The Rock’s demise is all the more surprising because despite lurid tales of its aggressive push at the start of this year to expand market share – it has a strong track record in loan origination. It has one of the lowest delinquency rates of any UK bank and it is no surprise that hedge funds are eagerly eyeing what is generally regarded as the best of the UK’s mortgage loan portfolios.
There are a number of myths that misrepresent the key reasons for the decline of this once proud mortgage bank. It is fair to say that, compared with some mortgage loan providers, Northern Rock was particularly reliant on the capital markets for finance. However, not all financial institutions are able to rely on a passive base of retail depositors. Look at the investment banks; they are hardly repositories for retail funds.
So what did for Northern Rock? Quite simply, the bank was being run on very little cash. This is distinct from being reliant on wholesale/capital markets funding – many institutions are. Northern Rock was able to borrow £4.6 billion of RMBS in mid-May on fantastic terms. That it was forced to knock on the Bank of England’s door, cap in hand, just three months later is shocking. There was clearly no element of pre-funding from this bank. It was a policy its managers were no doubt comfortable with because RMBS markets have always remained open in times of market woe. But to have no back-up contingency plan?
The contrast with Lehman Brothers could not be greater. The broker’s Chris O’Meara revealed in the latest quarterly earning call, his last as CFO, that the institution is run with enough cash to last for a whole year. One former UK bank treasurer told Euromoney that he always ensured that the institutions he was in charge of financing had enough liquidity for at least six months – not all cash but also in the form of readily marketable securities (gilts). This is a strategy that several sage institutions follow and one that, had Northern Rock used it, would have saved it the ignominy of being subject to a run on the bank.
Buy-to-let provider Paragon Mortgages is wholly reliant on wholesale/capital markets funding. In the late summer it had the foresight to get in bilateral funding to last it until February 2008. The thing is that Northern Rock could have got a deal away in June or early July, albeit at triple-A spreads in the high teens over Euribor/Libor compared with the 10 basis points it obtained in May. However, the market is full of anecdotes about how its management had got used to obtaining the best terms. They did not want to pay up and had laid a wager that the market would reopen in September as usual. Its late August journey to the US was in vain – the books of the biggest investors there were shut.
Leaving to one side speculation, as well as recriminations about Northern Rock’s failed attempt in September to print a RMBS transaction off its Granite platform – it is clear that the bank did not pre-fund. This is a spine-chilling strategy given the bank’s limited diversity of funding options. It had no bilateral lines of credit, for instance, only a limited covered bond programme and only a few friends among European banks. Its preference for US-targeted deals meant that its closest relationships were those investment banks with strong American distribution. And it is not apparent why UK banks would be overly keen to provide short-term liquidity to a rival that was taking substantial market share in the hotly contested domestic mortgage market. Either way it seems clear that someone forgot the maxim – access to capital first, price of capital second. And the adage that markets can remain irrational for longer than you can remain solvent.