By Steve Slater and Clara Ferreira-Marques
LONDON, Aug 5 (Reuters) – Britain has been forced to provide up to 3 billion pounds of extra capital for state-owned Northern Rock as the housing market worsens and the bank reported a 585 million pound loss and soaring bad debts.
Northern Rock, the UK's most aggressive mortgage lender until its funding crisis last year, has seen the proportion of customers more than three months in arrears with their mortgage payments jump threefold as Britons face rising food and fuel prices and slumping house prices.
The government said on Tuesday it would swap up to 3 billion pounds ($5.9 billion) of outstanding debt into equity after the transfer of a Bank of England loan to the Treasury.
It will also strengthen Northern Rock's capital base by converting 400 million pounds ($787 million) of Treasury preference shares into ordinary shares.
Britain's finance minister Alistair Darling said this was the best way to support Northern Rock's financial stability, protect taxpayers and depositors, and comply with European rules.
"We are being prudent," Northern Rock Executive Chairman Ron Sandler told reporters on a conference call.
"You need to bear in mind that the (EU) state aid rules do not allow for a drip-feed of capital into the bank. We have selected an amount that we believe is comfortable for the whole period of temporary public ownership."
He said any surplus could be returned to the government.
Northern Rock, which was nationalised in February after its near-collapse five months earlier, said it was ahead of its plan to repay its government loan, having cut the amount it borrowed from the Bank of England by 9.4 billion pounds to 17.5 billion.
It remains on course to repay the loan by the end of 2010 and Sandler said the burden for the UK taxpayer would not change as a result of the 3 billion pound swap, as Northern Rock will increase its monthly repayments.
Under the bank's business plan, unveiled after the government took control, Northern Rock had said it expected to be loss-making this year and not return to a profit until 2011.
The bank said its 585 million pound loss was inflated by restructuring costs, including the cost of slashing its workforce, and a writedown of 70 million on risky assets.
MORTGAGE MARKET WORSENS
Northern Rock had warned of worsening bad debts earlier in 2008 and on Tuesday it said the trend had continued.
The share of its mortgages more than three months in arrears jumped to 1.18 percent, near the industry average, as the lender tightened its arrears policy and grappled with a deteriorating UK housing market. That compares to 0.45 percent at the end of December and 0.38 percent a year earlier.
Excluding Together loans, which allowed consumers to borrow more than the value of their homes which were stopped in February, residential arrears were 0.8 percent, up from 0.28 percent.
Arrears on unsecured loans also increased, the bank said.
"We are clearly looking at a housing market which has deteriorated very considerably in recent months," Sandler said.
"We do not expect markets to ease substantially in the near future. We do think the economic climate and the housing market is going to be difficult for some considerable time."
Redemptions, however, were ahead of plan despite a crunch across the mortgage market which has made it harder for customers to remortgage elsewhere. Retail deposits, critical to the bank's aim of no longer relying on capital markets for funding, rose 3.7 billion over the last six months. It re-entered wholesale markets in July but "in modest amounts".
Northern Rock also wrote down 46.6 million pound on holdings of structured investment vehicles, adding to a 232 million charge last year. It also took a 23.8 million pound charge on holdings of collateralised debt obligations.
