Does Northern Rock’s business model suggest further credit crunch victims?

Source: Exec Digital UK

Date :06/12/2007 10:01:17

As the highest profile victim of the American sub-prime crisis. ExecUK assesses why the vulnerability of Northern Rock’s business model provides a stark warning for other mortgage providers.

Written by Terry Carroll and John O'Hanlon

On August 9, Bloomberg announced that liquidity in the credit markets had ‘evaporated’. This in itself was unheard of, but few could have expected what happened next.

One month later, one of the most prudent lending institutions of the last 150 years, Northern Rock, almost failed. Having been worth £6 billion, it may now be sold at a nominal value after spending months hogging the headlines in both the front and financial pages. But what went wrong - and could it happen again?

In 1987, the junk bond crisis was the forerunner to Black Monday; in 2007, the accident waiting to happen was ‘subprime’ mortgages in the US. When BNP Paribas, the French investment bank, announced that they had to suspend three funds that could not be valued, the market began to unravel at an astounding pace.

However, we didn’t have a subprime crisis like the US, so no-one could have foreseen that Northern Rock would crumble. Dodgy mortgage lending wasn’t the cause and only a few years ago, ‘the Rock’ was one of the soundest financial institutions in the UK. So how could it all happen?

Throughout its 142 year history, ‘the Rock’ has had a reputation for solidity, security and passionate commitment to its Northumberland roots. The Northern Rock Foundation, a charitable trust, has an excellent reputation well beyond Newcastle.

In the event of takeover, 15 percent of the capital value would go to the Trust. This was a ‘poison pill’ to ward off predators. Ironically, this safety measure may now inhibit a rescue.

Early warnings?

Since 2006, Northern Rock had been following an aggressive commercial growth strategy. And its shareholders were enthusiastically supportive. In 2006 its assets grew by 24 percent and became the UK‘s fifth largest mortgage lender, while in the first half of 2007 they increased lending by 47 percent and grabbed 19 percent of net UK mortgage lending.

It is now said that warning signs were appearing as early as March. But by April, the City was echoing to lunch talk about Northern Rock’s ambitious strategy, which was dependent on aggressive global wholesale market financing and massive programmes of securitisation.

The share price had been reflecting underlying concerns with a steady regression against the FTSE since February and the price fell over 100p in late June. And on August the 9th and 10th, it lost almost 20 percent of its value when the global credit crunch first crystallized. This ‘fracture’ tore out 80 percent of its value in just two weeks from mid September, after the Bank of England announced its support and investors stormed ‘the Rock’.

So who was to blame? Most of us really…

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