Nothern Rock caught on Speed Camera

Implications: 1.An innocent victim caught between subprime hurricane and credit squeeze. 2.Borrowing to invest without adequate savings is creating a false sense of growth. 3.Questionable role of money market intermediaries.

Analysis:  

Northern Rock was formed in 1965 from the merger of Northern Counties Permanent and Rock building societies. In 1997 it demutualised. The exponential growth started in 1999, when the bank used money markets to raise funds. Building a 76 branch network and focusing on mortgages and pioneering the use of securitisation it developed into a highy efficient Bank.The formula of using the wholesale market to fund its lending seemed to work for sometime. But in June this year the bank stunned the markets by issuing a profit warning as it was caught in the interest rates rises. By the time it opened its branch doors on 14^th September long queues had already formed. Customers wanted their money back. At one branch , police had to be called to restore order. On the other side, the customers reported they were unable to access their online accounts as volume of depositors and mortgage holders caused the website to freeze.

While the Bank was scripting its fast growth strategy, it had analysts eating out of its hand. It received fullsome praise for its high profits and generous dividends. But the same analysts are now condemning its strategy as risky.The amazing turnaround occurred as the very markets which helped script its runaway expansion caused its downfall .

However, as of now, it does not appear to be the fault of the bank as such. The bank had high standard of mortgage customers, the drawback was the means used to fund such mortgages.

This exposes the underlying faultline in the financial markets - as long as a strategy is working the inherent faults are overlooked and no sooner there is a setback, daggers are out. Why the underlying faults were not noticed when the bank was building its book on borrowings ? The margins would have been thin. How was the bank able to build its huge profits and sustain giveaways ?

The asset backed mortgages could be rock solid but the bank had no built in savings. There was another lending practice that may have caused its downfall. It had a innovative “Together” mortgage, which packaged a mortgage with a unsecured loan causing customers to borrow 125 per cent of the value of their home. Where is the margin for risk ? A revaluation of the the bank’s mortgage portfolio may open a Pandora’s box. The losses could be more than what is visible. With no cash. A strong mortgage portfolio, without a margin.Unsecured loans with no deposit back up. The bank is in a mess than it would appear at the moment. Time is ripe for a takeover by a healthy bank.

Added to this, the apparent bid by Bank of England to lend at penal rates, is going to hit bank’s already ‘under pressure’ profit margins. The attempted rescue could turn out to be otherwise.

This issue raises further questions about the value of opinions of the analysts and experts. Just as in the case of the role of rating agencies in the subprime crisis, the analysts should share part of the blame for not blowing the whistle when required.

The twin roles of the rating agencies and the analysts have brought the world’s financial markets and the economies to the brink by their timely inaction.