The one-time giant among U.K. mortgage lenders, Northern Rock, which holds a fifth of all residential mortgages, continues to find itself hobbled. Despite continued assistance from the Bank of England and impending takeover bids, the fate of the bank's Granite master trust is now facing dark predictions.

In the interim, the bank continues to operate in limbo, helping to feed criticism that the British government is taking too long in reaching an outcome on Northern Rock. In fact, the U.K. Chancellor of the Exchequer, Alistair Darling, is facing intense criticism in the mainstream media. Also, the general public has voiced fears that Northern Rock's capital lifelines will be footed by taxpayer money, a strategy that they see as inappropriate.

Another large issue of concern is the lack of information being made available from the U.K. Treasury. A much publicized meeting held by the Treasury last week was believed to have centered around solving the Northern Rock problem, with a focus on improving the banking industry's reputation as a whole.

But a press release from the government body regarding the meeting did not mention Northern Rock, understandable given the confidential nature of impeding acquisition proposals, and a spokeswoman from the department merely added, "they only talked about Sukuk bonds, not Northern Rock."

"We understand that Treasury concerns as to taxpayers' losses, frequently referred to, stem from bids which include interest write-offs on the loans from the Bank of England," said analysts at Societe General. "It is unlikely that many bids will include a facility to repay all of the loans extended so far, given the size, which is estimated to be in excess of GBP22 billion ($45 billion)."

The analysts added that an early conclusion, especially before year end, is highly unlikely. Bidders are asking the Treasury for more details in respect to the ongoing funding before placing a solid bid, while the Treasury is seeking greater information on the available capital of bidders before recommending or rejecting bids.

While market players and the British government continue to circle the drain, "we expect that bonds will remain at elevated levels while the bidding process continues," said Societe General. "For junior notes we believe the low risk of a significant extension justifies increased spreads. However, for senior notes the spreads remain extremely generous, in our view, especially those due principal in the earlier wave of payments from the trust."

No Single Solution

Market observers at Moody's Investor Service added that it is unlikely that a single, large institution will come to the bank's rescue. Instead, there are a "wide range of corporate solutions" becoming available. These include a takeover bid from a consortium and the break-up and sell-off of several parts of the bank.

In the meantime, the Bank's Financial Strength Ratings (BFSR) continue to degrade, as last Monday Moody's downgraded Northern Rock's BFSR to D+' with a negative outlook from C-' with a developing outlook.

"The D+' maps into a Baseline Credit Assessment of Ba1,'" said the ratings agency. "The bank's subordinated debt and Tier-1 securities were downgraded to Baa1' and Baa3,' respectively, and the direction of the review on these ratings was changed to possible downgrade from direction uncertain. The direction of the review on the bank's Aa3' long-term bank deposit rating was also changed to possible downgrade from direction uncertain. Northern Rock's short-term rating was affirmed at Prime-1."

Analysts at Deutsche Bank commented on the ratings action taken by Moody's, as well as the general situation surrounding the bank. Again, criticism rested on the lack of available information, which is only leading to speculation on the future of the Granite trust.

A confidential memorandum from Northern Rock detailed three scenarios for the sale of the bank, "one of which we understand aligned the takeover of the master trust along with the acquisition of the bank's infrastructure," said analysts at Deutsche Bank, and was silenced by Northern Rock after the bank obtained an injunction on the report's publication.

In a separate statement, however, the Treasury outlined its principles for assessing a takeover of Northern Rock. The deposit guarantee arrangements would remain in place, and any interested bidder should not assume that the current loan facilities will be available after the February 2008 expiry date.

Also, the GBP25 billion lifeline to Northern Rock may have to be deemed state aid and require European Commission approval.

In the meantime, "any insolvency or administration of Northern Rock would result in a non-asset trigger breach in the Granite master trust, which leads to an accelerated unwind of the structure with the seller share time subordinated in the waterfall, assuming economic or asset triggers remain in compliance," said the Deutsche Bank analysts. "Of further concern in such a scenario is the outcome for the basis swaps in the Granite trust."

Although Darling appears to be sitting tight, some of his colleagues may be feeling the heat.

Dame Deirdre Hutton has announced she will step down from the board of the Financial Services Authority in December, although a specific reason has not been explicitly given. One direct casualty, though, is in the form of Northern Rock's Chief Executive, Adam Applegarth, who tendered his resignation on October 16.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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