Northern Rock It Will Be A Close Run Thing

[Blue Peter]

Are the BoE going to prop them up, holding all those mortgage backed securities and just hope that the credit spreads will return to 100bps?

But isn't that what is happening? A&L and B&B are now below 100, and NR seems to have gone from 220 to 150 (so a bit more and it's there too).

However, I can't see why guaranteeing savers deposits has had this effect,

Peter.

[JustYield]

True, but it's akin to paying ransom money.

Northen Rock should be responsible for Northern Rock depositors as well as Northern Rock shareholders.

This sends the message to other banks; you look after your shareholders we will look after your depositors. Infact risk depositors money as much as you like, deposits are a free bond.

If you force depositors to look for safe banks it forces banks to be safe.

Darling has blown a new breath of risk into banking.

He has averted a minor crisis by offering to underwrite a deflating economy! Why should people suffer when we can all burn in hell together.

I think people are extrapolating his statement to extremes - he has NOT promised to underwrite the entire banking system's deposits, despite all the hysterical comments to that effect. Read his words carefully (I don't mean you specifically, ?...!).

The NR intervention costs the taxpayer nothing more than the provision of a temporary cash facility and the payback is enormous: confidence will be restored while NR gets busy being taken over. As the entity NR disappears from the high street they will be able to say, "Look the banking and regulatory system operated as it should - yes the shareholders lost out with NR, that was their risk, but the depositors were always safe. Keep saving with confidence."

It is not up to depositors to worry about bank's safety, it is a given within the UK framework - but it is a problem for shareholders who should know the risks.

[Guest tbatst2000]

Still deflation.

It'll make a change to see debtors rather than borrowers taxed without knowing it (although most people won't realise that's what's happening). Deflation is not necessarily a terrible thing in my opinion, it encourages people not to spend money they don't have, reduces general profligacy (which must have some environmental benefits if nothing else) and makes people concentrate more on the long term outlook.

There's still an argument to be had about what the inflationary outlook is going to be of course - it could go like the 70s in the UK with stagnation at the same time as deflation or it could be more like the Japanese experience of deflation. Both these followed on from enormous asset price rises funded by borrowing to buy real estate so it's hard to make a call on which is more likely. Personally, I suspect the global environment is the main thing that will decide - in the 70s, the whole world was in recession at the same time, in the 90s less so. Today of course, growth could well continue in China, India, Russia etc even if the US and Europe fall back. One thing I do predict is that the value of the pound will become a major economic and therefore political issue again - a big fall, say 20% vs the currencies of the places that we export most of our stuff from would cause inflation for sure particularly with north sea oil and gas running down.

[Goldfinger]

It has helped a lot first time buyers get on the housing ladder.

Ah, you mean the housing cliff, I suppose?

Edited September 18, 2007 by Goldfinger

[Guest tbatst2000]

It is not up to depositors to worry about bank's safety, it is a given within the UK framework - but it is a problem for shareholders who should know the risks.

I agree that it's not reasonable to expect them to given the complexity of most banks of any size, realistically it is something they should worry about to some extent given past banking failures (I'm mainly thinking BCCI here).

I hope we end up with something a bit more like the FDIC to replace the current arrangements with a guaranteed immediate payout in full up to, say 100K, of deposits per named individual per legal entity with some rules incorporated to cover cross collateralisation (i.e. if you have 150K at a bank and owe 50K to it on a mortgage or credit card even it should be clear that those numbers are netted together not treated as entirely separate).

[MarkyB]

Barely enough assets cover total deposits?

Deposits = 24 billion.

Assets = 113 billion.

Your all asking the wrong questions!!

I get the feeling the deposits are current accounts and savings accounts of depositors, the 24 bln has reduced by at least 2 bln to 22 bln in the last week. AT LEAST

the Assets = of 113 bln are only promises to pay, IOU's from mortgages the assets are actually the properties with according to rightmove went down 2.6 last month. So say 3bln, down to 110 bln, Im sure they dont revalue everymonth but you can see where this is going in future.

WHAT YOU HAVE ALL FAILED TO NOTICE, is the bank has packaged these mortgages as peices of paper which are traded with wholesale institutional investors, insurance companies and other banks who have stopped the trade. These are STILL liabilities!!! Arn't they??

WHERE ARE THE LIABILITIES??? surely the deposits dont include them too? They say that they are financed 75% by bonds... but no one has mentioned them anywhere? Will they still be solvent in a year when house prices come down say 10 - 15% or more even?

Im imagining 80 bln of imaginary bonds somewhere??? is there???? Why do people forget to mention them

So just how solvent is northern rock, and just how good is their cash flow??? to finance the withdrawing depositors and the wholesale market???

[Guest tbatst2000]

People are going to be punished for their past spending habits.

Reminds me of this:

“Ye miserable, crawlin' worms. Are ye here again then? Have ye come like Nimshi, son of Rehoboam, secretly out of your doomed houses, to hear what's comin' to ye? Have ye come, old and young, sick and well, matrons and virgins? Have ye come to hear me tell you of the great, crimson, licking flames of hell fire? Aye! You've come, dozens of ye. Like rats to the granary, like field mice when it's harvest home. And what good will it do ye? You're all damned! Damned! Do you ever stop to think what that word means? No, you don't. It means endless, horrifying torment! It means your poor, sinful bodies stretched out on red-hot gridirons, in the nethermost, fiery pit of hell and those demons mocking ye while they waves cooling jellies in front of ye. You know what it's like when you burn your hand, taking a cake out of the oven, or lighting one of them godless cigarettes? And it stings with a fearful pain, aye? And you run to clap a bit of butter on it to take the pain away, aye? Well, I'll tell ye, there'll be no butter in hell.”

[Blue Peter]

“Ye miserable, crawlin' worms. Are ye here again then? Have ye come like Nimshi, son of Rehoboam, secretly out of your doomed houses, to hear what's comin' to ye? Have ye come, old and young, sick and well, matrons and virgins? Have ye come to hear me tell you of the great, crimson, licking flames of hell fire? Aye! You've come, dozens of ye. Like rats to the granary, like field mice when it's harvest home. And what good will it do ye? You're all damned! Damned! Do you ever stop to think what that word means? No, you don't. It means endless, horrifying torment! It means your poor, sinful bodies stretched out on red-hot gridirons, in the nethermost, fiery pit of hell and those demons mocking ye while they waves cooling jellies in front of ye. You know what it's like when you burn your hand, taking a cake out of the oven, or lighting one of them godless cigarettes? And it stings with a fearful pain, aye? And you run to clap a bit of butter on it to take the pain away, aye? Well, I'll tell ye, there'll be no butter in hell.”

Terry Pratchett?

Peter.

[Guest tbatst2000]

WHERE ARE THE LIABILITIES??? surely the deposits dont include them too? They say that they are financed 75% by bonds... but no one has mentioned them anywhere? Will they still be solvent in a year when house prices come down say 10 - 15% or more even?

Im imagining 80 bln of imaginary bonds somewhere??? is there???? Why do people forget to mention them

The liabilities are a mix of commercial paper about to come due (which is what the BoE emergency cash will cover assuming they can't role it), covered bonds (like longer term commercial paper in many respects) which still have long periods to run and some other stuff. I've not been able to find out if the 100B mortgage book includes mortgages that have already been packaged and sold on as MBSs. Your comment on house prices falling giving them a problem is not so important until they've fallen quite a long way as the average loan to property value ratio is quite low for NR (less than 60% from what I've read).

[?...!]

But isn't that what is happening? A&L and B&B are now below 100, and NR seems to have gone from 220 to 150 (so a bit more and it's there too).

However, I can't see why guaranteeing savers deposits has had this effect,

Peter.

It's not the CDS spread on the business that is the problem (although it is an indirect problem), the problem is the spread on the securities that these companies sell.

It all happened in the very opaque world of mega-funds, i.e. sovereign reserves.

Whoever was underwriting the RMBS market (only the orient could afford it, so I presume it was them), simply withdrew their bids.

The cost of insuring against defaults for those funds holding these securities exploded.

The remaining underwriters have nowhere near the required funds to support the levels of equity in Western property markets. Without the orient underwriting the risk, the equity must collapse.

Now our own leaders rush to the aid of those trapped in the rubble. Promising the blood of the injured and wounded to the dying and dead weather they agree to it or not.

[Guest tbatst2000]

Terry Pratchett?

Peter.

No, Stella Gibbons taking the mickey out of Thomas Hardy and the rural primitive school in general in Cold Comfort Farm:

http://www.amazon.com/Cold-Comfort-Essenti...8879&sr=8-3

It's a fantastic book, very funny and well written.

[FollowTheBear]

Am I right in thinking the assets of 113 billion represent the entire outstanding mortage payments?

If this is the case then it would take 25 years for all of it to be repaid, so some savers or the government would be waiting a long time to get their money back.

(btw I am not a "troll")

[Sour Mash]

Barely enough assets cover total deposits?

Deposits = 24 billion.

Assets = 113 billion.

Mortgage backed securities are really performing well in the market, aren't they?

Wonder how much of their 'assets' are composed of 'lie to buy' and 125% LTV loans.....

[MarkyB]

The liabilities are a mix of commercial paper about to come due (which is what the BoE emergency cash will cover assuming they can't role it), covered bonds (like longer term commercial paper in many respects) which still have long periods to run and some other stuff. I've not been able to find out if the 100B mortgage book includes mortgages that have already been packaged and sold on as MBSs. Your comment on house prices falling giving them a problem is not so important until they've fallen quite a long way as the average loan to property value ratio is quite low for NR (less than 60% from what I've read).

I agree the LTV is probably quite low on mortgages generally, but they would not the be the sub prime, but what about the non secured loans... surely they make up a big% and the problem mortgages wont be the 40% LTV it will more likey be the 125% LTV which they have provided more recently...

which means the security on the house leads to much more of an impact on N R even if for only 50% of the entire mortgage loan book!?

But no one mentions the value of these bonds, I assume the bank is having potential cash flow problems. and expects a whole load of bonds to mature fairly soon? this situation has been worsened by the withdrawing of funds by depositors?

[Guest tbatst2000]

Am I right in thinking the assets of 113 billion represent the entire outstanding mortage payments?

If this is the case then it would take 25 years for all of it to be repaid, so some savers or the government would be waiting a long time to get their money back.

(btw I am not a "troll")

Mortgages, some other loans and some residual value for the business itself. It would be easy enough to sell on most of the mortgages for reasonable proportion of their face value of course so there's no real reason why it would actually take that long to pay out the depositors. Having said that, it would only take a small hit - say 3% of the mortgaged value on average - to wipe out a lot of real money.

[Guest mSparks]

Barely enough assets cover total deposits?

Deposits = £24 billion.

Assets = £113 billion.

As someone else said, Liquid Assests, But the real problem is what the media keep missing out and looks something like

Assets ~ £113 billion

Liabilities ~ £137 billion

up until last month, this was ok, because they paid ~4-5% on their liabilities, and got 5.9% income from there assets

that's an income of £6.667 billion

and outgoings of £5 billion (it was actually closer than this, but you get the point)

Nice little earner.

however, they would now pay 7-8%+ for their liabilities in the open market so they got a (slightly) cheaper loan from the BOE.

From what I gather these CDO's work to reduce their net liabilities, but also reduce their income from the assets.

The only way they can stay afloat afaics is if the market for CDOs opens up again, but that cant happen until someone works out how to value them given whatever changed a few months back, and even then this depends on that valuation not being prohibitively cheap (lose to much income for not enough reduction in liabilities).

[Guest tbatst2000]

I agree the LTV is probably quite low on mortgages generally, but they would not the be the sub prime, but what about the non secured loans... surely they make up a big% and the problem mortgages wont be the 40% LTV it will more likey be the 125% LTV which they have provided more recently...

which means the security on the house leads to much more of an impact on N R even if for only 50% of the entire mortgage loan book!?

But no one mentions the value of these bonds, I assume the bank is having potential cash flow problems. and expects a whole load of bonds to mature fairly soon? this situation has been worsened by the withdrawing of funds by depositors?

I'm not sure about the unsecured stuff, I had a read of a report from a Goldmans credit analyst the other day which listed it all but, typically, I think I deleted it....I'll see if I can get another copy and report back although I don't recall them making up a big %. The lending to credit impaired people is much harder t judge since, as the US has found out, just because some mortgage advisor filled out the forms to make the borrower look like they were a safe bet it doesn't mean that they were.

What I do remember is that the CP that's maturing soon and which is shortly going to cause them the enormous cash flow problem that sent them to the BoE in the first place is for around 20B - maybe they'll be able to roll some of that or fund it overnight rather than 3 monthly, who knows? The covered bonds mostly have several years to run I think and the stuff that's been securitised presumably runs until maturity. Is there a resident expert on MBSs that can answer that last one accurately?

[Blue Peter]

It's not the CDS spread on the business that is the problem (although it is an indirect problem), the problem is the spread on the securities that these companies sell.

It all happened in the very opaque world of mega-funds, i.e. sovereign reserves.

Whoever was underwriting the RMBS market (only the orient could afford it, so I presume it was them), simply withdrew their bids.

The cost of insuring against defaults for those funds holding these securities exploded.

The remaining underwriters have nowhere near the required funds to support the levels of equity in Western property markets. Without the orient underwriting the risk, the equity must collapse.

Now our own leaders rush to the aid of those trapped in the rubble. Promising the blood of the injured and wounded to the dying and dead weather they agree to it or not.

I am clearly still mssing something in the NR business model. Would you be able to point out the basic cash flows, as it were and where the problem(s) lie(s). I think that I've got this so far:

NR borrow short-term money (rate S). They loan this to people to buy houses. From the accumulated mortgages, they create long-term bonds (rate L), which they sell into the market. The proceeds of the sale of the long-term bond has to pay back the capital of the short-term money they borrow, the interest on that short-term money, and their profits.

The credit default swaps bit relates to the difference between S and L?

The LCDX spread graph which you keep showing us relates to insurance on the long-term bonds that people buy. We know that some mortgages will go wrong over a 25-year period, and so we need insurance on this to make sure that we still get what we thought we were getting? And, you're saying that this insurance is so high now that people can't afford to insure bonds at a rate L which leaves NR with a profit?

Peter.

P.S. And, while you're at it, I still can't see why guaranteeing deposits should make a difference to the credit default swaps.

[Matt Bear]

There's a breakdown of NR's assets etc. here:

http://investing.reuters.co.uk/news/articl...OCK-FACTBOX.XML

*The bank uses four sources for funding. Balances for each segment were:

--Retail 24.4 billion pounds (23.2 percent of total)

--Securitisation 45.7 billion pounds (43.6 percent)

--Non-retail 26.7 billion pounds (25.5 percent)

--Covered bonds 8.1 billion pounds (7.7 percent).

*The bank had total customer account liabilities of 30.1 billion pounds, consisting of retail balances of 24.4 billion and other customer accounts of 5.8 billion. The breakdown of customer account deposits is:

--Branch accounts 5.6 billion pounds

--Postal accounts 10 billion pounds

--Internet accounts 4.1 billion pounds

--Offshore accounts 3.8 billion pounds

--Telephone accounts 441 million pounds

--Legal & General branded accounts 464 million pounds

*Bank liabilities totalled 110.1 billion pounds, including:

--Customer accounts 30.1 billion pounds

--Debt securities in issue 71 billion pounds

--Deposits by banks 3.7 billion pounds

--Derivative financial instruments 2.9 billion pounds.

*Assets stood at 113.5 billion pounds, up 28 percent from a year earlier. Assets included:

--loans to customers 96.7 billion pounds

--available for sale securities 8 billion pounds

--derivative financial instruments 1.4 billion pounds

--cash and balances with central banks 768 million pounds

*Loans to customers totalled 96.7 billion pounds, including:

--Advances on residential property subject to securitisation 49.8 billion pounds

--Advances on residential property not subject to securitisation 31.4 billion pounds

--Buy-to-let loans subject to securitisation 110 million pounds

-- Buy-to-let loans not subject to securitisation 6.1 billion pounds

--Commercial loans 818 million pounds

--Unsecured loans 7.8 billion pounds

--Unsecured investment loans 619 million pounds

[Guest tbatst2000]

From what I gather these CDO's work to reduce their net liabilities, but also reduce their income from the assets.

The only way they can stay afloat afaics is if the market for CDOs opens up again, but that cant happen until someone works out how to value them given whatever changed a few months back, and even then this depends on that valuation not being prohibitively cheap (lose to much income for not enough reduction in liabilities).

It's a bit more complex than that...the market that's primarily gone away is the one for residential mortgage backed securities (MBSs or RMBSs). Some other people packaged these up into CDOs, and that market has mostly gone away too but because people are frightened of what's inside of them.

Agreed that the spread between their funding costs and their return on capital isn't looking too healthy right now.....

[Guest tbatst2000]

--Non-retail 26.7 billion pounds (25.5 percent)

That's the commercial paper and deposits held for other companies. The commercial paper is coming due and mostly can't be rolled over hence the need for a bailout.

[Wudolf]

It is probably worth bearing in mind that when the BoE and FSA refer to solvency they quite likely mean something completely different to the man in the street's general understanding of it.

Regulatory solvency is calculated by reference to specific formulas and is not the same test as " can they pay the debts as they fall due".

As I gather NR were unique,amongst other things, in their absolute rejection of any IVA proposals one can reasonably assume that the carrying value of their loans is over stated which would change their regulatory solvency, not to mention the attractiveness or otherwise of the business to any purchaser. No doubt there have been multiple other ruses to obscure the actual state of the business.

What really sticks in the craw about this is the concept of moral hazard of which Merv seemed to be so fond. He quite happily presided over an orgy of lending and spending for which the rash borrowers will be penalised by higher interest rates and maybe having to work a bit harder. The savers among us however have our good sense and thriftyness rewarded by being threatened with having our savings completely wiped out. Presumably Merv will then be telling us that if savers had not deposited these sums with the banks those institutions would not have been able to do rash things with the money and get themselves into all this trouble. The root of the problem is therefore the jollu thrifty chap and he really should know better. It does seem a rum old business when good old sterling in cash is potentially the riskiest asset of them all.

[Guest tbatst2000]

The credit default swaps bit relates to the difference between S and L?

The price for a credit default swap is just an indication of how likely the market (or at least the people that make markets in CDSs) thinks it is that Northern Rock will default on a particular bond (also called the reference obligation) factoring in how much they'll pay up once everything's over (called the recovery rate). It's not directly related to any one set of numbers although it's obvious that a company with very few real assets and ongoing losses is going to have a much higher chance of defaulting than one in the opposite position.

[Guest tbatst2000]

As I gather NR were unique,amongst other things, in their absolute rejection of any IVA proposals

Interesting, do you have any references for that?

[REP013]

Interesting, do you have any references for that?

I did see someone on the BBC blog say this. Either a FA or a debt councilor.

A little search found this: Court Case Against Northern Rock Rejection of IVAs Moving Ahead But Needs Feedback From IPs

Northern Rock were the only creditor at the meeting to vote against the IVA

• Northern Rock were the majority shareholders so had overall say

• The debt owing was unsecured

• Northern Rock, following rejection of the IVA, took immediate court action against the debtor

• Northern Rock obtained a judgement

• Following judgement Northern Rock applied for an immediate charging order

• Northern Rock’s unsecured position is now secured

In the comments (only 1)

Comment #1 (Posted by IP considering letter to the Chancellor of the Exc)

Rating

I sense that today will be a good day to write to the Chancellor, and perhaps the former Chancellor don't you Ron ? I guess it will draw his attention to the petition on the 10 Downing Street website and ask him how he has the unmitigated gall to prop up an organisation which is woefully failing to comply with the Banking Code, and creating misery for thousands who cannot access legal procedures put in place by parliament to help people in debt. We can write to Northern Rock as well and ask them why they feel free to seek to shore up their business and appear on the Today programme and all but say that their business is mortgage business when we all know that actually a very significant slice is actually unsecured at the point of lending, and until they do something to trigger their security. I wonder if the Bank of England have realised how unsecured the Northern Rock business is !? Perhaps another letter !

and this quote on another site ... LINK

Hi

I have a feeling that NR will be even less receptive to IVAs now,preferring to keep debts on the book rather than the full write off from an IVA or Bankrupcy.The last thing that they need now is an announcement of an increased bad debt provision to drive their shares even lower.

regards

Andy Davie

IVA.co.uk Spokesperson

Looks like they may be adverse to the use of IVA's.