A rock and hard place: Northern Rock faces years of debt wherever it turns

14 November 2007
There is doubt whether a solution exists for Northern Rock that will see it free of debt by 2010, regardless of whether it gets bought out or broken up.

Even if the struggling bank – which was Britain’s fifth largest bank, and biggest mortgage lender for the first half of 2007 – is bought outright, it could still owe the Bank of England billions of pounds in three years time, because it is doubtful that any buyer would be able to gather the necessary funds to repay the debt to the Bank. The debt currently runs at more than £20 billion and is expected to reach £25-£30 billion before the crisis is over.

The information came to light in a leaked memo issued by Northern Rock to potential bidders; it suggests that the stricken lender will continue to be indebted to the Bank of England for years to come, which could leave the Government red-faced when it realises it has made a long-term guarantee that might sit ill at ease with the European Commission’s rules regarding state aid.

Splitting up Northern Rock into its separate entities such as IT systems, branches, call centre and securitised mortgages seems likely, and this would leave the bank with assets that could be used to repay its debts. Another option is a buy-out – for which there are several possible contenders – and buyers are trying to reduce the amount of debt they end up with by urging the Bank of England to write off the interest on the loan which is currently at £2 billion but will continue to climb until the debt is cleared.

The bank issued the loan to bail out Northern Rock when it ran out of money in the summer as a result of the sub prime crisis in the US, but at a penal rate of about seven per cent. Bidders are arguing that reducing their costs will improve the likelihood of safeguarding Northern Rock’s employees in the North East where 5,500 jobs could be lost.

Northern Rock was especially vulnerable to the sub prime crisis and subsequent credit crunch as a consequence of putting all of its eggs in the lending basket when interest rates were at historic lows at the beginning of this year. In the US, 15 interest rate rises in 18 months were starting to take their toll, but in the UK, the Financial Services Authority’s laissez-faire attitude was cloaking any major warnings that something was about to go terribly awry.

While Bank of England governor Mervyn King believes that in order to protect tax payer’s money, banks should not be given favourable treatment, the Government is in a quandary because the Labour Party has a majority of seats in the North East which it will want to protect and a major job loss could prove detrimental. However, a decision to reverse the lending rules would be bad for the Bank’s reputation and worsen its situation when it comes to defending its actions to the European Commission.

Today, the chancellor Alistair Darling is expected to reassure City bosses that there will be no panic measures to tighten control of the financial sector in response to the credit crisis.

© Fair Investment Company Ltd