Northern Rock said last week that it plans to become a smaller, more focused mortgage and savings bank. However, it still intends to continue with its securitization business.

The mortgage firm disclosed its plans to reduce staff by a third. By 2011, it intends to get rid of between 2,000 and 2,500 jobs. This comes with a reduction in the asset base by half over the same period. Northern Rock said it also plans to phase out state aid support over three to four years.

The mortgage company is positioning its business by cutting in half its current outstanding mortgage loan book through much more selective originations. Its mortgage origination unit will now be focused on prime residential mortgages. It will also be working with the broker network to encourage refinancing away from Northern Rock.

The firm intends to keep the Granite securitization program running and stated that it will originate sufficient mortgages to replenish the Granite pools.

"Presumably the new deals will need an extension concentration risk clause, as the key risk is that the existing loans start to pay down well before the new loans will start to pay down," a market source said. "Because Northern Rock issued short-term paper with five or, at most, seven-year maturities with 20-year mortgages, even generating more mortgages might still cause Granite to hit ratings triggers and perhaps cause a realignment of payments."

The strategy will also involve the bank increasing its proportion of retail funding. Deutsche Bank analysts said that the bank's competitive savings rates have been criticized by other banks as giving it unfair advantage. In fact, a formal complaint against Northern Rock has been made by Danish lenders to the European Commission.

Fitch Ratings said in a report published last week that ratings for securities issued from Northern Rock's Granite Residential Mortgage-Backed Securities program and the related Whinstone program are expected to remain stable. However, the agency warned that the future remains uncertain and contingent upon the shape Northern Rock will be in during the three to four years it will be publicly owned.

"Whilst the underlying credit performance of Granite remains strong, the reality is that, given the change in the prepayment profile for the Granite series and the possibility of a breach of a non-asset trigger [...] some investors are facing exposure to extension risk," said Francesca Zwolinsky, a director in Fitch's RMBS team.

Despite Northern Rock's recent funding and liquidity difficulties, the credit performance of the underlying mortgage collateral backing the Granite master trust program, including Whinstone Capital Management's Whinstone series 1 and 2, remains strong. Fitch said that arrears performance is likely to deteriorate, but performance is driven by the current financial market crisis, rather than issues specific to Northern Rock. Nor does the agency expect that an increase in current arrears levels will threaten either Granite's credit ratings, given current credit enhancement levels, or threaten the credit ratings assigned to the notes issued by Whinstone.

It's Granite and Whinstone's higher- than-average exposure to higher LTV mortgages that presents a source of downside risk to performance. This risk is amplified by the recent withdrawal of similar high LTV mortgage products from the U.K. market generally, which closes off refinancing options to higher LTV borrowers.

New mortgages by Northern Rock have shrunk since the onset of its liquidity difficulties and the credit crunch in summer 2007. The bank's strategy of shrinking the balance sheet in combination with the possible implementation of strict guidelines governing its operation in the mortgage markets could result in a further decline in origination volumes as well as hinder its ability to substitute loans into the trust.

"The ability to redeem bonds to schedule, reducing extension risk, depends on the degree to which they are successful," Societe Generale analysts said. "The other element of rapidly reducing their balance sheet through an active redemption program' runs the risk of negative selection, despite their commitment to protect the quality of the mortgage book."

But Granite bondholders will be happy to hear of the new action. Their main concerns are likely to be that the government now owns the bank, so any decision is potentially politically influenced, despite the fact that Granite mortgages are still performing well.

"I guess this beats Bear Stearns, where you turn around and from a few clicks of the mouse across the globe, vast sums of money disappear and you become technically insolvent in just one day," a market source said. "At least Northern Rock's Web site shut down when everyone tried to move their money out."

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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