Standard & Poor’s Ratings Services said that it lowered its long-term counterparty credit rating on U.K. mortgage bank Northern Rock PLC to ‘A’ from ‘A+’. At the same time, the ‘A-1’ short-term counterparty credit rating was affirmed. The outlook, which we revised to negative on June 27, 2007, remains negative.
“The downgrade follows the trading update released by Northern Rock earlier today. It sources three-quarters of its funding from wholesale markets and has therefore been significantly pressured by current market conditions, particularly the nonavailability of the RMBS and covered bond markets,” said Standard & Poor’s credit analyst Richard Barnes.
Northern Rock today announced that it has agreed a liquidity facility with the Bank of England (AAA/Stable/A-1+) under which it can borrow against mortgages and MBS. It has also slowed new lending and expects total asset growth for 2007 to be about 9%, which implies very limited net mortgage growth in the second half. Northern Rock now expects underlying pretax profit to fall to £500 million-£540 million in 2007, compared with £588 million in 2006. In the medium term, Northern Rock intends to pursue a less aggressive growth strategy than it has to date.
The downgrade reflects Northern Rock’s constrained earnings capacity and franchise development in the current environment, which appears likely to persist until at least year-end 2007. Rather than a larger downgrade, we consider that one notch is appropriate at this time since the Bank of England facility considerably strengthens Northern Rock’s funding and liquidity, and it continues to benefit from a well-collateralized loan portfolio and satisfactory capitalization.
“We have been in regular contact with Northern Rock over recent weeks regarding its funding and liquidity position, and we will continue to do so. We revised the outlook on Northern Rock to negative from stable on June 27, 2007, due to inadequacies in its hedging policy that reduced its earnings prospects and consequently restricted its ability to manage through a more testing market environment,” added Mr. Barnes. A revised hedging strategy implemented at that time has protected Northern Rock’s earnings from the spike in LIBOR in recent weeks.
“The negative outlook reflects the potential for Northern Rock’s earnings to be pressured further if the current unfavorable market conditions continue significantly beyond year-end 2007. It also takes into consideration the potential impact on the bank’s franchise from negative media reports and its slowdown of new mortgage lending,” added Mr. Barnes. In the medium term, we will closely monitor the evolution of its business model and the implications for its credit profile.
The ratings could be lowered by one or more notches if a prolonged liquidity squeeze leads to materially lower 2008 earnings and/or significant franchise impairment. A positive rating action is not expected unless Northern Rock is acquired by a higher rated entity. The current ratings do not incorporate the effect of a potential acquisition, however, since there are no offers at this time.
