Northern Rock considers its options, while Paragon and other banks can no longer fund for themselves

21 November 2007
Northern Rock is struggling to choose the lesser of several evils as its shares continue to plummet to new lows. And buy-to-let lender Paragon is suffering a similar fate to the stricken lender; its shares have fallen by an estimated 85 per cent this year.

Paragon has a business model akin to that of Northern Rock; it has no income from savings, so it is at the mercy of the wholesale money markets and commercial banks to fund its mortgage business. With the Libor – the rate at which banks lend to each other – rising to 6.3 per cent, its highest since Northern Rock first asked for help from the Government’s fund of last resort, borrowing could become increasingly hard to come by.

Paragon is the second lender to admit that a freeze on lending could jeopardise its mortgage business and put its survival in serious doubt. Paragon’s shares slumped 39 per cent when the bank announced it was facing potential difficulties this week, wiping £140 million off its value. However, Paragon is determined not to become the next Northern Rock, which experienced the first run on a British bank for nearly 150 years, because it refuses to borrow from the Bank of England to fund its 75,000 buy-to-let book of mortgages.

Northern Rock’s shares have suffered a beating, dropping to their lowest ever of 67p yesterday, but recovered to 97p when US private equity firm JC Flowers confirmed it has made a bid for the bank. The bid is the only one that offers to buy the whole bank; it will repay £15 billon of the £20 billion contingency loan, and will pay off the rest by 2010, but offers nominal rewards for shareholders.

Shares in other banks such as Alliance & Leicester and Bradford & Bingley have also fallen 47 per cent and 40 per cent, respectively, amid concerns that banks are finding it increasingly difficult to support themselves.

The other main contenders include the Virgin Group and Olivant. Virgin would pay off £10 billion immediately and repay the remainder over the next two to three years; it would also replace the brand with Virgin Money, which might reinstate some confidence in the damaged reputation of Northern Rock. Bidders are saying that a huge injection of cash is needed to stabilise the bank and allow it to continue as a viable business.

The worst possible outcome for Northern Rock would be to go into administration, which would double the Government's commitment to the cause because it has guaranteed retail and wholesale depositors, and it could also worsen confidence in other banks and shake the foundations of the financial system.

The Government will favour the offer which makes repaying the Bank of England a priority, but shareholders may throw a spanner in the works if they think they are getting a raw deal, and could delay the process of a takeover.

© Fair Investment Company Ltd