By Gonzalo Vina
Feb. 23 (Bloomberg) -- Chancellor of the Exchequer Alistair Darling ordered Northern Rock Plc to expand lending by 14 billion pounds ($20 billion), the first in a series of measures due this week to revive the U.K. banking industry.
“This is against a background where a lot of the foreign- based banks have withdrawn” from Britain, Darling told BBC Radio 4 in London today. “What I want to do here is use Northern Rock to help fill that gap.”
The decision is aimed at increasing the availability of mortgages in the U.K. after turmoil in financial markets dried up credit and sent property prices tumbling at their fastest pace since 1991. Northern Rock effectively closed its doors to new mortgages when it was nationalized 12 months ago.
Prime Minister Gordon Brown’s government is upset institutions are rationing credit and holding back from customers the benefits of lower Bank of England interest rates after receiving 37 billion pounds in recapitalization funds. Later this week, the Treasury will detail a program to guarantee hundreds of billions of pounds in loans.
“The injection of new capital should allow Northern Rock to go on a significant spending spree,” said Simon Willis, a London-based analyst at NCB Stockbrokers Ltd. “It will beneficial for the U.K. as a whole because it will put less strain on the banks.”
Bonus Curbs
Northern Rock also said it will scrap cash bonuses for senior managers and freeze their pay in 2008 and 2009. The decision mirrors one made by Royal Bank of Scotland Group Plc last week to shift compensation toward non-cash forms including bonds and equity, answering calls from unions and members of all political parties concerned executives have been overpaid.
Last year “was an extremely difficult year” for Northern Rock, said Chief Executive Gary Hoffman. “The company has been substantially restructured and we are in a much better shape to move forward from here.”
The lender is making progress repaying an 18 billion pound loan from the government. It will be split into two divisions, with a “good bank” channeling government funds to alleviate loan bottlenecks and a “bad bank” running the existing mortgage portfolio.
Lending Drought
Banks approved 31,000 new mortgages in December, close to the lowest in a decade and below the 104,000 monthly average in 2007 before credit markets seized up. A dearth of credit quelled activity in the property market.
“This is a huge U-turn for Northern Rock and the government, but it’s not going to make a massive difference,” George Osborne, a Conservative lawmaker who speaks on finance, said on BBC radio. “What the government should be doing is establishing a national loan guarantee scheme. Until we get credit flowing in this economy, nothing else is going to work.”
For weeks, Darling and Treasury officials have been discussing the terms of an insurance program for toxic assets held by banks with executives of Royal Bank of Scotland Group Plc and others seeking to tap government funds. Lloyds Banking Group Plc may also take part in the program.
Guarantee Program
The Sunday Times and Sunday Telegraph said the Treasury will insure almost 500 billion pounds of assets. Ministers are still in talks with bankers about the amount and conditions of any guarantees, a Treasury official said. The government will insist on more lending as a condition of the guarantees insuring toxic assets, Treasury officials have said.
“We’ve got to make sure that credit can flow to businesses, that mortgages can flow to families,” Brown said in a speech today in Southampton, England. “In the past people would let the recession take its course. We are prepared to lend to businesses small, medium and large.”
The Bank of England separately is purchasing securities to unfreeze credit markets and asking Darling permission to use that policy to expand the money supply and bolster economic growth. Darling and Central bank Governor Mervyn King may exchange letters detailing that part of the program this week.
Northern Rock, which became the first British institution to tap government funds after a run on its deposits in 2007, has been paying off Treasury loans since it was nationalized. Last month, Darling asked the bank to slow repayments until the industry is able to provide more mortgages.
Loan Requirements
Now, the government is directing Northern Rock to expand the value of its mortgage portfolio by 5 billion pounds this year and about 9 billion in 2010, depending on demand, according to a person with knowledge of the plan. The existing mortgage book will be siphoned off into a separate business, allowing new lending to take place unhampered.
“I want to ensure that as we come into the recovery phase, the money is there for businesses, the money is there for people who want to buy a house,” Darling said. “Until we get the banking system operating properly, that will slow down the recovery.”
The split effectively allows the government to channel money it borrows on the bond market straight to households. The 14 billion loans will register on the government accounts as a loan to a public corporation.
The government loaned the Newcastle-based lender 3 billion pounds in July. Northern Rock will be able to delay repayments of that loan and channel that money, along with any other profit from its existing mortgage book, to fund new mortgages.
Yesterday, after meeting European leaders in Berlin, Brown called for a return to more prudent banking, a tacit admission that his government didn’t do enough to restrain lax lending standards during the economic boom of the last decade.
‘Prudent, Careful’
“We do want to see the reinvention of the traditional savings and mortgage bank in Britain, for loans to be made on prudent and careful terms, not just to people with large deposits, but to first-time buyers and those on middle and modest incomes,” Brown wrote in the Observer newspaper.
Northern Rock was among the banks offering mortgages without a deposit from the borrower. Darling said Northern Rock would offer loans of up to 90 percent of property prices.
Today’s measures will allow banks to fund their activity by creating a new class of non-voting share, the Telegraph said. This would allow for dividend payments without diluting the value of stakes held by existing shareholders.
RBS wants to include 250 billion pounds of assets in the insurance plan, which will probably be announced when the lender releases full-year earnings on Feb. 26, the Telegraph said. Lloyds is seeking to submit a slightly smaller amount, while Barclays Plc is waiting for details of the deal and will also likely take part, the newspaper said.
To contact the reporter on this story: Gonzalo Vina in Westminster at gvina@bloomberg.net
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