility. Since the Bank was in effect taking mortgages on to its books – a risky move for the public purse – it needed the agreement of its Court of Directors, which called an emergency meeting to thrash out terms, ending late at night.

By now, the rescue was public knowledge, but the legal documents were finalised only at 3am.

Now, the pressure to find a buyer is likely to increase, especially as savers have exacerbated the crisis by seeking to withdraw their cash. “It’s got to be sold quickly,” one investment banker said on Friday. “Otherwise it’s mayhem.”

source: 15sep2007

Takeover is Now the Only Way to Prop Up the Rock

ANDREW HILL / Financial Times (UK) 14sep2007

Would the people queuing on Friday to withdraw their savings or switch their mortgage from Northern Rock be happiest with a) a four-paragraph statement of reassurance from the chancellor of the Exchequer, the Bank of England and the Financial Services Authority; b) a sign over the bank that says Lloyds TSB, HSBC or Halifax; or c) both of the above?

The obvious answer is c). On its own, the tripartite statement seems insufficient to quell retail customers’ concern, even if – as Northern Rock’s chief executive implied on Friday – the central bank’s provision of short-term credit makes his group as safe as, well, the Bank of England.

Northern Rock might be solvent, according to the FSA’s official judgment, but its model and – perhaps more important – its reputation are irreparably damaged with customers and investors. Only a takeover will put this right. That is more true now than it was even two days ago, before the Bank’s intervention, when Lombard outlined why the Rock needed a wealthy patron. Having grabbed the Bank of England lifeline, Northern Rock now seems as likely to stay independent as a man who has nearly drowned is likely to linger in the pool for another couple of lengths of breaststroke.

The tripartite procedure for support operations clears the way for the FSA to “facilitate a market solution”, in the words of the same memorandum that justified the Bank of England’s intervention. “An introduction of new capital into a troubled firm by one or more third parties” is one of the explicit examples of the sort of operation the regulator can encourage.

There may not be much need for active facilitation. Pricing Northern Rock is the main challenge, but a takeover is certainly not getting any dearer. The group had a market capitalisation at Friday’s close of only £1.83bn – about £3.4bn less than in February. It is, in effect, a cut-price asset with a tripartite kitemark of solvency, sufficient regulatory capital and a “good quality loan book”. Only a bid from HBOS, owner of Halifax, would risk triggering a competition inquiry. Lloyds TSB, in search of growth, and HSBC, in search of UK market share, would probably be untrammelled by regulatory concerns. (If the latter decided to bid, it could even be construed as a neat riposte to Eric Knight, the Monaco-based activist who is complaining about lack of strategic direction at HSBC and a migration away from Asia to Europe and North America).

But speed looks essential. Northern Rock’s market share of savings and mortgages will slide with each passing day of blog-borne misinformation and mistrust. Given that a bigger bank could immediately refinance the mortgage book at a profit, how much due diligence would a suitor really have to do?

They don’t like it up ‘em

Alistair Darling made an ill-judged call this week for a return to “old-fashioned banking”. Instead, he ended up with an old-fashioned banking crisis, dealt with, to a degree, through old-fashioned methods. Sometimes, it seemed as though it was being handled according to the Lance-Corporal Jones Manual of Crisis Management Communications.

It would be churlish to castigate Northern Rock for not warning about its funding squeeze earlier. You can argue about whether the lender’s situation constituted “exceptional circumstances”. But once the authorities had put it in that category, they rightly applied exceptional rules. By any standards, a problem that necessitates recourse to the Bank of England must be “material”, but that problem had been evident – and widely commented on – since early August. There was no need to exacerbate the problems with a public declaration until the authorities were ready to deal with any systemic consequences.

Part of the problem on Friday was explaining the situation to a wider audience. Northern Rock’s flawed business model is not especially complicated. But to the outside world, it sounds like alchemy. Also, while talk of liquidity and cash flow problems may calm interbank markets, they are also the jokey euphemisms of skint youngsters out on the town: hardly reassuring to the general population in other words.

The British Bankers’ Association issued a priceless “don’t panic” plea on Friday afternoon, urging everyone to “refrain from making simplistic comments in a very complex area which just cause unnecessary worry and concern”.

Some hope. Angela Knight, the BBA’s chief executive, was at least out there from dawn on Friday, actively and openly trying to explain the situation.

It is harder to defend the absence from the airwaves on Friday of Bank of England and Financial Services Authority officials. Granted, Mr Darling was omnipresent (although given government’s reputation for mishandling past financial scandals, that does not cut as much ice with the general public as perhaps the chancellor’s handlers believe). It is also true that regulators run the risk of having to answer direct questions either with simplistic answers, which could mislead, or with regulation-speak, which could sound evasive.

Yet if the Bank of England and FSA represent the elite of world financial regulation and supervision, we should surely expect them to put their crack troops into the field in times of crisis.

source: 15sep2007