Northern Crock - What Exactly Is Going On?

[ImA20SomethingGetMeOutOfHere]

Given that it looks that Northern Rock is going to be nationalised I thought it would be interesting to try and figure out what is actually going on with the bank's balance sheet, take a look at who owns what and generally figure out what the hell is going on. I also wanted to speculate a little over what the governments likely course of action will be.

First of all, I thought it would be interesting to have a look at how the bank is actually structured at the moment. Sadly I can find no information about Northern Rock's current balance sheet but what I have been able to find is some information from the first half of last year showing how the bank is actually funded:

http://companyinfo.northernrock.co.uk/inve...ockEx070725.asp

Now as we can see Northern Rock had just under £25bn of retail deposits (bank accounts basically), £26 billion in non-retail deposits (basically money from short and medium term loans from other financial institutions and bond issues), £45 billion in securitisations and around £8 billion in covered bonds (these are basically mortgage backed securities which are kept on the bank's balance sheet).

The £45 billion, nearly half of the bank's total funding comes through bond issues through its Granite subsiduary. Unsurprisingly information on this operation is not particularly forthcoming but I have been able to find out a couple of things:

http://ftalphaville.ft.com/blog/2007/10/08...-northern-rock/

http://www.taxresearch.org.uk/Blog/2007/09...eeding-answers/

Basically Granite is set up as a charitable trust fund to raise money for a small Down's syndrome charity called Downs Syndrome North East. Despite having somewhere between £45 and £50 billion in assets, Granite has never actually made a profit or donated a penny to Downs Syndrome North East. Its very existance came as a bit of a surprise to the charity which issued a press release saying it had never heard of Granite and confirmed that it had never received a penny in funding. Granite itself is owned by a holding company called the Law Debenture Society which is in turn controled by Northern Rock.

Granite has a prospectus which can be downloaded from Northern Rock's website here

The kind of securities issued by Granite are shown on the first page of its prospectus:

Basically they are long term bonds and appear to be backed by the choicier bits of Northern Rock's mortgage book. As far as I can see the majority of these have been bought by large US institutions such as Merril Lynch.

Now there is a particularly tasty problem to deal with in relation to Granite in that the average length of time somebody has a Northern Rock mortgage for is three years after which many people choose to remortgage. Some of the bonds issued by Granite have a 50 year term, not maturing until 2054. Northern Rock has a contractual obligation in that it has to make sure that should some of the mortgages be repaid or should one of the moregagees go bankrupt then it has to replace that mortgage with another from its book. In other words Northern Rock, a soon to be nationally owned company has a legal obligation to keep feeding an offshore holding company with new mortgages for up to 50 years from now. If it doesn't then investors are contractually entitled to call in their entire £45 billion worth of loans (http://www.telegraph.co.uk/money/main.jhtm....xml&page=1). It was partly this relationship which allowed Northern Rock to obtain large amounts of funding in the first place. In essence, in exchange for £45 billion in funding it has allowed Wall Street to cherry pick its assets for the next 50 years.

Dodgy though all this undoubtedly is, this was not, as far as I can see, the source of all Northern Rock's troubles to begin with. If we go back to the balance sheet we can see that about a quarter of Northern Rock's funding, some £26 billion or so comes from "non-retail deposits". Again the structure of these is about as clear as mud, but one or two tidbits of information can be gleaned from the Crock's own website.

The "investor relations" page from 2004 gives a little more detail:

Non-Retail Funding

Total net non-retail funding for the year amounted to £3,317 million with balances at 31 December 2003 amounting to £17.0 billion (2002 - £13.7 billion). Our non-retail funding provides a balanced mixture of short and medium term funding with increasing diversification of our global investor base. In July 2003 Moody's confirmed an upgrade to our long-term credit rating from A2 to A1, which will further benefit diversification and the cost of funding.

During 2003 several notable transactions were successfully concluded, contributing to the £3.6 billion of medium term funds raised during the year. We completed the first benchmark senior fixed rate Euro transaction for a single A rated UK financial institution raising €750 million. In October 2003 we raised US$600 million of Floating Rate Notes achieving 40% placement with Asian investors. In May 2003 we signed a £750 million syndicated revolving loan facility which at the time was the largest plain vanilla term facility ever established by a UK financial institution. Already in 2004 we have raised £1.5 billion through our US and Euro Medium Term Note programmes.

We intend, subject to market conditions and regulatory approval, to strengthen our funding this year with the introduction of a covered bond programme.

So the plan was to raise money by whatever dodgy bond issues, loans and securitisations the market would bear. Another more recent page tells the story of what went wrong:

Funding

Global investor appetite in the medium and long term markets, for either senior unsecured or asset backed securities, is currently greatly reduced. Whilst we expect conditions will improve over the medium term, potential volumes and pricing levels for the remainder of 2007 are likely to remain less favourable than those which have been achieved during the last two years. While Northern Rock has continued to raise new funds, these have been mainly in the short term wholesale debt markets and the amounts raised have not allowed Northern Rock to refinance maturing liabilities as well as to write new business at previous levels. In view of the difficulties Northern Rock has had in accessing longer term funding and the mortgage securitisation markets, the Company has been using its cash and other liquid reserves to support the funding of its business. Northern Rock expects current market conditions to continue for some time.

In light of the above, Northern Rock has concluded that it is important to ensure that additional standby liquidity arrangements are available. Accordingly, Northern Rock has agreed with the Bank of England that it can raise such amounts of liquidity as may be necessary by either borrowing on a secured basis from the Bank of England or entering into repurchase facilities with the Bank of England. Such repurchase facilities would include securities that have prime residential mortgage assets as underlying collateral. The collateral that can be used under this "Repo" facility is similar in nature to the collateral currently utilised by many Eurozone banks with the ECB. This additional source of funding will enable Northern Rock to adapt its business model in line with the developing market conditions.

So basically the bank was unable to sell long or medium term bonds to cover its funding needs, perhaps because the market didn't expect a chunk of its customers to be actually paying their mortgages in 5 years. It was forced to turn to shorter and shorter term funding and when this dried up it had to start eating into its cash reserves and shareholder capital. Since these were of the traditional "waffer thin" Basle II variety it was forced to seek emergency funding from the Bank of England which in turn triggered a bank run which required the government to step in and guarantee its deposits with taxpayers' money.

The government itself is now in quite a bind. It has at this moment something like £28 billion in direct exposure to Northern Rock in the form of emergency loans from the Bank of England. Presumably there is still a large chunk of Northern Rock bonds and securitisations out there which will need to be redeemed at some point, and if it can't do this via the money markets, which seems likely, or from whatever is left of the Crock's deposit base then that will have to be met by further loans from the Bank of England. What the government would presmuably like to do is gradually wind up the bank and use money from interest payments on its mortgages to gradually pay back the Bank of England loan. Whatever is left of the bank at this point would then be on a relatively sound business model. The gigantic problem for them however is what to do about Granite, the offshore charitable foundation with billions of assets which has never actually raised a penny for Down's syndrome. The government has to keep feeding the monster with new mortgages and so can't simply wind down the Crock's mortgage book - it has to keep getting new business. The problem of course is that the Crock doesn't actually have any money to lend. Furthermore the sheeple are basically maxed out on debt now and physically finding people to take out new mortgages may be difficult. Of course the government could use powers given to it in the forthcoming banking bill to nationalise Granite as well but then it has to find another £45-50 billion to do this. Unlike the Crock's shareholders, whose assets are effectively worthless, Merril Lynch and the like are currently sitting on hard assets with a real value providing (currently) a decent yield and are going to want hard currency for those bonds, presumably at face value as well. The government could try and raise this money through a bond issue, but guess who buys the bonds? Probably the same cartel of Wall Street banks that set up the Granite deal in the first place.

Looked at this way one of the reasons the US banks wanted the Granite deal structures this way in the first place become clear - they've got the government right where they want them. They get 50 years worth of guarenteed payments from Granite because the alternative is basically the government defaulting on the debt. Whilst Granite was owned by the Crock then defaulting on the debt was a real possibility but now the Crock has been nationalised the banks are sitting on top of £50 billion of sovereign backed debt yielding not the measly 4.5% or so of UK treasury bonds but rather US$ LIBOR plus a premium of anything up to half a percent. I don't know what LIBOR currently is but I'm guessing the yield on these will be somewhere around 6-7%.

So let's all take a moment to look at this picture of Gordon Brown and marvel at what a good job he's done of running the economy, shall we?

[lets get it right]

Excellent job.

Please go to that web site that allows you to contact your MP and email that to them - or at least a link to the post.

I'm doing it now.

[Methinkshe]

The gigantic problem for them however is what to do about Granite, the offshore charitable foundation with billions of assets which has never actually raised a penny for Down's syndrome. The government has to keep feeding the monster with new mortgages and so can't simply wind down the Crock's mortgage book - it has to keep getting new business.

Sorry to be dumb, but could you explain why Granite has to keep being fed with new mortgages?

BTW, thanks for a really good analysis.

[ImA20SomethingGetMeOutOfHere]

Sorry to be dumb, but could you explain why Granite has to keep being fed with new mortgages?

BTW, thanks for a really good analysis.

Some of Granite's bonds have a 50 year maturity - this means that the people who bought them expect to be receiving interest payments for 50 years. Now none of Northern Rock's current mortgages are going to be around in 50 years - they will have been repaid, the mortgagees will have remortgaged or they will have gone bankrupt. In order to guarantee the investment the bonds have a clause in them which states that if a particular mortgage is repaid Northern Rock has to find another mortgage to replace it with or the bond holder is entitled to reclaim the value of the bond. For example, if a hedge fund has paid £500 million for some mortgages from Northern Rock then they expect to be holding £500 million worth of mortgages. If Northern Rock is unable to provide those mortgages then the hedge fund is entitled to ask for its money back.

[Paddles]

Superb analysis!

I even understand some of it!

Incompetent/corrupt (delete where appropriate) company now nationalised by an incompetent/corrupt (delete where appropriate) government.

[ImA20SomethingGetMeOutOfHere]

Superb analysis!

I even understand some of it!

Incompetent/corrupt (delete where appropriate) company now nationalised by an incompetent/corrupt (delete where appropriate) government.

Don't forget the part about the definately not incompetant cartel of banks making a killing from the whole thing.

[Blue Peter]

Superb analysis!

I even understand some of it!

I'll second that.

Do we know how much of this the government understood when they decided to rescue NR rather than let it go under? Do we know how much of this the government (or perhaps the FSA) should have understood when NR came to them. Finally, does any of this (presumably the Granite connection) have any impact on the decision to save NR? I mean this in the sense that if it folded would it have had unfavourable implications for the UK as a financial centre?

Oh, not final...Is anyone going to get done for what looks like the fraud involved with Granite (doesn't hold breath)?

Peter.

[starsign]

Some of Granite's bonds have a 50 year maturity - this means that the people who bought them expect to be receiving interest payments for 50 years. Now none of Northern Rock's current mortgages are going to be around in 50 years - they will have been repaid, the mortgagees will have remortgaged or they will have gone bankrupt. In order to guarantee the investment the bonds have a clause in them which states that if a particular mortgage is repaid Northern Rock has to find another mortgage to replace it with or the bond holder is entitled to reclaim the value of the bond. For example, if a hedge fund has paid £500 million for some mortgages from Northern Rock then they expect to be holding £500 million worth of mortgages. If Northern Rock is unable to provide those mortgages then the hedge fund is entitled to ask for its money back.

excellent analysis. This seems to be the heart of the issue facing NR/Govt now, are there any further details on these bonds? Do they have to last the 50 yrs? What would have happened to Granite if NR had gone bust...presumably the same and the bond owners would have lost out. I think that would be a pretty strong negotiating point from the govt in renegotiating these deals. Is Granite is a seperate legal entitiy to NR...? Is the govt definitely liable for granite?

I guess what I am saying is that on the face of it the govt has a liability to these bonds for a generation, but I'd like to know more.

[ImA20SomethingGetMeOutOfHere]

I'll second that.

Do we know how much of this the government understood when they decided to rescue NR rather than let it go under? Do we know how much of this the government (or perhaps the FSA) should have understood when NR came to them. Finally, does any of this (presumably the Granite connection) have any impact on the decision to save NR? I mean this in the sense that if it folded would it have had unfavourable implications for the UK as a financial centre?

Oh, not final...Is anyone going to get done for what looks like the fraud involved with Granite (doesn't hold breath)?

Peter.

I think that the worst thing of all with this is that it's all totally legit.

Re the "implications for the UK as a financial centre" bit: I can't help but wonder if what this really means is that one of the few things that is propping the UK economy up at the moment is the ability of foreign companies to come and buy up well yielding investments, be it mortgage backed securities, utility companies, hospitals, schools or the London Underground. Much of these investments come with a government guarantee - be it implicit or explicit. For example, in the case of the recent failed PPP scheme on the tube, one reason that banks were willing to buy into the scheme was that it was underwritten with public money. The government "wins" because somebody else is able to borrow money on its behalf but also because it brings in investment capital to the UK, helping to support the economy. On the flip side the big banks are only willing to lend to something as flakey as the tube PPP scheme because of that government guarantee. In other words a large part of the economy is supported by big banks ploughing money into government backed investments but if the government is unwilling to support these investments then the money leaves and we get a major recession. IMO the government felt it was necessary to intervene to prop up the big banks' investment in Northern Rock because if they didn't their money would up sticks and leave and then we'd be proper f***ed. We might even have to start making things for a living.

[Blue Peter]

Thanks again. It will be very interesting when the full history of NR is written,

Peter.

Edit: Change to a better adjective.

Edited February 20, 2008 by Blue Peter

[Methinkshe]

Some of Granite's bonds have a 50 year maturity - this means that the people who bought them expect to be receiving interest payments for 50 years. Now none of Northern Rock's current mortgages are going to be around in 50 years - they will have been repaid, the mortgagees will have remortgaged or they will have gone bankrupt. In order to guarantee the investment the bonds have a clause in them which states that if a particular mortgage is repaid Northern Rock has to find another mortgage to replace it with or the bond holder is entitled to reclaim the value of the bond. For example, if a hedge fund has paid £500 million for some mortgages from Northern Rock then they expect to be holding £500 million worth of mortgages. If Northern Rock is unable to provide those mortgages then the hedge fund is entitled to ask for its money back.

Many thanks for explaining. I'm beginnning to see the light.

That's some millstone, isn't it? The ramifications hardly bear thinking about.

[youthoftoday]

Some of Granite's bonds have a 50 year maturity - this means that the people who bought them expect to be receiving interest payments for 50 years. Now none of Northern Rock's current mortgages are going to be around in 50 years - they will have been repaid, the mortgagees will have remortgaged or they will have gone bankrupt. In order to guarantee the investment the bonds have a clause in them which states that if a particular mortgage is repaid Northern Rock has to find another mortgage to replace it with or the bond holder is entitled to reclaim the value of the bond. For example, if a hedge fund has paid £500 million for some mortgages from Northern Rock then they expect to be holding £500 million worth of mortgages. If Northern Rock is unable to provide those mortgages then the hedge fund is entitled to ask for its money back.

I'm not sure I understand the problem. Surely if £500m of NR mortgages are repaid (i.e. NR customers remortage to a different bank) then NR has £500m cash (received from other banks on mortgage redemption) which it then passes on to Granite. Granite can then repay the hedge fund / cancel the bond.

[ImA20SomethingGetMeOutOfHere]

Here's something interesting.

Here's the balance sheet for Bradford and Bingley:

http://www.bbg.co.uk/bbg/ir/fininfo/kfd/balance

Bradford and Bingley currently has just under £18 billion issued in the form of mortgage backed securities. Let's have a look at what these are made up of, shall we?

http://www.bbg.co.uk/bbg/ir/dis/securitisation/

Well well, what do we see here? It would seem that Bradford and Bingley has set up a subsiduary operation called Aire Valley Mortgages. Aire Valley Mortgages has written billions of pounds of mortgage backed securities over the past few years, the details of which are on the page linked to above. These securities mature around either 2030 or 2066 although currently most are scheduled to be redeemed long before then.

An interesting point though is that if Bradford and Bingley were to be nationalised the government would face the exact same problems it has with Northern Rock.

[AteMoose]

Ohh it sounds just like debt payments the german government had to pay to allied nations after first world war, incedently the German government was forced to print money to pay the debt/keep things going which caused hyper inflation.

Edited February 20, 2008 by moosetea

[ImA20SomethingGetMeOutOfHere]

I'm not sure I understand the problem. Surely if £500m of NR mortgages are repaid (i.e. NR customers remortage to a different bank) then NR has £500m cash (received from other banks on mortgage redemption) which it then passes on to Granite. Granite can then repay the hedge fund / cancel the bond.

That's correct however NR is also supposed to be repaying £28 billion of loans to the Bank of England. It can't do both at the same time unless it can either 1. attract a huge amount of savers or 2. secure large amounts of funding on the wholesale money markets. 2. isn't looking like much of an option right now and while 1. is a possibility that number of savers taking money out of other bank accounts is going to stuff up another part of the banking system somewhere else.

[ImA20SomethingGetMeOutOfHere]

Here's another one:

Abbey Holmes

[AteMoose]

looks like the government isnt getting granite

http://news.bbc.co.uk/1/hi/uk_politics/7254451.stm

Mr Cable said: "The problem is that Granite is a separate institution which, as I understand it, securitises the best assets of the bank.

"The best mortgages of the bank are wrapped up in the Granite vehicle."

The members of HPC understand otherwise....

Edited February 20, 2008 by moosetea

[Blue Peter]

Here's another one:

Abbey Holmes

Are you a forensic accountant or something?

On 21st December 2007, mortgage backed notes totalling £7.25 billion equivalent were issued via Holmes Master Issuer 2007-3, from a £40 billion residential mortgage master trust. This is Abbey’s 17th residential mortgage backed transaction and the fourth from our Holmes Master Issuer vehicle. The notes are denominated in euro and sterling and have been subscribed for by Abbey.

I thought that the UK/Euro RMBS market was dead? Though what does "have been subscribed for by Abbey" mean? that they bought up their own mortgage debt (I'm not sure what my sentence means; it feels right to use here, but it doesn't sound very good),

Peter.

[ImA20SomethingGetMeOutOfHere]

looks like the government isnt getting granite

http://news.bbc.co.uk/1/hi/uk_politics/7254451.stm

The members of HPC understand otherwise....

Top quote from Vince Cable:

"What is going on here appears to be not public ownership of Northern Rock but an asset-stripping operation designed to benefit whoever, we don't know. This is a very serious development."

He said the remainder of Northern Rock's assets, which have been acquired by the government, consisted of unsecured mortgages for up to 125% of the value of a home.

[ImA20SomethingGetMeOutOfHere]

Are you a forensic accountant or something?

Bradford and Bingley had a very informative PowerPoint with most of the details of the scam which I found here:

http://www.bbg.co.uk/bbg/ir/dis/presentati...res/mtspres.ppt

I am currently trying to find out about HBOS' Mound Finance operation. It's not easy.

I thought that the UK/Euro RMBS market was dead? Though what does "have been subscribed for by Abbey" mean? that they bought up their own mortgage debt (I'm not sure what my sentence means; it feels right to use here, but it doesn't sound very good).

As I understand it there seem to be almost two different MBS markets. One is the one for all the short term garbage like what the Crock was trying to flog recently and the other seems to be for much longer term securities which are isued through a subsiduary company like Granite, are not tied in to specific mortgages and seem to be bought by big, and I do mean BIG banks. In essence they allow the big banks to cherry pick the nicest mortgages from the smaller bank (often a demutualised building society) and leave the rest to rot.

[Optobear]

Bradford and Bingley had a very informative PowerPoint with most of the details of the scam which I found here:

http://www.bbg.co.uk/bbg/ir/dis/presentati...res/mtspres.ppt

I am currently trying to find out about HBOS' Mound Finance operation. It's not easy.

As I understand it there seem to be almost two different MBS markets. One is the one for all the short term garbage like what the Crock was trying to flog recently and the other seems to be for much longer term securities which are isued through a subsiduary company like Granite, are not tied in to specific mortgages and seem to be bought by big, and I do mean BIG banks. In essence they allow the big banks to cherry pick the nicest mortgages from the smaller bank (often a demutualised building society) and leave the rest to rot.

Fantastic posts ImA20Something.

Let's hope that journalists and commons researchers are browsing.

Is it helpful to make an analogy here with the oil tanker industry?

All the oil tankers are now registered in places like Liberia, because if there is a massive oil leak the regulation is offshore.

The Government here seems to have allowed the UK mortgage market to operate in much the same way. We have the equivalent of dodgy old single skin oil tankers, registered offshore, but with the toxic stuff about to slosh all over the UK shoreline.

Cameron's first question to Gordon should be. "What will be the effect of the Northern Rock nationalisation on children with Down's Syndrome." He should keep asking the question until all of the press pick up on it, and communicate to the people just how corrupt the whole business is. If there was any justice, Gordon should be marched out of Number 10 to the Tower of London by masses of disgusted citizens. Economic miracle? Economic miracle based on mis-using the name of a Down's syndrome charity. Shame on the government.

I really hope that the Lords bounce this back.

The BBC is doing its part.

http://newsvote.bbc.co.uk/1/hi/uk_politics/7254451.stm

[The Hooded C law]

Bradford and Bingley had a very informative PowerPoint with most of the details of the scam which I found here:

http://www.bbg.co.uk/bbg/ir/dis/presentati...res/mtspres.ppt

I am currently trying to find out about HBOS' Mound Finance operation. It's not easy.

As I understand it there seem to be almost two different MBS markets. One is the one for all the short term garbage like what the Crock was trying to flog recently and the other seems to be for much longer term securities which are isued through a subsiduary company like Granite, are not tied in to specific mortgages and seem to be bought by big, and I do mean BIG banks. In essence they allow the big banks to cherry pick the nicest mortgages from the smaller bank (often a demutualised building society) and leave the rest to rot.

WHat leverage have the bond holders got over Crock? Do the cherry picked mortgages held in "Granite" pay out directly too Granite? Is Granite named as the mortgage holder on the property deeds?

[ImA20SomethingGetMeOutOfHere]

Here's HBOS:

http://www.hbosplc.com/investors/Debt/secu...vered_bonds.asp

They've got at least 5 different trust companies issuing securities on their behalf, and some don't mature until 2044.

[ImA20SomethingGetMeOutOfHere]

WHat leverage have the bond holders got over Crock? Do the cherry picked mortgages held in "Granite" pay out directly too Granite? Is Granite named as the mortgage holder on the property deeds?

At the time the mortgage was sold to Joe Punter to buy a BTL empire or whatever the mortgage would have been from the Crock and this is what would appear on the documentation. The Crock is contractually obliged to keep Granite stuffed full of sufficient mortgages to cover payment on its bonds and so sells however many it needs to do this to Granite. If Granite doesn't like the look of any of them I think it can sell them back to the Crock again. To be honset I have absolutely no idea what contractual obligations the Crock has to Granite and I suspect it would take a much finer legal mind than mine to work them out

this is from HBOS and is talking about covered bonds, which aren't quite the same thing as the securities that Granite holds:

Pool Assets Analysis

A very small number of loans were repurchased from the Trust by the Seller during the period, for being in breach of the representations and warranties

under the Mortgage Sale Agreement.

There was a hugely funny case in the US not too long ago where somebody managed to avoid foreclosure because the bank he took his mortgage out with had sold it on and nobody could figure out who actually owned it.

[The Hooded C law]

At the time the mortgage was sold to Joe Punter to buy a BTL empire or whatever the mortgage would have been from the Crock and this is what would appear on the documentation. The Crock is contractually obliged to keep Granite stuffed full of sufficient mortgages to cover payment on its bonds and so sells however many it needs to do this to Granite. If Granite doesn't like the look of any of them I think it can sell them back to the Crock again. To be honset I have absolutely no idea what contractual obligations the Crock has to Granite and I suspect it would take a much finer legal mind than mine to work them out

this is from HBOS and is talking about covered bonds, which aren't quite the same thing as the securities that Granite holds:

There was a hugely funny case in the US not too long ago where somebody managed to avoid foreclosure because the bank he took his mortgage out with had sold it on and nobody could figure out who actually owned it.

Yes I remember that case. It probably holds true for many mortgages sliced and diced and put into CDO's.

Crock doesn't seem to be having problems obtaining repo's at the moment though.