Northern Rock Gets a Reprieve

U.K. mortgage lender Northern Rock's bailout by the Bank of England dominated U.K. headlines this morning. Although initial reports paint the Bank of England's intervention as somewhat positive news claiming that the bank would only intervene if it believed that the U.K. mortgage lender had the ability to quickly sort itself out, by late afternoon skittish customers were already queuing outside Northern Rock branches. At the same time, nervous ABS investors sent trades on Northern Rock paper wider. According to market reports, the Bank of England injection aids the U.K. mortgage lender to continue funding its operations, while it works on a resolution to its current liquidity problems. "The BoE is providing an uncapped facility to Northern Rock to the extent that it has eligible collateral, through the freeze period," explained Sarah Barton the primary analyst at Morgan Stanley. "Northern Rock will fund itself either by borrowing on a secured basis from the Bank of England or by entering into a repurchase agreement with Bank of England at an interest rate premium." Barton added that the repo would include RMBS backed by prime residential mortgage assets - collateral similar in nature to the collateral used by many Eurozone banks with the ECB. "The Chancellor's decision to authorize was made on the basis of recommendations by the Governor of the Bank of England and the Chairman of the FSA," Barton said. "The FSA judged that NR was solvent, exceeded the required regulatory capital and has a good quality loan book. The Bank of England also mentioned that 'in its role of lender of last resort' it was ready to provide facilities under similar circumstances to other institutions facing short-term liquidity difficulties." Several traders reported that Northern Rock paper under the Granite master trust series has started to trade wider on the back of the news released early Friday morning. Barton said she expected Granite to widen further adding that any further relative widening for Granite spreads was seen as a buying opportunity at the triple-A level. According to date reported by Morgan Stanley the three months plus arrears in the residential book were 0.47% at the end of August (0.47% in June), which was still under half the industry average of 1.21% (1.11% in June). "This is not an asset quality issue for Northern Rock [because] the collateral is performing well among its peers," Barton said. "We acknowledge that CPRs could potentially increase and this could potentially impact the average life of the pass-through tranches. As borrowers potentially become aware of the problems of their lender through the media, they may not wish to remain in a business relationship with them." Fitch Ratings on Friday downgraded Northern Rock's long-term Issuer Default rating (IDR) to 'A' from 'A+' and Individual rating to 'B/C' from 'A/B' and placed them on Rating Watch Negative (RWN) but explained that the current 90% asset percentage and available overcollateralization level of just under 52% help the mortgage lender's covered bonds withstand Fitch's 'AAA' asset and cash flow stresses.