Global credit crunch reaches new dimension
By Eric Pfanner
Copyright by The International Herald Tribune
Published: September 14, 2007
LONDON: A bailout of a big British mortgage bank caused shudders among account-holders and investors alike Friday, opening a new phase in the global financial turmoil that emanated from a shakeout in the U.S. home lending business, analysts said.
Depositors flocked to withdraw money after the bank, Northern Rock, unable to raise funds from its usual sources - capital markets - because of the global credit crunch, turned to the Bank of England for an emergency loan. Northern Rock shares plunged more than 30 percent, prompting a broader sell-off in European stock markets.
While other European banks have gotten burned by investments tied to shaky U.S. mortgages, known as subprime, Northern Rock said it had only a small subprime exposure in its portfolio. Instead, the bank ran into trouble because the credit squeeze undermined its business model. Northern Rock relies heavily on raising money in the capital markets, rather than consumer deposits, to finance its mortgage lending.
"The problems are potentially much wider now," said Jonathan Loynes, an economist at Capital Economics, a consultancy in London. "This means we have to worry about a wider range of institutions that aren't directly involved in this credit crisis but are in a way innocent bystanders."
The British government said it had authorized the Bank of England to provide a "liquidity support facility" of unspecified size to Northern Rock, based in Newcastle, England, which has expanded aggressively in recent years.
The news prompted a sell-off in the shares British banks as investors worried about the possibility of similar problems at other institutions - as well as threats to the broader economy. The FTSE 100 index was down more than 2 percent at midday but recovered to close down 1.17 percent. Shares elsewhere in Europe fell less sharply.
"I don't think the worst is behind us," Jean-Claude Juncker, who chaired a meeting of European finance ministers and central bankers Friday, said during a news conference in Porto, Portugal, Reuters reported.
The U.S. Federal Reserve and the European Central Bank have been under pressure to keep key interest rates low or even cut them as the market turmoil threatens to choke economic growth. The Bank of England has raised its rates several times in recent months to try to cool a frothy housing market, which while driving economic growth has also raised fears of a bubble.
The emergency loan to Northern Rock came only two days after Mervyn King, the governor of the Bank of England, warned that moves by other central banks, like the Fed and ECB, to pump extra cash into the financial system in recent weeks could encourage "excessive risk-taking" by rewarding bad behavior.
On Friday, the Bank of England emphasized that Northern Rock would have to pay a premium to market interest rates for its emergency credit line, offered under the central bank's role as "lender of last resort."
"Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book," the Bank of England, the Financial Services Authority and the Treasury said in a joint statement.
But those words failed to soothe some Northern Rock customers. Account-holders rushed to branches throughout Britain, many of them reportedly withdrawing large amounts of money.
Outside a Northern Rock branch in central London, Constance Hackford, a manager at an interior design firm, weighed joining a line of about two dozen people.
"I can't imagine the Bank of England is going to let it fail - can they?" she said. "I've got rather a lot of money in there. Maybe I should spread my bets a bit."
A spokesman for Northern Rock said Friday afternoon that the bank did not have any estimates yet of the amount that had been withdrawn.
Because Northern Rock - and, perhaps, other British mortgage lenders - will now have to pay more to raise money for loans, they will have to pass along higher interest rates to consumers, analysts say. That will cause a slowdown in lending, they added, which could act as a drag on the housing market in Britain, which has soared over the last decade.
"Costs for first-time borrowers, already stretched in the affordability stakes, will rise substantially," said Paul Mortimer-Lee, an economist at BNP Paribas. "First-time buyer activity seems pretty certain to show a sharp fall, which, since the whole market rests on the shoulders of the first-time buyer, is like throwing a spanner in the works of the whole market."
There have been some signs of a slowdown lately. A survey released this week by the Royal Institute of Chartered Surveyors, a real estate group, showed that prices in August fell in more areas of Britain than they rose. And several British banks have already increased raised their lending rates in recent days.
Adam Applegarth, chief executive of Northern Rock, said the bank would cut back on issuing new loans, as well as cut costs through a hiring freeze and other steps. But the bank on Friday also downgraded its profit outlook for this year and next year.
"I don't expect us to move back to the volume of lending we were doing before," Applegarth said. "I think those volume days are in the past."
He said the bank, whose level of residential lending in the first eight months of the year was 55 percent higher than a year earlier, had been more aggressive than some of its rivals in using "wholesale funding" rather than deposits to back its loans.
Analysts said the bank's business model was based on issuing large numbers of loans, with thin margins between the rates it charged mortgage-holders and those that it paid for its funding. Northern Rock converted from a "building society," or member-owned lender, to a publicly traded bank a decade ago.
"With hindsight, if we had seen this coming, would we have run the same strategy? No," Applegarth said. "But hindsight is a great thing, and I don't think anybody else saw this coming either."
Northern Rock said it had only £75 million, or $150 million, in direct exposure to the U.S. subprime market, with £200 million in exposure to U.S. collateralized debt obligations, some of which was indirectly exposed to the subprime market. But together, that represents less than one-quarter of one-percent of the bank's total assets, it said.
That distinguishes Northern Rock from other European banks, like BNP Paribas in France and IKB Deutsche Industriebank in Germany, which were hurt by large direct exposure to the U.S. subprime market.
But with banks increasingly reluctant to issue anything other than short-term credit, Northern Rock faced the possibility of being unable to meet existing obligations.
Northern Rock approached the central bank, Applegarth said, because of the "astonishing" conditions in the markets that it had used to raise financing, and because "we could see no end to this in the short term."
Some analysts said Northern Rock could now become a takeover target.
Others said the bank could emerge intact from the current turmoil, assuming the credit crunch eases.
While repossessions of homes have been rising in Britain over the last year, Northern Rock has a generally sound portfolio, they said. Less than one-half of 1 percent of the bank's mortgage loans are more than three months in arrears, Northern Rock said. That is less than half the British industry average.
"We think there is a strong bank here, but with a vulnerability, which is its sources of funding," said Matthew Taylor, an analyst at Fitch Ratings, which downgraded some of the bank's credit ratings Friday.
At the EU finance ministers' meeting in Portugal, officials said the fallout of the recent market turbulence would be limited for the real economy.
"We're all aware the risks of lower growth have increased," European Economic and Monetary Affairs Commissioner Joaquin Almunia said, according to Reuters.
But he, Juncker and the ECB president, Jean-Claude Trichet, all stuck to forecasts of only marginally lower growth this year than the 2.7 percent rise in gross domestic product seen in 2006,
Scramble to quit UK mortgage lender
By Peter Thal Larsen in London
Copyright The Financial Times Limited 2007
Published: September 14 2007 20:40 | Last updated: September 14 2007 20:40
The turmoil in global banking hit the streets of Britain on Friday as thousands of Northern Rock customers queued up to withdraw their savings from the UK mortgage lender after it was rescued by the Bank of England.
As regulators and politicians called for calm, Northern Rock – Britain’s fifth-biggest mortgage lender – scrambled to contain the fallout after it became the first British bank in decades to be bailed out by regulators. One person close to the situation said customers had withdrawn about $2bn Friday but Northern Rock declined to comment on the figure, which would amount to 4 per cent of its deposit base.
The rescue demonstrates the risks from a decade of financial innovation in the capital markets, which allowed a small regional lender to wield financial clout far greater than its network of 76 branches would suggest.
It also shows how the turmoil in the financial system that resulted from excessive lending to Americans with patchy credit histories triggered the failure of a bank with no direct links to the US mortgage market.
Shares in Northern Rock plunged more than 30 per cent as analysts slashed their earnings forecasts for the bank. The news also dragged down share prices for other UK banks such as Alliance & Leicester, HBOS and Barclays.
The FTSE 100 saw sharp falls until US markets opened and helped soften the bearish tone. As the day wore on, sentiment soured again. The list of leading UK shares ended 74.6 points lower, almost 1.2 per cent down at 6,289.3. The FTSE Eurofirst 300 was 16.2 points lower at 1508.1, 1.1 per cent down.
In the US, equity markets pared early losses after economic data showed retail sales, excluding sales of vehicles, fell sharply in August. The data cemented investors’ expectations of at least a quarter-point interest rate cut from the Federal Reserve when policymakers meet on Tuesday.
The commerce department reported retail sales fell 0.4 per cent in August, excluding vehicle sales, compared with forecasts of a 0.1 per cent rise, and a 0.7 per cent increase in retail sales in July. The S&P500 was down 0.1 per cent to 1,482.45 by midday in New York. The Dow Jones Industrial Average of blue-chip stocks fell 0.01 per cent to 13,423.66.
Financials were among the worst performers, after Merrill Lynch, the world’s largest brokerage, warned that shaky credit markets had forced it to adjust the value of securities linked to risky subprime mortgages.
Concern over Northern Rock and the ability of UK banks to maintain new mortgage lending at attractive rates added to concerns about the housing market and the economy in general.
Under the terms of the bail-out, the Bank of England will provide an open-ended facility to Northern Rock, allowing it to access liquidity by posting mortgages or mortgage-backed securities as collateral. The rescue – finalised yesterday after days of negotiations involving the Financial Services Authority and the UK Treasury – came just two days after Mervyn King, governor of the Bank, insisted it would not intervene to bail out the markets.
According to people familiar with the matter, several banks considered buying Northern Rock. However, a deal was undermined by a shortage of liquidity and uncertainty about Northern Rock’s value. Adam Applegarth, Northern Rock’s chief executive, said the bank was not in talks with a buyer.
Additional reporting by Chris Giles, Lina Saigol, Paul J Davies and Saskia Scholtes in London
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