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That shrinking feeling

New Star chief economist Simon Ward says Northern Rock’s eagerness to repay its £26.9bn Bank of England loan is exacerbating the mortgage market squeeze.

New Star chief economist Simon Ward says Northern Rock’s eagerness to repay its £26.9bn Bank of England loan is exacerbating the mortgage market squeeze.

Ward says the bank is repaying its loan faster than projected in its restructuring plan and he believes this is affecting the wider market.

The bank originally aimed to get the £26.9bn loan down to £20bn by the end of 2008. According to a trading update, the loan had declined to £24.1bn by March 31 but Ward estimates from the weekly Bank of England return that Northern Rock has repaid a further £3bn to £4bn since the start of April, which would bring its outstanding loan close to the £20bn full-year target.

He says repayment is likely to have been funded via mortgage redemptions.

Ward says: “Other assets fell by £7.9bn between April 2 and last week. As well as the Northern Rock loan, this category includes foreign currency lending, which may have declined by £4bn over this period, judging from information in the latest Bank of England quarterly bulletin. A reasonable assumption is that Northern Rock has repaid a further £3bn to £4bn since the end of March, implying the outstanding loan may already be close to the £20bn full-year target.”

However, a Northern Rock spokesperson says: “Not everything in the other assets column of the Bank of England’s return pertains to Northern Rock. The facility is continuing to be paid as per our plan.”

The bank’s three-year plan, outlined earlier this year, envisages halving its £107bn mortgage book and repaying its Bank of England loan by 2010. It hopes to shed 60 per cent of its borrowers by encouraging them to switch to other lenders through increased rates. It has also done a deal which helps eligible Northern Rock borrowers remortgage with Lloyds TSB.

Ward says while the Government is constrained by EU state aid regulations, a less rapid reduction in Northern Rock’s mortgage book would help to reduce the risk of a severe economic downturn.

Rock’s restructuring plan projects a fall in the bank’s share of the stock of mortgages from 7.5 per cent at the end of last year to 3.7 per cent by December 2009.

Ward says: “Economy-wide net mortgage lending totalled £108bn last year of which Northern Rock contributed £13bn. Its U-turn will cut the supply of mortgage loans by over £30bn in 2008 compared with last year, significantly worsening the impact of the wider credit crisis.”

Alexander Hall chief operating officer Andy Pratt says Northern Rock is failing to take proper account of borrowers, brokers and even taxpayers by paying off its loan too quickly and too cheaply.

He says: “Through its recent deal with Lloyds TSB, Northern Rock is sticking it to brokers and potentially misleading borrowers. Most borrowers were recommended Northern Rock mortgages by brokers but are being encouraged to remortgage with Lloyds TSB and will probably assume, because the bank is Government-backed, that this is the best deal when it is really a commercial agreement.

“I understand that Northern Rock is waiving penalty charges for borrowers moving to Lloyds TSB. I think the taxpayer has a lot more to gain here. Northern Rock is moving too quickly and too cheaply to pay back this loan and if it goes too fast, it will erode value. The bank is not taking the borrower, the broker community or even the taxpayer into account.”

Mortgageforce managing director Rob Clifford says while the rapid shrinkage of Northern Rock’s mortgage book and repayment of its Bank of England loan is affecting the whole market, he believes the most significant factor is the bank’s withdrawal from new business.

Clifford says: “In rushing to pay off its loan, Northern Rock is making the credit crunch worse but the real impact I think is the withdrawal from new business. Northern Rock was attracting 15 per cent or more of the new business in the market. Consumers and brokers have lost a significant manufacturer and this is putting pressure on other lenders.

“I think taxpayers would be pleased to see that the loan is being paid back swiftly. I do not think the market would be helped a huge deal by Northern Rock paying off its loan more slowly. It is the lack of new business that needs to be addressed but I do not think Northern Rock or any other lender at this point in time is willing to do that. I do not think we can be overly critical of Northern Rock paying off its debts quickly.”

However, while Ward claims that Northern Rock is paying off its loan too rapidly, chairman Ron Sandler warns that it may take longer than two years for the bank to be debt-free.

In an interview with the Financial Times last week, Sandler said the bank’s repayment plan could stumble if it does not shed borrowers at the rate it has envisaged.

He said: “If we have a situation in which other lenders have pulled their horns in very considerably, that will impact on the rate at which we obtain the redemptions required to pay back the debt. That will extend the period we need the Government loan.”

Sandler added that the economic downturn, rising unemployment and financial pressure on borrowers pose significant risks because more people are likely to default on their loans.

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