Yours!

September 14, 2007 12:30 PM


Congratulations! If you're a taxpayer you're now effectively the proud owner of Northern Rock's mortgage book.

Northern Rock has been a crisis waiting to break. They have been just about the most aggressive mortgage lender: they have been lending at very high income multiples, and they have been prepared to top up their mortgage loans with further unsecured lending. Just in the first 8 months of this year, despite the toppiness of the housing market, their net mortgage lending increased by 55%, driven by their low rate mortgage deals (see their emergency statement here).

To fund this lending, they have been very heavily dependent on the wholesale money markets. Whereas the Halifax gets more than half its funding from retail deposits (ie personal savers), NR only gets about one-quarter. The rest has to come from the markets, the same markets that have now refused to lend.

So we lucky taxpayers have had to step in.

Darling has emerged from his hole to assure us there's no need to worry. Well, for depositors at NR, that's certainly true- they're now guaranteed by us taxpayers (declaration of interest- the author has a small residual deposit with NR).

But we taxpayers should be anything but calm.

What if the collateral against which we're now lending to NR turns out to be worth less than NR claim? How confident can we be about the value of those highly geared mortgages in an environment of rising rates and (probably) falling house prices? What about their £15.4bn of other assets, including exposure to CDOs, SIVs, and SIV-lites (see this blog)- how secure are they? The answer is nobody knows- which is precisely why the money markets no longer want to lend to them.

Of course, there's no way NR can now maintain its independence. Other banks have been looking at it for some time, but reckoned it was overpriced. Now that the shares have plumetted (down 20% today, and 60% from their peak earlier this year), a buyer may be more interested. Analysts at Credit Suisse comment:

“We assume Northern Rock will cease writing new business. The lack of new business flow and a penalty cost of funding will have a detrimental impact upon Northern Rock’s earnings ... Northern Rock is unlikely to remain independent but the value of the company to an acquirer may be significantly below the current share price.”

No doubt "the authorities" are right now frantically trying to strongarm someone into taking them over. And no doubt the possible buyers are saying they will need some form of government guarantee on that dodgy loan book. And maybe the authorities will offer some form of... what shall we say... douceur.

But there's one thing we must be absolutely insistent on.

Before taxpayers are required to shell out a bean, the NR shareholders must lose everything. As we argued here, they've had the upside, and now they must pay the price.

Congratulations! If you're a taxpayer you're now effectively the proud owner of Northern Rock's mortgage book.

Northern Rock has been a crisis waiting to break. They have been just about the most aggressive mortgage lender: they have been lending at very high income multiples, and they have been prepared to top up their mortgage loans with further unsecured lending. Just in the first 8 months of this year, despite the toppiness of the housing market, their net mortgage lending increased by 55%, driven by their low rate mortgage deals (see their emergency statement here).

To fund this lending, they have been very heavily dependent on the wholesale money markets. Whereas the Halifax gets more than half its funding from retail deposits (ie personal savers), NR only gets about one-quarter. The rest has to come from the markets, the same markets that have now refused to lend.

So we lucky taxpayers have had to step in.

Darling has emerged from his hole to assure us there's no need to worry. Well, for depositors at NR, that's certainly true- they're now guaranteed by us taxpayers (declaration of interest- the author has a small residual deposit with NR).

But we taxpayers should be anything but calm.

What if the collateral against which we're now lending to NR turns out to be worth less than NR claim? How confident can we be about the value of those highly geared mortgages in an environment of rising rates and (probably) falling house prices? What about their £15.4bn of other assets, including exposure to CDOs, SIVs, and SIV-lites (see this blog)- how secure are they? The answer is nobody knows- which is precisely why the money markets no longer want to lend to them.

Of course, there's no way NR can now maintain its independence. Other banks have been looking at it for some time, but reckoned it was overpriced. Now that the shares have plumetted (down 20% today, and 60% from their peak earlier this year), a buyer may be more interested. Analysts at Credit Suisse comment:

“We assume Northern Rock will cease writing new business. The lack of new business flow and a penalty cost of funding will have a detrimental impact upon Northern Rock’s earnings ... Northern Rock is unlikely to remain independent but the value of the company to an acquirer may be significantly below the current share price.”

No doubt "the authorities" are right now frantically trying to strongarm someone into taking them over. And no doubt the possible buyers are saying they will need some form of government guarantee on that dodgy loan book. And maybe the authorities will offer some form of... what shall we say... douceur.

But there's one thing we must be absolutely insistent on.

Before taxpayers are required to shell out a bean, the NR shareholders must lose everything. As we argued here, they've had the upside, and now they must pay the price.

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