Results
01.08.2008
NORTHERN ROCK GROUP HALF YEAR RESULTS
Highlights
Bank of England Loan
- Net borrowings provided by the Bank of England have reduced by £9.4 billion to £17.5 billion, compared with £26.9 billion at the end of December 2007 and are ahead of the business plan
- The balance of £17.5 billion represents amounts outstanding to the Bank of England of £21.0 billion, less balances held for liquidity purposes at the Bank of England of £3.5 billion
- Bank of England loan to be novated to HM Treasury during the second half of 2008
Retail funding
- Net inflow of £3.7 billion in the first half of 2008
- Retail balances of £14.2 billion at 30 June 2008, compared with £10.5 billion at 31 December 2007 and £24.4 billion at 30 June 2007
Redemptions
- Cash inflows from redemptions of loans are ahead of Northern Rock’s business plan
- Total redemptions of £16.2 billion in the first six months of 2008 (including £2.2 billion asset disposal)
Balance sheet reduction
- Total assets reduced to £99.0 billion at 30 June 2008, compared with £109.3 billion at 31 December 2007
- Loans and advances to customers reduced by £14.5 billion in the first half of the year to £84.4 billion
Earnings
- Under the business plan the Group is expected to be significantly loss making in 2008
- Loss before tax for six months to 30 June 2008 of £585.4 million – including various exceptional charges
- Underlying loss before tax of £176.3 million reflecting loan loss provisions, lower interest margins and reduced volume of new business
Capital
- Significant strengthening of the Company’s capital base through conversion into Ordinary shares of HM Treasury holding of £400 million of Preference shares as well as up to £3 billion of outstanding debt following novation of Bank of England loan to HM Treasury
- This capital restructuring will not involve any cash transfer and will be finalised subject to State aid approval
Organisation
- Key appointments made to leadership team
- Risk and control environment strengthened and debt management capabilities upgraded
Northern Rock Foundation
- Donation to The Northern Rock Foundation of £7.5 million in the first half of 2008, taking the total donated since 1997 to almost £200 million
CHAIRMAN’S STATEMENT
Northern Rock was taken into temporary public ownership on 22 February 2008. In the following weeks, a business plan (the “Plan”) was developed that was approved by HM Treasury on 31 March 2008. This Plan was designed to deliver the Government’s stated objectives of protecting UK taxpayers, maintaining financial stability and protecting consumers. It envisaged that Northern Rock, although significantly loss-making in 2008, would return to break-even in 2011 followed by progressive profit improvement thereafter. The Plan contained a number of key targets, including repayment of the Bank of England loan by the end of 2010, release of the Government guarantee arrangements (subject to FSA requirements) during 2011, and the creation of a smaller, profitable bank capable of returning to private ownership in due course.
To achieve the Government’s stated objectives, Northern Rock set out four strategic priorities in its Plan:
- Repay the facilities provided by the Bank of England;
- Build a stand-alone funding and capital position;
- Align the organisation and operations of Northern Rock to reflect the new commercial strategy; and
- Strengthen the risk and control environment.
The period since 22 February has been one of intense activity at Northern Rock, and I am pleased to report that good progress has been made on all of these key priorities. Net of liquidity deposits held at the Bank of England of £3.5 billion, amounts outstanding to the Government have been reduced by £9.4 billion since the start of the year, which is considerably ahead of Plan; the retail deposit base has grown and the Company has successfully re-entered the wholesale markets; operational restructuring is well advanced; both the management team and the Board have been bolstered by key new appointments; and the risk procedures in the Company have been substantially overhauled.
However, the external environment has deteriorated and the consequences of this for Northern Rock are increased credit losses. Following a review in July of the Company’s ongoing regulatory capital requirements, HM Treasury has committed to a significant strengthening of the Company’s capital base. This will not involve any cash transfer to Northern Rock and will be provided by HM Treasury through conversion into Ordinary shares of both its holding of £400 million of Preference shares as well as up to £3 billion of outstanding debt, following transfer of the Bank of England loan to HM Treasury. This capital restructuring will be finalised, following a further review of the Plan and subject to approval by the European Commission of the application for State aid.
With this balance sheet strengthening, Northern Rock is well placed to press ahead with delivery of the Plan. While the losses reported today are likely to continue as the restructuring proceeds and as the credit environment remains difficult, I am confident that the foundations have been well laid for recovery and return in due course to private ownership.
Progress against Plan
Bank of England Facilities
The Company is currently well ahead of its loan repayment target having, on a net basis, reduced the amount outstanding to the Bank of England by £9.4 billion to £17.5 billion at 30 June 2008 (from £26.9 billion at 31 December 2007). This represents a 35% reduction in the debt facilities (net of liquidity deposits held at the Bank of England) in the first six months of 2008 and is already approaching £3 billion ahead of the 25% repayment target originally set for the whole of the year. This strong performance reflects the Company’s success in redeeming loans in the first half of the year.
The Plan is not without challenges, not least in relation to the Company’s ongoing ability to redeem loans at the required pace given external market factors, but the experience so far is encouraging. The agreement reached with Lloyds TSB in June to offer its mortgage products to selected maturing borrowers should assist Northern Rock to continue to meet its maturity redemption target of 60% in the second half of the year. As anticipated in the Plan, it is the higher quality end of the loan book that is most easily able to re-mortgage with other lenders; this is contributing to the deterioration in the average quality of the Company’s credit portfolio, although this still remains within planned parameters.
Funding and new lending
Retail deposits have grown by £3.7 billion over the last six months, from £10.5 billion to £14.2 billion, although this is still substantially below the level at the same time last year. The majority of the growth in retail deposits in the first half of 2008 was achieved at the start of the period, and net inflows have slowed notably following the introduction in March of the Company’s Competitive Framework, designed to minimise competitive distortions arising from the Government guarantees. Northern Rock is determined not to take unfair advantage of its Government support and has maintained a rigorous adherence to the Framework, which imposes considerable constraints on how the Company competes. The Board remains satisfied that an appropriate balance continues to be struck between the desire to minimise competitive distortions, and the need to create a sound, sustainable retail funding profile.
In July, the Company successfully re-entered the wholesale funding markets, albeit in modest amounts. This represents a further important step in rebuilding Northern Rock’s funding franchise.
New lending in the first half of the year was below the levels anticipated in the Plan, reflecting the slowdown in the housing market and a cautious approach to the quality of lending that Northern Rock is pursuing. The level of new lending is expected to increase modestly in the second half of the year, while remaining significantly below the Company’s historic levels.
Organisation
A central element of the Plan is the restructuring of the Company leading to a reduction in staff numbers of approximately 2,000 over the next three years. The statutory 90 day collective consultation period with our staff concluded at the end of July and individual discussions are underway with all affected employees. This has been a challenging process, and inevitably one which is highly unsettling for the organisation. Nevertheless, the Company remains on track to conclude this process and achieve the necessary reductions in line with the Plan.
The engagement with Unite and other employee representatives has been constructive throughout and it is looking increasingly likely that the downsizing will be achieved with around 800 compulsory redundancies. The final figure will be subject to a number of existing members of staff, who are currently in jobs that will no longer exist, agreeing to stay on in new roles created within the restructured Company. It is pleasing to note that during this challenging period, the Company has continued to operate normally and high standards of customer service have been maintained throughout.
A determination to support all affected staff as fully as possible has been at the core of this process and appropriate outplacement services have been put in place for those who will be leaving the Company. The assistance of One NorthEast and other members of the Northern Rock Response Group has been invaluable, and the Company is indebted to these organisations for all of their efforts.
Strengthening the leadership team has been another key objective and in this regard, I am delighted with the appointment of Gary Hoffman who will take over as Chief Executive from 1 October. Gary’s capabilities, experience and personal qualities will be invaluable in the years ahead. His appointment is complemented by additional outstanding new recruits into key executive positions in the Company: Rick Hunkin as Chief Risk Officer, Richard Smelt as HR Director and Andy Tate as Director of Debt Management. These appointments serve to strengthen considerably the senior leadership team of Northern Rock.
When the appointment of Gary Hoffman as Chief Executive takes effect in October, I shall relinquish my executive role and revert as planned to being a Non-Executive Chairman.
Risk and control environment
Alongside the recruiting activities, wide-ranging changes have been made to the management structure and processes within the Company, with a particular focus on improving decision-making effectiveness and strengthening the risk and control environment in the business. The Company has also embarked on a programme to upgrade its debt management capabilities, with significant investments in both people and technology. Staff numbers in debt management are planned to increase from 185 to around 500 over the course of the year and, as the housing market continues to be challenging, this will assist Northern Rock in dealing with its customers effectively and fairly during this difficult period.
Steps have also been taken to strengthen the Board, with the appointments of Kent Atkinson and Richard Coates as non-executive Directors. Both bring considerable experience in banking finance, and the management and control of risk.
Financial performance and capital position
While the Company’s performance against its strategic priorities is encouraging, there remain a number of areas of concern. Most significantly, the deterioration in the housing market and the broader economic environment, coupled with the evident stresses on household budgets as a result of rising food and fuel prices, have put pressure on the Company’s loan books. Residential arrears over 3 months have more than doubled since the start of the year to 1.18% at the end of June, and the higher LTV end of the book is particularly exposed to housing market deterioration. Whilst this increase is partly attributable to the Company tightening the application of its arrears capitalisation policy and the shrinking of the mortgage book, the underlying trend is all too evident. The impact is also being felt on possessions. The number of properties in possession grew from 2,215 at the start of the year to 3,710 by the end of June.
As indicated in the Plan, the Company was expected to make a substantial loss in 2008. Actual performance in the first six months of 2008 shows a statutory loss before tax of £585.4 million. On an underlying basis, excluding various exceptional costs (including restructure costs, provisions against treasury assets, the volatility associated with changes in fair values and hedge ineffectiveness and recognition of the rebate on interest and fees which is subject to State aid approval), the loss before tax reduces to £176.3 million. The primary reasons for this underlying loss were lower net interest income reflecting the Company’s current funding mix, higher loan loss impairment provisions and lower non-interest income reflecting much lower levels of new business.
The deterioration in market conditions, particularly the downturn in the housing market, and the need to ensure an adequate regulatory capital position throughout the period of State aid and temporary public ownership, have led to the need to strengthen the capital position of the Company.
HM Treasury has committed to reinforce the Company’s capital base through conversion into Ordinary shares of its holding of £400 million of Preference shares and swapping up to £3 billion of the outstanding debt into equity (following the planned transfer of the Bank of England loan to HM Treasury). These measures will not involve any cash transfer to Northern Rock. This restructuring will be finalised following a further review of the Plan and will be implemented subsequent to State aid approval.
These actions to be taken to improve the regulatory capital position of the Company will not change the Government’s net cash exposure to Northern Rock. We continue to envisage that the Government loan facilities will be repaid before the end of 2010, in line with the Plan. This is after the deduction of any amount converted under the debt for equity swap.
Employees
In what has undoubtedly been a most difficult time for Northern Rock’s employees, I wish to thank all members of staff and applaud their maintenance of the highest levels of customer service and professionalism. Their drive to succeed and standards of performance have been exemplary throughout.
I wish to pay particular tribute to Andy Kuipers, who will be stepping down from his position as Chief Executive at the end of August. Andy took on the role in the most challenging of circumstances and his performance has been admirable. On behalf of his Board colleagues, I would like to thank him for all he has contributed to Northern Rock over the past twenty years.