Northern Rock

The Northern Rock (NR) Bank was the first high profile U.K. casualty of the so-called Global Credit Crunch. It was the first British Bank in over 140 years to suffer a "Run on the Bank". The NR became a Bank in 1997 when it converted from a Building Society. NR was not the only bank to suffer funding problems, Paragon also suffered funding problems.

Bank Run

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The bank run was triggered by an announcement on the 13 September 2007 that the NR had arranged an emergency borrowing facility with the Bank of England. Savers panicked and rushed to withdraw their money as they feared that NR may go bankrupt, and thus they might loose some of their savings (over £30,000 there was no protection from the Financial Services Compensation Scheme). There was wide spread criticism of the way the announcement had been leaked by the authorities, to the BBC, prior to any official announcement, thus increasing confusion and fear amongst savers. Savers were thought to be sceptical of official announcements following the number of recent financial scandals such as pensions miss-selling and Equitable Life. At the start of the run NR was solvent. The run was stopped by a verbal announcement, on the 17 September 2007, from the Government (Alistair Darling) that the Government would guarantee all savers deposits. Trusting savers then returned home after deciding to leave their money in the NR. With the Government guarantee in place, NR was now underwritten by the U.K. taxpayer and thus was the safest Bank to put money in. Several days latter the Government clarified the guarantee by making clear that it only applied to accounts that were opened before the end of the bank run. Thus people opening new accounts would not be covered by the Guarantee.

As a result of the bank run the government decided to marginally increase the protection for savers by increasing the amount that the Financial Services Compensation Scheme will payout in the event of a bankruptcy.

A bank run is a very dangerous situation as it can cause banks to rapidly call in loans thus causing borrowers to go bankrupt.

Northern Rock (NR) Business Model

Before the Bank run

The Banks business model was built on the principle of "borrowing short term, but lending long term". The bank borrowed most of its money on the three monthly credit markets and then lent it as mortgages to homebuyers. This business model left the bank vulnerable to the liquidity crises which had been triggered by the US sub-prime mortgage market collapse. In addition, the Bank had also experienced rapid growth (at the time of the run it was the fifth largest U.K mortgage lender) during a period when lenders were becoming increasingly concerned about the risky undertakings that some mortgage banks had made.

After the Bank run

Once the bank run finished NR continued to offer high multiple mortgages (6 x salary) and high loan to valuation mortgages to low risk customers. This is in contrast to some other lendors who were gradually tightening lending rules. It is reported the NR had to borrow £23billion from the Bank of England. In response to the House of Commons Treasury Committee NR stated that the target "growth" for NR had now been reduced. The Bank could only continue to trade after the Bank run due to the loan from the Bank of England.

Employees

At present NR is still trading and has not made any employees redundant. However, this may change if NR problems continue and thus the employees future is far from certain even thought they have not done anything wrong. 75% of employees are also thought to own NR shares.

Savers

See Financial Services Compensation Scheme for information on the level of protection savers have in the event of bankruptcy. Note: In the case of Nothern Rock the accounts opened prior to the end of the bank run have a special protected status as they are guaranteed 100% by the government. However, this is a fast changing situation so savers need to watch the news to remain up to date.

This was the first Bank run in the internet age. The Banks web site crashed as savers rushed to withdraw their deposits further increasing anxiety. In the response to the House of Commons Treasury Committee, Adam Applegarth stated that the leaking of the news had removed the time the bank needed to improve the web sites bandwidth.

Northern Rock Foundation

Northern Rock Foundation is a charity that is funded by donations from the Northern Rock Bank (typically the funding was 5% of Northern Rocks pre tax profit. It was founded in 1997 when the Northern Rock converted from a mutual organisation (Building Society) to a Bank.

Share Holders, Share Price & Bond Holders

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Northern Rock Share Price

Between 2000 and January 2007 the NR share price rose 325%. In January 2007 the NR share price stood at an all time high of £12. However, between February and the end of August the price had fallen to £7 (a decline of 42%) as hedge funds started to short sell the stock, on rising concerns of the effect of the Credit Crunch. Following the announcement on the 13 September the shares fell to a low of £1.32 (a 90% fall since January). The announcement caught out savers and traders alike. On 13 September one trader tipped "Load up with NR for your children, your mum, your goldfish... it is not going bust, gives an interesting yield, is cheap and is a realsitic takeover target - buy it now."

Unlike savers there is no protection scheme for share holders and as such they stand to loose a significant amounts of money. Shareholders still own the company and some are concerned that the government may force the company to be sold at a discount price (similar to Railtrack) in a fire sale. Some big shareholders were pension funds.

In September 2007 NR had to scrap its £59million dividend payment to share holders.

Management

On the 19 October 2007 the Chairman Matt Ridley resigned and was replaced by an outsider Bryan Sanderson. On the 16 November 07 Bryan Sanderson then removed all the management team - see Daily Mail Bloodbath at Northern Rock

In addition, on the 30 October 2007 Adam Applegarth resigned as non-executive director of Persimmon.

Some of the Northern Rock management team are also significant shareholders in NR.

Auditor

NR auditors were PricewaterhouseCoopers.

Regulation

Under the so called "Tripartite Agreement", The Treasury, Financial Services Authority (FSA) and the Bank of England are all responsible for regulating financial institutions, with the FSA responsible for supervision of NR. The regulatory issues were further complicated by the fact that four separate pieces of legislation formed the legal framework in which these three authorities could operate. When answering questions to the House of Commons Treasury Committee Mervyn King, the Governor of the BoE, stated that he would have preferred to have offered the NR a secret loan but legal advice, taken during the crisis, stated that this was not possible and thus a public announcement was made triggering the run. The Tripartite Agreement had been sent up during the granting of independence to the BoE by the then Chancellor of the Exchequer Gordon Brown.

Investigation

The investigation is being led by the House of Commons Treasury Committee and is entitled "Financial stability and transparency". It has taken evidence from the Bank of England, FSA and NR. It was also take evidence from the Treasury. See the House of Commons Treasury Committee for more information.

During the investigation Adam Applegarth admitted that the news of the Bank of England loan had been leaked but denied that the leak came from NR. In addition, he admitted that he was not a qualified banker. However, before we all throw our hands up in horror, we had better ask ourselves the questions how many other banks are run by none qualified bankers and also what business qualifications does our Chancellor have to run U.K PLC?

What does this mean for the U.K. house prices?

In the immediate aftermath of the bank run it is likely that prospective homebuyers will loose confidence in the economy and thus house sales will decline. However, confidence in the banking industry may return quickly and thus the NR bank run in itself may not seriously impact the housing market. More serious damage will probably be caused by the global Credit Crunch and the damage to the reputation of the U.K. banking industry. Those pictures of people queuing to withdraw their savings should put fear in to U.K. bank managers thus making them more conservative in their lending (no more 6 x salary or 120% of valuation loans). This will probably result in money for mortgages becoming scarce and more expensive. This in turn will reduce the number of potential house buyers at the same time as redundancies may increase, as companies will also find it difficult to borrow money.

See also:

Quotes:

  • "Be careful what you wish for" Source unknown.


Now for some fun!

After all that depressing stuff it is time for some fun.

  • Northern Rock = Northern Wreck!
  • The end of the saying "Solid as a Rock"!
  • Stock market darling to Alistair Darling!
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