4 February 2008

Northern Rock from Building Society to Bust

When the board of Newcastle based former building society Northern Rock persuaded its members to float their business on the stock market the shares were snapped up like hot cakes.

Today the 115,000 small investors left holding the stock have watched in disbelief as the value of their investors has fallen from £12 at the start of 2007 to just 101p this morning.

So how has it been possible in the ten short years since becoming a public limited company for the Directors to reduce to rubble a business that took 150 years to build?

The Northern Rock Building Society was created in 1965 when the Northern Counties Permanent Building Society and Rock Building Society (established in 1850 and 1863 respectively) merged. On the 1st October 2007, after amalgamating with fifty three smaller societies, the Northern Rock gave up its mutual status, became a bank, and was listed on the London stock exchange.

By the year 2000 Northern Rock valued as one of top hundred listed companies and a widely tipped takeover target by city analysts and the press.

The cause of Northern Rock’s very public failure in 2007 is paradoxically directly related to the very same strategy responsible for its success following conversion from Building Society to in 1997.

Offering combination of low cost mortgages, funded substantially loans from other financial institutions, customers flocked to the Northern Rock. At its peak the Northern Rock grabbed a fifth of all new mortgages business in the UK. Who would have thought, as the share price teetered in the middle of 2007, that Northern Rock’s business winning strategy would herald the first run on a bank in living memory.

The fact is that rather than relying on depositor’s savings to support its loan, as building societies do, the Northern Rock was borrowing as much as 70% of the money it lent to its mortgage customers from the capital markets. This meant that when the Credit Crunch hit the money markets in the summer of 2007 Northern Rock’s was hit disproportionately hard. As the Northern Rock's source of funds dried up the bank could not balance its books and on the 13th September 2007 the Bank of England had to step in to save it.

Naturally, as soon as Northern Rock’s savers heard the news that the bank had gone begging to the Bank of England they wanted their money back.

In September last year Northern Rock’s high street branches were besieged by nervous investors desperate to empty their accounts. At the same time shareholders sold out as quickly as they could as the Northern Rock stock plunged on the stock market.

Desperate to restore confidence in the panicking financial markets, and plug the gap in the bank’s books the Chancellor of the Exchequer, Alistair Darling sunk 25bn of public into the Northern Rock. At the same time the Chancellor pledged to safeguard savers money who understandably believed the Northern Rock was about to go bust.

So what is to become of the Northern Rock?

The Government will be hoping that one of the predators circling the carcass of Northern Rock will take it off its hands. As I write a three way competition for control of the Northern Rock is underway. Tax payers will welcome the news that any successful bid is expected to include plans of how the new owners intend to repay the U.K. Tax Payer, but a £25bn debt mountain will prove a difficult pill to swallow.

Currently, Sir Richard Branson’s Virgin Group, Olivant Group, headed by former Abbey National Boss Luqman Arnold and a Northern Rock Management buyout team are considering acquiring the struggling bank. The three bidders wishing to take control of the Northern Rock are expected to put their case to the Treasury later today.

The sticking point remains, however, whether any offer will include a satisfactory proposal to pay back British Taxpayers their £25bn? If a serious offer is not forthcoming, and the private bids fails, the Government remains adamant that the bank will come under temporary public ownership. In anticipation the Treasury has appointed renowned financial troubleshooter Ron Sandler who successfully rescued Lloyd's of London from the brink of collapse in 1995.