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Rock plans show UK taxpayers silver lining, says New Star

The nationalisation of Northern Rock could prove highly profitable for UK taxpayers, says New Star economist Simon Ward.

He says this week’s plan could show taxpayers a silver lining, providing the Government can avoid making a significant compensation payment to equity and subordinated debt holders.

Ward says in spite of guarantees by the Treasury, Northern Rock has been forced to offer high initial rates to retain its retail deposit base.

He says EU state aid requirements suggest the Bank of England will continue charging a penal interest rate on its loan, but says this now represents a transfer within the public sector.

Ward says regarding assets, the aim is to shrink the mortgage book, allowing early repayment of the BoE loan. New lending will be negligible and mortgage rates will be raised to encourage existing borrowers to refinance elsewhere.

He says assuming they stay, this will boost the profitability from lower funding costs and says job losses are also inevitable, further reducing the bank’s cost base.

Ward says the key concern is that housing market weakness, coupled with possible adverse incentive effects from public ownership will lead to significant default losses.

Northern Rock had £97bn of customer loans at June 30, 2007 but credit risk on £46bn of the total had been partially transferred to holders of securitised notes.

He says: “In the housing recession of the early 1990s repossessions nationally reached a peak of 0.77 per cent of outstanding mortgages in 1991. Assume Northern Rock is forced to foreclose on 1 per cent of its loans each year for three years and achieves a recovery rate of only 70 per cent. Based on a £97bn book, this would imply a loss of £850-900m, of which about £150m might fall on holders of securitised notes.

“Northern Rock’s shareholder funds stood at £2.3bn at June 30, 2007. Even assuming significant erosion since, the remaining equity in the business should easily absorb any losses barring an Armageddon scenario for the housing market.”

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