Rock around the clock
For better or worse the future of Northern Rock has dominated the headlines this month, as it has done for almost half a year.
Following scenes of Richard Branson schmoozing with the prime minister on his trade mission to China, and the Goldman Sach’s Rock rescue proposal that amounted to an issue of state-backed bonds to the tune of £25bn, the clever money was on Richard Branson’s Virgin getting the business on the cheap.
But on Sunday 17 February all became virtually clear – the Northern Rock was to be taken into public ownership and in the ensuing week the chancellor Alistair Darling introduced emergency legislation that would nationalise the failed mortgage bank – although, of course, Darling reassured us all that it would be business as usual.
Thus, instead of the spectacle of panicking investors queuing outside Northern Rock branches to withdraw their money we may well now witness queues of of bank and building society executives waiting in line to deposit fat cheques and why not? Unless the situation changes under the direction of new executive chairman Ron Sandler, they will be making more money out of saving with the Rock than they can make from their own mortgage books. And what’s more, the money is as safe as government gilts!
Maybe it was a coincidence, or perhaps Darling had planned it, but the emergency legislation was put before parliament on Wednesday 21 February, Gordon Brown’s first birthday as prime minister. So, in a sense, he was given his very own state-owned mortgage bank.
It’s a wonder that the opposition didn’t club together (maybe they could have claimed it against expenses?) to buy him a giant rock cake with 57 candles. One also wonders what he would have wished for, if he could have blown out all 57 candles in one go. Would he have wanted to rewrite his previous six months as prime minister, or his last 10 years as chancellor?
Ironically, by end of play on Gordon’s birthday the emergency legislation was facing a crisis of its own over the issue of the £49bn Granite barrier – MPs were concerned that Granite, an offshore special purpose vehicle used by Northern Rock, might cost the taxpayer £6bn (the amount that Granite has invested in Northern Rock) should the virtuous circle of money between the Rock and Granite dry up.
Put simply, Jersey-based Granite, which was established by the Rock to raise low-cost funding, owns around £50bn of Northern Rock mortgages. It has packaged these as bonds and sells them on to investors in return for an income but the model is only sustainable if the Rock continues to write new mortgage business to replace those loans that have been redeemed.
The fear was that, following nationalisation, the government would have to repay that £6bn immediately. There was also the additional concern that the best of the business had been sold-on this way, leaving the marginal business on balance sheet for the state enterprise.
The upshot of all this is that government is asking parliament and the electorate to take a lot on trust. And it is not just the state of the Rock’s mortgage book – much depends on what Darling calls business as usual and management at arms length by Ron Sandler and his business plan, to be presented to Brussels on 17 March.
Sandler has already said that he does not intend to run down the Rock to extinction and the concern, as expressed by Angela Knight of the British Bankers Association, is that a state-subsidised Northern Rock UK Limited could be anti-competitive. Assurances by Darling on that score and, for example, that the bank would not be discouraged from repossessing homes of borrowers who fell behind with their mortgage payments, sounded hollow as well as somewhat ironic.
On the trust issue, the government subsequently suffered a defeat in the House of Lords in a vote for an independent audit of the bank’s books within three months, followed by annual checks. The amendment, backed by a vote of 154 to 142, was the first in a series of changes that were discussed by peers before they sent the bill back to the House of Commons.
The big mystery
Why has the government singled out Northern Rock for rescue when lending institutions are not exactly in short supply and others with troubles are left to sink or swim in the same troubled waters? What is certain is that the casualty list is growing, though February was not the worst month in terms of attritionDuring the month Lehman Brothers announced that it would be making further redundancies of up to 200 staff in its Mortgage Capital business as a result of “ongoing severe dislocation in the mortgage markets”. The good news here is that it also confirmed it would continue to originate loans under both the Preferred and Southern Pacific Mortgage Limited brands.
And there has been a senior management reshuffle at Britannia, which saw Gerald Gregory, managing director of Britannia Capital Investment Group, being replaced by Group finance director Phil Lee. Gregory, whose empire embraced treasury, commercial lending, Platform, Britannia International, and Britannia Treasury Services, effectively masterminded the building society’s members’ reward scheme which has been largely funded by profits from Platform, the society’s non-conforming subsidiary, which had been acquired by Gregory and relies heavily on the capital markets for its funding.
News of Gregory’s departure was followed by the announcement that Platform, was to be restructured (“to ensure it remains competitive when stability returns to the mortgage market”). This involves job-cuts “in response to continuing difficult market conditions and the significant reduction in business volumes due to the closure of securitisation markets”.
David Tweedy, Platform’s managing director, said: “The impact is much less than we are seeing with most of our competitors but, nonetheless, it is likely that up to 65 colleagues from a total headcount of 305 will lose their jobs”.
Platform has been under pressure for some time. In November Britannia and rumours warned that profits for 2007 were unlikely to exceed levels experienced in 2006 when membership rewards totalled £51m.
Then came the results
The month saw the reporting season start in earnest with the expectation that the building societies would do well and that some of banks might suffer either from their exposure to the US sub-prime market and/or as a result of funding problems because of the credit crunch.
In the event, the building societies performed more or less as predicted with (in alphabetical order) the Bath, Darlington, Leeds, Norwich & Peterborough, Newcastle and Skipton all recording successful years.
Bath, for example, claimed 2007 has been the most successful year in its history, with asset growth of over 15%, taking assets to more than £190m. Group pre-tax profit was also up by over 25%, and the society chalked up record gross lending of over £45m.
Darlington Building Society reported new lending 10% higher than in 2006 at £158m, and an increase in total mortgage balances of over 11% to £538m. Total assets grew by 14% to £689m and pre-tax profit was up by 19% to £2.2m. Its management expenses ratio was down by 8%
Leeds saw savings balances rise by above market share to a record £757m, providing the funding for 94% of all the society’s net lending in 2007. Net lending, in turn, was up by 16% to a record £807m, with much lower redemptions than market share. Efficiency improvements reduced the cost/asset ratio to 53p per £100 of assets from 58p and the cost income ratio improved to 40% (41% in 2006). Pre-tax profits rose 10% to a new record of £63.2m (£57.2m in 2006) with reserves increasing to £446m.
Norwich & Peterborough Building Society, which was the first UK financial institution to obtain a Basel II waiver from the Financial Services Authority, reported group pre-tax profit of £24.3m, up 20.3%. Total income grew by 10.3% to £83.5m, while costs grew by 4.7%. The return on capital increased to 13.0% from 11.7%, while the management expense ratio fell by 0.11% to 1.40%. Total mortgage assets were up 12.9% to £3.2bn with new mortgage advances of £974m (2006 £809m).
Newcastle Building Society reported some rare good news from the North East with group profit up 52% to £17.6m and a 48% increase in other income, supported by expansion of the Solutions business and high demand for investment products through Newcastle Financial Services.
Total assets grew 9% and gross lending exceeded £1bn for the first time. Chief executive, Colin Seccombe said: “With this progress has come job creation and long-term investment. Not only were there no redundancies as a result of the merger with the Universal, but we also created over 200 additional positions in 2007. We are now one of the largest private sector employers in the North East.”
Finally, the Skipton Building Society Group and its subsidiaries delivered a strong lending performance – mortgage applications to the society, Skipton Guernsey, Pink Home Loans, Connells and Amber Homeloans totalled nearly £19bn.
The annual results also show strong performances in other areas – pre-tax profit (excluding dividends from subsidiaries) is up 11.7% to £33.4m while its management expenses ratio dropped from 57p to 49 per £100 of assets.
At a group level, Skipton’s diversification and ongoing profitability resulted in pre-tax profits of 1.43% as a percentage of mean assets – which chief excutive John Goodfellow confidently expects to be double that of any other building society. The group pre-tax profits of £165.5m include a one-off gain of £36m (2006: £15.7m)) following the sale by Connells of 4.7% of the shares in Rightmove, the property website it helped set up in 2000.
The results of the other lenders on the high street were more mixed. Alliance & Leicester, for example, found itself once again in the limelight as a potential takeover target, after revealing a 30% drop in annual profits. Barclays, however, basked in the sunshine after revealing that its sub-prime losses in 2007 amounted to £1.6bn – £300m higher than had original been expected and reporting profits of £7bn – 1% down on the previous year.
The A&L bank’s losses of £165m looked trivial in comparison with those of Barclays but scale and overall performance are the issues. A&L attributed its losses to a reduction in the market value of its £23.1bn of treasury investments and the impairment of a large proportion of its structured investment vehicle, mezzanine and capital notes. It stated that the value of its treasury investments plummeted by £242m due to market conditions in the second half of the year.
Lloyds TSB, like Barclays, hardly raised eyebrows when a few days later it revealed a 6% fall in annual pre-tax profits and investment losses of £280m in its 2007 results. The bank attributed the fall in profits and write-downs to market volatility and said the dividend paid to shareholders has increased by 5%. Its pre-tax profit was £4bn in 2007, down from £4.25bn in 2006. Write-downs rose to £280m from £200m in 2006.
RBS was scheduled to report on 28 February, after Lending Strategy had gone to press, but the expectation was that it would be writing down US sub-prime related assets worth £1bn.
Death of supersized mortgages
Another sign of the times was the death knell of supersized 125% LTV mortgages which was rung, albeit softly, by BM Solutions when it withdrew its Mortgage Plus Range on 22 February.
BM was the last lender to withdraw from the high LTV loan arena. Alliance & Leicester started that particular ball rolling on 19 February and was followed by Godiva Mortgages. Abbey then axed its pilot scheme, launched last September, for a combined 100% mortgage with a £25,000 loan.
On 21 February Northern Rock (and we now seem to be back where we started), buckling under political pressure, pulled its Together range that allowed a maximum 125% LTV. That move generated headlines in the weekend press to the effect that thousands would be trapped in Rock loans (The Sunday Times estimated that about 175,000 borrowers had been ‘lured’ into these loans) and would find it difficult to remortgage.
Certainly the lender exodus from this particular market could create problems for borrowers and limit their remortgaging options. As Ray Boulger of John Charcol pointed out in the context of Northern Rock: “The government is in effect a negative equity lender, while borrowers who owe more than the value of their home are left with few options as their chance of remortgage onto another 100%-plus deal are slim.
Indeed, Nationwide Building Society’s decision around the same time to introduce higher repayments for mortgages above a 75% LTV effectively demonstrates that it is not just those at the margin who are being squeezed and that even borrowers with a 20% deposit of £40,000 on a £2000,000 property will also be sharing some of the pain.