A Run on the Banks?
By Adrian Ash
September 15, 2007
People queued in Britain
today to withdraw their money from a struggling mortgage bank...
ON WEDNESDAY THIS WEEK the UK mortgage bank
Northern Rock ran a banner advertisement across the bottom of The
Daily Telegraph's front page.
It promised 6.30% interest on cash deposits, more
than 250 basis points above the average rate-of-return offered
on time deposits by UK banks in August.
British savers haven't been offered that much money
to keep their cash in the bank in nearly a decade.
But Northern Rock's plea for hard cash appears to
have failed. On Thursday, it arranged an emergency loan facility
from the Bank of England, the UK's central bank. On Friday,
queues formed at its branches across the country.
"I am going to take out the lot, every
penny," said one anxious saver to Bloomberg as he queued
outside the bank's West End branch in central London.
Over in the Square Mile of the City, reports the Financial
Times online, a queue formed at the Northern Rock branch
just 100 yards from the Bank of England's very own front door.
"The website was down and no-one was answering
the phone this morning," said one of Northern Rock's
anxious depositors to the FT. "When the shares fell 20% [on
Friday morning] I decided to come down and take my money
out."
Bereft of both cash deposits and the short-term
funds it's been unable to raise in the capital markets, Northern
Rock called on the Old Lady to act in its capacity of
"lender of last resort". The Bank of England hasn't
done this since 1973, back when the collapse of Cedar Holdings
a pioneer of second-mortgage refinancing threatened to
spark a crisis in the country's banking industry.
Northern Rock has also been a true pioneer in UK
mortgages. Its sudden trauma also gives the lie if the lie
were still needed to any claim that America's subprime
crisis has been "contained".
The UK's fifth largest mortgage lender, Northern
Rock repeated on Friday that only 0.24% of its total assets are
exposed to the US subprime market. Ain't no subprime in them
thar' home-loans!
Instead, the problem stems from how Northern Rock
financed its runaway growth. "In the first 8 months of the
year, Northern Rocks total net lending was up 43% over the
same period in 2006, with net residential lending up 55%,"
as it stated today. This stellar performance compared to its
peers came thanks to what the Financial Times now calls
"an alternative banking model".
The alternative being that it came from the United
States, the home of debt securitization.
"Eschewing customer deposits kept down costs
the bank has just 76 branches and facilitated a rapid
expansion of the loan book," says the FT online.
"Compared with the UK banking average of 7%, Northern Rock
used wholesale market securitization for 43% of its
funding." All told, the UK banking sector held one-fifth of
liabilities in securitized loans by April this year, according
to the Bank of England.
Back in the United States, meantime, "almost
68% of home mortgage originations were securitized by
2005," says the Federal Deposit Insurance Corporation on
its website, and "in the first quarter of 2007, about half
of all revolving consumer credit outstanding was held by pools
of securitized assets," says Sheila Bair, chair of the
FDIC. That matched the pattern of the last 10 years, Bair
explained in testimony given before a House of Representatives
subcommittee in early June.
If the need to refinance the loan book by appealing
to the money markets has undone Northern Rock in the UK, what
havoc might the ongoing liquidity crunch be causing in the US
banking sector? Outstanding mortgage loans totaled more than
$12.7 trillion by the end of last year, according to Plunkett
Research. That makes for more than $8.5 trillion in
mortgage-backed bonds used to fund America's recent but now
soured love affair with real estate.
What if the need to raise new finance before
extending new loans to buy new homes continues to meet with a
big fat "No!" from the money markets?
"Northern Rock is a prime-only lender,"
as the distressed borrower itself said today, "and credit
quality on all its loan books remains strong. Three-months plus
arrears in the residential [UK] book were 0.47% at the end of
August, still under half the industry average."
But built by borrowing short to lend long
rather than by the old fuddy-duddy method of attracting cash
savers and then lending out their deposits Northern Rock's
spectacular growth relied on cheap and plentiful liquidity.
That's what the City of London knew. The capital's hacks, on the
other hand, did not.
"Buy" said The Times on July
27th. "Buy" said The Telegraph the same day.
"I have bought Northern Rock," added an FT journalist
one month later, "unable to resist a price of 645p, which
gives a forward p/e of 6 and a dividend yield of 6.2%."
The next day, Aug 25th, brought news that private
investors were filling their boots with Northern Rock stock, as
well. "Last week and the end of the week before were the
busiest time we've seen since February/March this year,"
the FT learnt from Alison Cashmore at TD Waterhouse,
the big retail brokerage. Trading volumes increased by more than
50%, she said, with private investors "focusing
particularly on banking stocks."
The top five purchases for Britain's private
investors in August this year? Four banks and one airline
including both Northern Rock and Barclays, the third largest
bank in the UK, whose CEO, Bob Diamond, demanded action from the
Bank of England at the start of September.
If you're tempted to buy banking or finance stocks
now they've pulled back so sharply, it might be worth asking
yourself: What might the capital markets know that you can't as
a private investor?
You're left with only last quarter's trading
statement for guidance. Just like British share investors who
piled into Northern Rock at the end of August.