Northern Rock Is Nationalised - What Does This Mean ?

Northern Rock plc was nationalised by the UK government and the shares suspended on 18 February 2008.

There are several groups of interested parties in Northern Rock. They are the shareholders, depositors and mortgage holders.

Shareholders

Nationalisation is devastating news for shareholders. There were several options for a rescue plan, and the City considered the Virgin bid, by Sir Richard Branson, to be the front runner. Sir Richard unashamedly lobbied Gordon Brown during the visit to China in January, and many financial reporters thought a deal was in the bag.

When shares were suspended, they were trading at 90 pence. Around 420 million shares are in issue, so this values the company at GBP 378 million. The price of 90 pence is a dramatic reduction from the price in January 2007, which was GBP 12. At that time the company was valued at GBP 5 billion.

Due to the way that the Government intends to work out the compensation for shareholders, it is quite possible that they will receive very little indeed for their shares. This is because the government has directed that the valuation takes account of the fact that the company is unable to continue as a going concern, and is in administration, that is, effectively bankrupt.

These terms of reference dictate that any valuation will determine that the shares are worthless. However, on the contrary, it is clear that the company remains a going concern as it continues to accept deposits and is offering mortgages to borrowers.

Shareholders are very likely to mount a legal challenge, although they will need to await the official valuation before commencing legal action.

Depositors

Savers with Northern Rock enjoy the best security of any UK Bank or Building Society. Savers with other institutions are only given a guarantee for the first GBP 35,000 of any holding, yet Northern Rock savers can invest unlimited funds and have the assurance of UK government support.

At the same time, the rates of interest enjoyed by depositors are among the highest available. There is a Tracker Online account which pays 6.49% plus a 1.24% bonus. This is just one of the attractive products being offered by Northern Rock.

The problem is that other financial institutions in the UK have already started complaining to the government about unfair competition. The combination of high interest rates for savers, backed by a government guarantee, is an unbeatable package which no other bank or building society can match.

The Governor of the Bank of England has met with senior bankers on several occasions in order to assuage fears and complaints about unfair competition.

Mortgage Holders

As with savers, it is business as usual. However, in order to reduce taxpayers' funding of Northern Rock, the book value of mortgages will have to shrink dramatically. It is estimated that the UK government have advanced some GBP 35 billion to Northern Rock since it encountered funding difficulties.

The total value of mortgages outstanding is some GBP 115 billion. This means that the mortgage book needs to be reduced by around 30%.

The clear implication is that existing borrowers will face sharp increases in the costs of borrowing. These increased costs will take effect as soon as possible, and there will be no extension on 'sweetners' enjoyed by new mortgage customers. Mortgage holders will be charged interest rates of up to 7.9% in the near future.

Northern Rock have already suggested that mortgage holders seek alternative mortgage products and have indicated that independent financial advice may be appropriate.

This policy is bound to cause distress to mortgage holders. Northern Rock had a scheme whereby some 125% of the value of a property could be used for the purpose of a mortgage advance. In other words, the value of the mortgage greatly exceeded that of the property. New mortgage holders would be in a negative equity situation.

Many Northern Rock mortgage holders will have great difficulty finding alternative lenders. This is due to the current market conditions in which lenders are reigning in on attractive mortgage offers, and are expecting customers to increase their own level of deposit.

Some customers who currently enjoy 125% mortgages from Northern Rock may be horrified to learn that other mortgage lenders may only offer around 90% of a property valuation.

In addition, property valuations are moving downwards in line with the depressed state of the UK housing market. This means that many Northern Rock customers will be penalised by increased lending costs from the company and will also be unable to find an alternative mortgage lender.

We will soon face the prospect of Northern Rock mortgage holders defaulting on their repayments and risking re-possession. What will make this different from foreclosures in the US subprime mortgage market is that the mortgage lender is the UK government, and moreover, a Labour government committed to helping families on low incomes and those experiencing financial hardship.

The prospect of repossessions must be a nightmare for the Labour government. Not only would it antagonise traditional Labour Party supporters, but it would remove any vestige of economic competence from Gordon Brown.

Mr Brown has consistently sought to take credit for the economic prosperity enjoyed by the UK during the Blair years. He has been put to the test by Northern Rock. By any yardstick, he has failed. Government incompetence has also damaged the international reputation of the City of London.

Further bad news is expected.

About The Author-- Leslie Hardy is a noted writer on North Cyprus Investments and the UK Chairman of Wellington Estates Ltd. Read more aboutNorthern Rock

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