Why a nationalised Northern Rock will make money

Here's a guest post from Simon Ward of New Star fund management. Simon (pictured) made a name for himself after being the only economist in a Reuters poll to correctly predict a bank rate rise last January (2007).

Here, he explains why he thinks the Government - and taxpayers - could turn a tidy profit from Northern Rock..

"Media comment has focused on the risks but the nationalisation of Northern Rock could prove extraordinarily profitable for UK taxpayers – assuming the government can avoid making a significant compensation payment to equity and subordinated debt holders.

Despite Treasury guarantees, Northern Rock has been forced to offer high interest rates to retain its retail deposit base, with savers concerned that their accounts would be frozen in the event of the bank going into administration. (Including a temporary loyalty bonus, Rock’s tracker online account currently pays a 6.99% AER.) Nationalisation removes this liquidity risk and should allow the bank to reduce its retail funding costs significantly.

European Union state aid requirements imply the Bank of England will continue to charge a penal interest rate on its loan but this now represents a transfer within the public sector.

On the assets side, the aim will be to shrink the mortgage book to allow early repayment of the Bank of England’s loan. New lending will be negligible and mortgage rates will be raised to encourage existing borrowers to refinance elsewhere. Assuming they stay, this will add to the boost to profitability from lower funding costs. Job losses are also inevitable, reducing the bank's cost base.

The key concern is that housing market weakness coupled with possible adverse incentive effects from public ownership will lead to significant default losses. Northern Rock had £97 billion of customer loans at 30 June 2007 but credit risk on £46 billion of the total had been partially transferred to holders of securitised notes.

In the housing recession of the early 1990s repossessions nationally reached a peak of 0.77% of outstanding mortgages in 1991. Assume Northern Rock is forced to foreclose on 1% of its loans each year for three years and achieves a recovery rate of only 70%. Based on a £97 billion book, this would imply a loss of £850-900 million, of which about £150 million might fall on holders of securitised notes. Northern Rock’s shareholder funds stood at £2.3 billion at 30 June 2007.

Even assuming significant erosion since, the remaining equity in the business should easily absorb any losses barring an Armageddon scenario for the housing market."

So will Northern Rock be a nice little earner for Gordon Brown & Co? Have your say below - just post your comments and add your email (which is only for verification). Ignore the URL box.

- What next for Northern Rock?

- Q&A: Northern Rock and nationalisation
- What will happen to Northern Rock mortgages?
- Should you put your money in Northern Rock?
- Why house prices will decide Northern Rock's future
- Northern Rock sending customers to rivals

Comments

[Mr Georges]

I have my mortgage from the Rock and the fixed rate offered me will expire in August this year and from what I read, the Rock is likely to increase its rate in order to off load it Mortgage customers. What should be the best for me. Should I re-mortgage when my fixed rate comes up in August or stay and try and get the best from the Rock?

[Mrs. Layton]

Whether or not the Nationalisation of Northern Rock will turn out to be a "nice little earner for Gordon Brown & Co" the tax payer should never have been put in this invidious position.

What should have happened is either the Government should have authorised the Lloyds TSB takeover, with a limited liability of £30million or they should have compelled a consortium of other banks to buy Northern Rock amongst themselves.

If Northern Rock had been Southern Rock in the south east of England, the labour goverment would have let it go to the wall. What they have done is tantamount to gerrymandering, and is an absolute disgrace.

[Lou Valdini]

Simple, concise and, accurate. Finally, an 'expert' talking sense about Northern Rock. Simon also managed to address some of the concerns about the state of the housing market by putting the potential financial impact into some context. It's not much help to those who will suffer foreclosure but, all I can say is that if there is any way that home owners can continue with their morgages through re-financing, the benefits will be significant. Just look at the value of a house in 1991 and, it's value today. It's here that the banks need to help with supportive re-finance rates and, I believe the Government needs to crack the whip to make sure they do. A strong housing market, supported by a viable buy-to-let market for all those that need to live somewhere but can't afford to buy, is essential for us all. If Gordon Brown wants to salvage just a piece of his self-acclaimed economic 'miracle' he must focus on the housing market.
If the retail banks won't help, we now own our own bank that could. It's not sexy but, Nothern Rock really is just another Government department now, like the DWP (whick leaks £billions each year.)