Northern Rock’ Crisis Essay

Northern Rock is one of the top mortgage lenders in the United Kingdom. According to Council of Mortgage Lender statistics, the bank was ranked one of the top five mortgage bank. The bank served loans, insurance and savings account as their core business. Some secured loans also have been promoted to their existing customer. That loans business was underwritten by Ventura. For home and contents insurance, it was administered by AXA. While, Legal & Generals was arrange stock market based investment and insurance for Northern Rock.

The bank went to FTSE 100 index in 2000.

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Northern Rock’ Crisis
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However it was downgrade to FTSE250 in December 2007 because the crisis that has been faced. The bank caught crisis by subprime mortgage financial crisis that happen at US. Consequence of the crisis, the bank has credit markets problems. It need more cash to support their running business. It received liquidity support facility from Bank of England. The reasons bank get into crisis because the subprime mortgage that have been face by Lehman Brothers.

The bank had moved to make a deal with Lehman Brother before, which the risk was being underwritten by Lehman Brothers.

The starting point of the crisis is the bank business plan itself. The bank involved heavily borrowing to UK and international market. The bank extends mortgages to customer and then resells to international markets. This is known as securitization. The business plan for the Northern Rock bank is to raise money from securitization. However, when the crisis in August 2007, the bank faced liquidity risk because of the dropped demand from investors for securitized mortgage. The bank did not have problems to cover its liabilities since it will be covered by its assets.

However, the institutional lenders became nervous following US subprime crisis. The crisis has dragged Northern Rock to liquidity problems that force the bank to ask the help from Bank of England. The bank unable to raise their money and faced liquidity problems. To replace funds that the bank lost, the bank of England has given liquidity support facility. However, this still cannot create confident for depositors. They panic and line up outside the bank to withdraw all of their savings. This incident is the UK’s first in 150 years. This happens on 14 September 2007, where people already queue to withdraw their money.

It is like snowball effect and lead to liquidity risks. It is estimated about $1 billion had been withdrawn from Northern Rock bank on that day. The shares dropped fast. It has lost 32% on previous Friday. On Monday 17 September, it still dropped from 438 pence to 263 pence. To avoid more chaos, the Chancellor of the Exchequer announced that British Government and the Bank of England will guarantee all deposits in Northern Rock. Fortunately after the news, the shares of Northern Rock raise by 16%. There also no queue after the announcement outside of Northern Rock.

Northern Rock also makes the statement at major UK newspaper to reaffirm that their customer money is safe. Financial Services Authority (FSA) has released an internal report on 26 March about this. The report is about the problems of handling that face by Northern Rock. One of the reasons is the supervision of the bank had not carried a standard acceptable. Another reason of collapse that happens to Northern Rock is because of senior management. The FSA’s internal report stated that, the board and managements regulated firms carry the primary responsibility for ensuring their institutions financial soundness.

FSA also publicly state that Northern Rock is a good quality company which has exceeded its capital. As the result of this crisis, Northern Rock was out from FTSE 100 index and demoted back to FTSE 250. After that, the shares was delisted when the takeover’s proposal from others companies had been rejected. Because of the incident, Matt Ridley was forced to resign as chairman in 2007. He was blamed because for not recognized the risks of the bank’s financial strategy. The crisis that happens to Northern Rock has attracted a few companies to take over the bank. One of the companies is Virgin Group.

Another company is Olivant, which was an investment company. Until 17 November 2007, there are ten companies has put proposal to take over the banks. However, all the offer is reject since it had been “material below” the previous trading value. The companies come with new bids which the deadline is 4 Feb 2008. However, announcement that made on 17 February 2008 said that not any companies win since the bids did not offer sufficient value for money to the taxpayer. The result, the bank will be in public ownership for a temporary period. However, customers are not affected by the ‘nationalization’ of the Northern rock.

Shares for Northern Rock suspended short later after the announcement. Although there is no technically nationalization, but in all but name, Northern Rock is now nationalized. Northern Rock was formally nationalized on 22 February 2008. The bank is managed by government through UK Financial Investments Limited. The function of the company is to manage Northern Rock and Bradford & Bingley shareholdings. There are also a few changes in board directors. The government has appointed Ron Sandler as a new Executive Chairman. In October 2008, Ron Sandler moved to a Non-Executive Chairman position when Gary Hoffman came in.

Garry Hoffman became Chief Executive of Northern Rock in October 2008. Some of the Northern Rock’s former directors were fined and banned by FSA for failing to ensure accurate financial information. One of them is former deputy chief executive David Baker. The bank planned to repay the money that his received from the government within three to four years. A few debt reduction strategies were taken. One of the ways to do that is by encouraging mortgage customer to take their mortgage to another bank. Northern Rock also reduced the number of their staff to cut cost. The bank plans to cut 2000 jobs which is a third of jobs by 2011.

There is about 1300 staff have been reduced at end of July 2008. 500 staffs are through voluntary redundancy program. Another 800 staff are through compulsorily redundant. Northern Rock also sold its portfolio of lifetime home equity to JP Morgan. The money it got, ?2. 2 billion is used to pay off for the Bank of England loan. Since the crisis, the bank has developed its own staff. This is as a way to reduce operational risk. Most appointments are made internally. After revised make by Standard & Poor’s Rating Services, new outlook for Northern Rock is from stable to positive.

The bank’s long and short-term ‘A/A-1’ counterparty credit ratings also had been affirmed by them. The bank’s employee received a 10% bonus as reward on 21 January 2009 for bank meeting its target for repaying Government loan. There is only ?8. 9 billion of the loan remained unpaid on March 2009. The latest 1 October 200, it announced another ?700 million had been paid off. This slowly create confident from the people. The bank was repaid their loan ahead of target. The bank also decided to remove its commitment to take only 1. 5% shares of total UK retail deposits.

Northern Rock also announce on January 2009 to change its business strategy by offering retention deals to its existing mortgage borrowers. As the Northern Rock is becoming more stabile, the government had removed the 100% guarantee of deposits at Northern Rock’s bank on February 2010. This means customer’s money are now guarantee for only ?50,000 like most banks. The bank was split into two parts, asserts and banking on 1 January 2010. After the split, each company has its own board directors. Now, the bank is ready to going private again. There are a few big player still interested to own it.

References :

* http://www.telegraph.co.uk/news/uknews/1563266/The-Northern-Rock-crisis-explained.html
* http://www.guardian.co.uk/business/2008/feb/17/northernrock.nationalisation
* http://news.bbc.co.uk/1/hi/uk_politics/7258492.stm
* http://news.bbc.co.uk/1/hi/business/7007076.stm
* http://news.bbc.co.uk/1/hi/business/7587718.stm
* http://www.bankofengland.co.uk/publications/news/2007/090.htm
* http://en.wikipedia.org/wiki/Northern_Rock
* http://en.wikipedia.org/wiki/Nationalisation_of_Northern_Rock

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