Northern Rock May Point to U.K. Crunch
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By CARRICK MOLLENKAMP and MARK WHITEHOUSE
September 24, 2007; Page A2
Source
The immediate danger for depositors of British mortgage lender Northern Rock may have passed, but the company's troubles highlight a greater threat ahead: the broader impact of the global credit crunch on the United Kingdom's housing market and the world's fifth-largest economy.
Scenes of worried customers crowding Northern Rock branches disappeared last week after the British government stepped in with a promise to guarantee bank deposits. In making that promise, Prime Minister Gordon Brown said "it is the strength of the U.K. economy that has allowed us to do this." The U.K. economy has done well -- expanding at an inflation-adjusted rate of close to 3% this year, above the five-year average of about 2.5% -- even as the U.S. has struggled under the weight of a deepening housing downturn.
The Northern Rock episode illustrates how the credit turmoil that began with risky mortgages in the U.S. could be setting the U.K. up for a fall. As with Northern Rock, many mortgage lenders are having difficulties getting the money they need to keep lending, a factor that could destabilize a U.K. housing market that already appears to be reaching the end of a boom.
"Clearly the risk now is that the housing-market slowdown could be far more pronounced than it looked like it would be," says Howard Archer, chief U.K. economist at consultancy Global Insight in London. "That's likely to weigh down on consumer spending and, hence, the economy." Mr. Archer believes the credit problems could help bring U.K. economic growth, adjusted for inflation, to less than 2% next year -- the lowest rate since 1992.
In the past decade, U.K. consumers have become more dependent on borrowed money, both to buy homes and to finance spending. As of July, total mortgage debt in the U.K. had reached £1.1 trillion ($2.2 trillion), more than double the level of 10 years earlier and equivalent to more than 80% of annual gross domestic product. In the first quarter of this year, U.K. homeowners tapped their home equity for about £13.2 billion, or 6.1% of disposable income, an indication of how much rising home prices have been raising consumer spending, which makes up about two-thirds of the U.K. economy.
Perhaps no company symbolizes the borrowing boom better than Northern Rock. In the late 1990s, the company became a pioneer in the securitization of U.K. mortgage loans, packaging thousands of loans into pools and selling the cash flows as securities to investors in the U.S. and Asia.
By tapping capital markets rather than relying solely on typical deposits, Northern Rock was able to expand at great speed. By June, it had about £87 billion in mortgage loans outstanding and had accounted for almost a fifth of new mortgage loans made in the first half. According to brokers, Northern Rock gained market share in part by taking risks -- allowing home buyers, for example, to get loans covering as much as 90% of the purchase price.
Their mortgages "were prime, but they were operating at the outer limit of it," said Howard Cook, a partner at Talbot Insurance Services, an independent financial adviser in Cumbria, in northwestern England. A Northern Rock spokesman said the credit quality of the company's loans was solid, and that the percentage of loans in arrears was well below the industry average.
Northern Rock wasn't alone. Other lenders -- such as Paragon Group of Cos., which focused on customers who bought homes to rent out -- took the business model still further, relying entirely on wholesale capital markets to fund their operations. According to a report from Citigroup Inc., which didn't name specific companies, such lenders accounted for about a quarter of new mortgage approvals for home purchase from May through July, up from about 5% in early 2002.
The picture for those lenders has changed dramatically. The credit troubles that began with subprime mortgages in the U.S. have led investors to shy away from mortgage-backed securities, all but drying up the markets on which the lenders depended. Northern Rock was the most visible casualty of that change, but others are no less exposed. Subprime lender Victoria Mortgage Funding went out of business this month.
Last week, stock-research firm Numis Securities expressed concern Paragon might have to wind down its business if market conditions don't improve. Paragon Chief Executive Nigel Terrington said in an interview he believes the company will be able to continue to raise money in longer-term debt markets and ride out a slowdown in demand for mortgage-backed securities that may last several months.
"There's been a sort of quiet crisis," said Michael Saunders, U.K. economist at Citigroup in London. Mr. Saunders said he expects the resulting pullback in mortgage lending to contribute to a 20% drop in home sales in the next year, a shift that could trigger a significant drop in house prices. According to the Royal Institution of Chartered Surveyors, U.K. house prices fell in August for the first time since October 2005.
If U.K. home prices do keep falling, many homeowners may find themselves not only feeling poorer, but owing more on mortgages than their homes are worth. In that case, the U.K. economy -- and the policy makers who oversee it -- will face a much greater challenge than the liquidity troubles of one bank.
Write to Carrick Mollenkamp at carrick.mollenkamp@wsj.com and Mark Whitehouse at mark.whitehouse@wsj.com
September 24, 2007; Page A2
Source
The immediate danger for depositors of British mortgage lender Northern Rock may have passed, but the company's troubles highlight a greater threat ahead: the broader impact of the global credit crunch on the United Kingdom's housing market and the world's fifth-largest economy.
Scenes of worried customers crowding Northern Rock branches disappeared last week after the British government stepped in with a promise to guarantee bank deposits. In making that promise, Prime Minister Gordon Brown said "it is the strength of the U.K. economy that has allowed us to do this." The U.K. economy has done well -- expanding at an inflation-adjusted rate of close to 3% this year, above the five-year average of about 2.5% -- even as the U.S. has struggled under the weight of a deepening housing downturn.
The Northern Rock episode illustrates how the credit turmoil that began with risky mortgages in the U.S. could be setting the U.K. up for a fall. As with Northern Rock, many mortgage lenders are having difficulties getting the money they need to keep lending, a factor that could destabilize a U.K. housing market that already appears to be reaching the end of a boom.
"Clearly the risk now is that the housing-market slowdown could be far more pronounced than it looked like it would be," says Howard Archer, chief U.K. economist at consultancy Global Insight in London. "That's likely to weigh down on consumer spending and, hence, the economy." Mr. Archer believes the credit problems could help bring U.K. economic growth, adjusted for inflation, to less than 2% next year -- the lowest rate since 1992.
In the past decade, U.K. consumers have become more dependent on borrowed money, both to buy homes and to finance spending. As of July, total mortgage debt in the U.K. had reached £1.1 trillion ($2.2 trillion), more than double the level of 10 years earlier and equivalent to more than 80% of annual gross domestic product. In the first quarter of this year, U.K. homeowners tapped their home equity for about £13.2 billion, or 6.1% of disposable income, an indication of how much rising home prices have been raising consumer spending, which makes up about two-thirds of the U.K. economy.
Perhaps no company symbolizes the borrowing boom better than Northern Rock. In the late 1990s, the company became a pioneer in the securitization of U.K. mortgage loans, packaging thousands of loans into pools and selling the cash flows as securities to investors in the U.S. and Asia.
By tapping capital markets rather than relying solely on typical deposits, Northern Rock was able to expand at great speed. By June, it had about £87 billion in mortgage loans outstanding and had accounted for almost a fifth of new mortgage loans made in the first half. According to brokers, Northern Rock gained market share in part by taking risks -- allowing home buyers, for example, to get loans covering as much as 90% of the purchase price.
Their mortgages "were prime, but they were operating at the outer limit of it," said Howard Cook, a partner at Talbot Insurance Services, an independent financial adviser in Cumbria, in northwestern England. A Northern Rock spokesman said the credit quality of the company's loans was solid, and that the percentage of loans in arrears was well below the industry average.
Northern Rock wasn't alone. Other lenders -- such as Paragon Group of Cos., which focused on customers who bought homes to rent out -- took the business model still further, relying entirely on wholesale capital markets to fund their operations. According to a report from Citigroup Inc., which didn't name specific companies, such lenders accounted for about a quarter of new mortgage approvals for home purchase from May through July, up from about 5% in early 2002.
The picture for those lenders has changed dramatically. The credit troubles that began with subprime mortgages in the U.S. have led investors to shy away from mortgage-backed securities, all but drying up the markets on which the lenders depended. Northern Rock was the most visible casualty of that change, but others are no less exposed. Subprime lender Victoria Mortgage Funding went out of business this month.
Last week, stock-research firm Numis Securities expressed concern Paragon might have to wind down its business if market conditions don't improve. Paragon Chief Executive Nigel Terrington said in an interview he believes the company will be able to continue to raise money in longer-term debt markets and ride out a slowdown in demand for mortgage-backed securities that may last several months.
"There's been a sort of quiet crisis," said Michael Saunders, U.K. economist at Citigroup in London. Mr. Saunders said he expects the resulting pullback in mortgage lending to contribute to a 20% drop in home sales in the next year, a shift that could trigger a significant drop in house prices. According to the Royal Institution of Chartered Surveyors, U.K. house prices fell in August for the first time since October 2005.
If U.K. home prices do keep falling, many homeowners may find themselves not only feeling poorer, but owing more on mortgages than their homes are worth. In that case, the U.K. economy -- and the policy makers who oversee it -- will face a much greater challenge than the liquidity troubles of one bank.
Write to Carrick Mollenkamp at carrick.mollenkamp@wsj.com and Mark Whitehouse at mark.whitehouse@wsj.com