UK mortgage lender hit by credit concerns

UK mortgage lender Northern Rock eased market concerns today that the current credit crisis could force it to issue a fresh profits warning.

Shares fell by more than 10% as investors considered the impact of the turbulence on Northern, which is heavily reliant on wholesale credit markets to fund its mortgage lending. The conditions led to speculation that the group will find it harder to get its hands on cash.

But a spokesman for the company said: “We have continued to fund during these difficult conditions, which are now easing, because of our strong, diversified global funding franchise, with four main sources, raising a balanced mix of funds from both wholesale and retail markets.”

Shares closed the session 3% lower at 703.75p.

The mortgage group has seen its shares drop 23% after it warned in June it would not meet annual profits growth expectations and cut its forecasts by 2% after rising interest rates took their toll on margins.

Credit Suisse said yesterday there was a chance that Northern Rock will “further downgrade full year guidance at some point soon”.

“With about 87% of incremental funding from wholesale sources last year, Northern Rock would be the most affected bank from a sustained period of difficult credit conditions,” it added.

Most of the group’s funding comes from wholesale markets, either through borrowing from other banks at the London interbank offered rate (LIBOR) or by securitising existing mortgages and selling them on.

The recent turmoil in credit markets has seen LIBOR jump to way ahead of the Bank of England’s base rate – on which mortgages are based.

Panmure Gordon analyst Sandy Chen said that if this gap remained at its current levels it could lead to a sharp drop in Northern Rock’s earnings during the second half of the year.

The cost of this borrowing means lenders would have to charge mortgages at such a level to remain profitable that they would become uncompetitive.

Northern Rock also uses securitisation to fund new business, meaning it sells mortgage packages based on their income flows – from homeowners paying back their loans.

However, following the fall-out from the US sub-prime mortgage crisis, which has seen the number of defaults soar, investors are more reluctant to invest in these assets, or are paying less for them.

While Northern Rock’s current funding is not affected, analysts point out that the longer the situation lasts the more damage the group stands to take.

The problem could also be made worse as millions of mortgage holders are about to come off cheap fixed-rate deals over the next year and, following the rises in interest rates and current credit turmoil, stand to see mortgage costs soar.

This could lead to an increase in losses from mortgages, as highlighted by recent Council of Mortgage Lenders figures which showed home repossessions jumped 30% in the first six months of the year.