Bank of England plans unprecedented bailout of mortgage lender

By Peter Thal Larsen and Neil Hume
Financial Times, London
Thursday, September 13, 2007

http://www.ft.com/cms/s/0/6cdb3a98-6236-11dc-bdf6-0000779fd2ac.html

The Bank of England will on Friday bail out Northern Rock by providing emergency funding to the beleaguered mortgage lender, which has fallen victim to the liquidity squeeze in the banking sector.

In an unprecedented move, the bank, working with the Financial Services Authority and the Treasury, will step in to prop up Northern Rock by providing it with a short-term credit line that will allow it to carry on operating. The bailout, which has been approved by the chancellor of the Exchequer, is the most dramatic illustration to date of how the British banking sector is being hit by the wave of market turmoil that has paralysed the money markets.

It will lift the uncertainty that has been hanging over Northern Rock's future for much of the past month because it could not access the wholesale funding upon which it is heavily dependent. The bank is also expected to reassure thousands of the bank's customers that their deposits are secure.

Northern Rock is the first institution to be propped up since the bank in 1998 revised the rules under which it will act as a lender of last resort to banks that have hit financial difficulty. The bank on Friday is expected to say that a similar facility is available to any other institution facing short-term difficulties.

It is understood that there is no concern about the quality of Northern Rock's mortgage book, which has no exposure to subprime borrowers, or its capital levels. But the bank, one of the UK's largest mortgage lenders, has proved particularly vulnerable to the liquidity squeeze because it has a much smaller deposit base than other banks.

Northern Rock approached the bank at the end of last week to discuss using the facility, people familiar with the situation said. The bank made its decision because it faced pressure to refinance obligations that are due to mature in the next couple of weeks.

Northern Rock executives are on Friday expected to say that it will try to trade through its difficulties with the help of the Bank of England facility.

However, the move is likely to make it hard for Northern Rock to remain independent in the long term.

The bailout is a devastating blow for the bank, which grew from its roots as a building society in the north-east of England to become the most efficient mortgage lender in the UK, winning wide praise for its business model and its ability to take advantage of the innovations in the capital markets.

The bank is on Friday set to issue a trading update setting out the impact of the recent market turmoil on its business. Northern Rock declined to comment.

Since hitting their peak in February, shares in Northern Rock have lost half their value amid concerns that the rising cost of wholesale funding would squeeze margins and limit the bank's growth. On Thursday the shares closed down 33p, or 4.9 percent, at 639p.

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