Northern Rock Provisional Restructuring Plan March 31 2008

8/8/2019 Northern Rock Provisional Restructuring Plan March 31 2008

1/12

Provisional Northern RockRestructuring Plan: Executive Summary

31 March 2008


2/12


3/12

Northern Rock Restructuring Plan during Temporary Public Ownership 3

A. Background to Temporary PublicOwnership and the Restructuring Plan

The core business of Northern Rock plc (theBank) is secured residential mortgage lending.

During the rst half of 2007, Northern Rocksoperational performance was in line withpreviously stated strategic targets, with assetgrowth of 12.4% over the six months to 30June 2007. However, nancial performancewas impacted by margin pressure experiencedin the rst half of 2007, due in large part to the

prevailing interest rate environment as well asthe Banks timing of transacting hedges for xedrate mortgages. This resulted in a downwardrevision to prot guidance in June 2007.

Northern Rock raised 12.1 billion in aggregatein the rst half of 2007 to support growththrough the four funding channels of wholesalefunding, securitisation, covered bond issues andretail deposits. The Bank also sold a tranche ofcommercial secured loans in June 2007 withfurther tranches sold in the second half of theyear. These transactions provided additionalfunding for secured residential lendingamounting to 1.46 billion. As at 30 June 2007

around 75% of Northern Rocks total fundingwas sourced from the non-retail money marketswith 53.8 billion of total non-retail fundingbalances of 80.5 billion, i.e. two thirds, raisedfrom securitisations and covered bonds.

Concerns about credit exposure in nancialmarkets began to surface in the summer of2007 and credit spreads (the cost of credit)increased. The announcement by a major USinvestment bank of difculties in one of itsinvestment conduits and subsequent similarannouncements by other banks led to a seriousdisruption in the medium term funding marketson 9 August 2007. This quickly led to severe

restrictions in the liquidity of the short termwholesale markets. In the week commencing 10September 2007 it was necessary to arrange afacility to provide liquidity for Northern Rock inthe event that medium term and securitisationmarkets failed to reopen. This facility wasprovided by the Bank of England at a premiumrate of interest.

In the days that followed the grant of theBank of England facility, there were signicantwithdrawals by Northern Rocks retail depositors

reecting customers concerns as to the securityof their savings. The substantial amount of retaildeposits withdrawn following the grant of the

Provisional Northern Rock

Restructuring Plan: Executive Summary

A.Background to Temporary Public Ownership

B.Objectives and strategic priorities

C.Achieving strategic prioritiesD.Working within the Competitive Framework

E. Key fgures and milestones


4/12

4

loan facility, together with the impact of maturingwholesale funding, contributed to NorthernRock having to draw on the Bank of Englandfacility.

On 17 September 2007, the Chancellor ofthe Exchequer announced that, should it benecessary, arrangements would be put in placeto guarantee all existing deposits in NorthernRock during the current instability in thenancial markets, which signicantly slowed thelevel of customer withdrawals. The guaranteearrangements were claried and extendedby HM Treasury on 20 and 21 September, 9October and 18 December 2007 to include allunsecured retail products, all uncollaterisedderivative transactions and all obligations of the

Company to make payments on the repurchaseof mortgages under the documentation for theGranite securitisation programme. In order tominimise any unfair commercial advantage tothe company, Northern Rock has agreed topay a fee to HM Treasury for the guaranteearrangements. Consent was obtained fromthe European Commission for the provision ofsupport for the six months from 17 September,in accordance with European law.

Following a strategic review with its advisersNorthern Rock, having consulted with the

Tripartite Authorities (HM Treasury, the Bankof England and Financial Services Authority)acting in their respective capacities, exploreda range of options for the business; theseincluded proposals put forward by bothmanagement and third parties. On 17 February2008, the Chancellor of the Exchequerannounced that this process had failed toreach a solution that adequately safeguardedtaxpayers interests and that the Governmenthad decided to take Northern Rock into aperiod of Temporary Public Ownership. A further

submission to the European Commissionin relation to the longer term restructuringproposals was made 17 March 2008 and theexisting arrangements may be maintained whilethis submission is considered.

The Tripartite Authorities have set out theirobjectives for Northern Rock during the periodof Temporary Public Ownership: to protecttaxpayers, to maintain wider nancial stabilityand to protect consumers. Northern RocksProvisional Restructuring Plan (the Plan) hasbeen developed to achieve these objectives ina way that complies with State aid

requirements. It sets out the basis for theremoval of nancial support provided by HMTreasury and the Bank of England throughthe creation of a smaller, more focused andnancially viable mortgage and savings bank

that will be returned in due course to the privatesector.

Those elements of the Plan which are likely toimpact on Northern Rocks workforce remainsubject to consultation with representativesof Unite and other employee representativesbefore any nal decisions are taken.

B.Northern Rocks objectives andstrategic priorities

Northern Rocks prime objectives are therepayment of the Bank of England debt,the release of HM Treasury guaranteearrangements and a successful return to theprivate sector.

The Bank will pursue four strategic priorities inorder to achieve these objectives by creating asmaller, more nancially viable mortgage andsavings bank. These are to:

Repay the facilities provided bythe Bank of England, principally bycontracting the business to becomesmaller and more sustainable reducingthe balance sheet from around 107billion in 2007 to about 50 billion bythe end of 2011, and withdrawing fromseveral non-core businesses

Align the organisation and operationof Northern Rock under a newexecutive management team with aproposed downsizing and reshapingof the organisation, while supportingemployees through this process

Build a stand-alone funding andcapital position that will facilitate theearliest possible release of the HMTreasury guarantee arrangementsand a return to the private sector, withretail deposits representing a greaterproportion of total funding (although at alower absolute level than before the 2007

crisis)


5/12


Strengthen the risk and controlenvironment throughout the Bank bymeans of improved risk organisation,capabilities and processes

The overall effect of the Plan, under a basecase scenario, would be an improvement inprot before tax from a substantial loss in 2008to break-even in 2011 followed by progressiveprot improvement. In 2008 the businessis expected to be signicantly loss-making,as a consequence of both the anticipatedone-off restructuring costs, which are likely tobe substantial, and higher funding costs. In theyears following this, and reecting a lower costbase, the Plan anticipates that Northern Rockwill achieve sustainable protability and

a nancial structure sufcient to obtain astand-alone credit rating of at least A- anda return to the private sector.

Section C provides details of Northern Rocksstrategic priorities and the actions the Bankproposes to deliver these.

The Plan also recognises that NorthernRock cannot take advantage of the support itreceives from Government during the period ofTemporary Public Ownership to compete on abasis that is unfair or that introduces competitive

distortions into the markets in which it operates.The basis on which the Bank intends tocompete over this period will therefore beconstrained by adherence to a set of self-imposed competitive restrictions. These areset out in Section D.

C.Achieving Northern Rocksstrategic priorities

The Plan, which has been developed ona six year horizon, sets out the Boardspresent assessment of the actions most likelyto achieve Northern Rocks four strategicpriorities. As the market environment evolves,the management team and the Board willperiodically assess progress and adapt thePlan as necessary, subject to the approval ofHM Treasury under the governing ShareholderFramework Document. Any adaptations to thePlan which may impact on Northern Rocksworkforce will be the subject of consultation with

representatives of Unite and other employeerepresentatives.

1. Repay facilities provided by the Bankof England and contract to a smaller,sustainable business

Northern Rocks planned commercial strategy

has as its priority the repayment of the Bankof England debt through the contraction ofthe balance sheet from 107 billion in 2007 toaround 50 billion by 2011. Under the Plan,repayment will come primarily from acceleratingthe pace of consumer mortgage repayment(redemptions) and proposed withdrawal fromnon-core lending activities. In parallel, modestdevelopment of the Banks retail savings basewill create a more balanced funding platform forfuture growth.

Accelerate mortgage redemptionsIn order to reduce the size of its balancesheet to a sustainable level, NorthernRock will work to achieve a considerablyhigher level of mortgage redemptions thanhas historically been the Banks practice.Management expects that, by ceasing theBanks proactive retention programmeand encouraging and helping existingcustomers to transfer their mortgages toother lenders shortly after the customersxed or discounted period expires,redemption levels of some 60% can be

achieved.

The redemption programme will involvecontacting those customers with mortgageproducts approaching the end of theirxed or discounted period and helpingthem nd a new mortgage productelsewhere. Customers will be directedback to a panel of selected mortgageintermediaries who will assist them innding a new mortgage with anotherlender. The company will also explore

arrangements to provide mortgagesdirectly to some customers on behalf ofother lenders. This would enable NorthernRock to improve its service to customersand help achieve the desired level ofredemptions.

It is proposed that, generally, customerswho remain with Northern Rock oncexed or discounted periods come to anend will move onto the standard variablerate. The redemption programme willprovide customers with sufcient notice oftheir product maturity and new paymentdetails, at all times observing regulatoryrequirements to treat customers fairly.


6/12

6

Develop Northern Rocks savingsbusinessIt is critical for the future viability of theBank to achieve a more balanced mixbetween retail and non-retail sources

of funding. In order to do this, NorthernRock plans to rebuild its retail savingsbusiness, as other funding sourcescontract, to create a sustainable mix. TheBank will achieve this with gradual growthin its retail funding base from its presentmarket share of around 1.0% althoughit will remain substantially below theBanks pre-crisis level of 1.9% of UK retaildeposits stock. This approach aims toincrease the proportion of retail funding toaround 50% of the Banks total funding by

2012 (compared to 15-20% in 2008).

Northern Rock will aim to recapture manyof its recently lost customers, develop abetter mix of high value and low balancedepositors, and encourage a higherpercentage of accounts under 35,000.Northern Rock plans to offer a broadproduct range and utilise all of its existingchannels (postal, branch, online andtelephone) to attract savings. In particular,Northern Rocks branch network hasan important role to play in attracting,

servicing and retaining savings accounts.The Banks branch network will bemaintained at its present size throughoutthe Plan period, although, having regardto the requirement to moderate itscompetitive impact, the network will notbe extended.

The Irish and Guernsey savingsbusinesses will be retained, providingimportant funding diversity. NorthernRocks share of the Irish market has

always been small and will remain below0.8% until 2011.

Under the Plan, it is proposed that normalnon-retail funding activities will verygradually recommence from 2008 to2012 as Northern Rocks nancial proleimproves, investor appetite returns andavailable terms become more attractive.

Retain a reduced core lendingbusiness

In order to facilitate its return to theprivate sector as a mortgage andsavings bank, Northern Rock plans toretain a footprint in the new mortgage

market averaging 5 billion per annumof gross new lending from 2008 to 2011(compared to a total of around 30 billionin 2007). New mortgage lending will alsoassist the management of overall credit

quality and the maintenance of NorthernRocks nancing programmes (such asGranite) in a prudent manner.

Lending will be offered predominantlyto high credit quality customers withstandard residential mortgage products.The Together product (100%+ loan-to-value lending) has been discontinuedfor new customers. Credit quality willbe managed with more selective creditquality standards and lower loan-to-value

ratios for all new business taken on.

New lending will be originated mostlythrough intermediaries, maintainingthis distribution channel and especiallyNorthern Rocks panel representationwith key intermediary organisations.The intermediary channel is strategicallyimportant to Northern Rock: historically,it has represented approximately90% of lending volumes. The plannedintermediary channel lending envisagedunder the Plan represents approximately

15% of Northern Rocks historic volumesthrough this channel.

Re-establish the Northern Rock brandand revitalise marketingThe Northern Rock branding willbe retained. Although retail customercondence has eroded, recent researchon behalf of the Bank indicates continuingloyalty to the brand (in particular in thenorth-east of England and among IFAs).A continuing research programme will

conrm the validity of this strategy andassist the development of appropriatemarketing activity to support the Plan.

Discontinue non-core business linesNorthern Rock has already announcedthe run-off and closure of its Danishsavings operations in 2008. In additionthe Bank will discontinue unsecuredlending (2007: 4.0 billion closingbalances) and allow these loan books torun down over the period of the Plan.

Subject to consultation withrepresentatives of Unite and otheremployee representatives over the


7/12


8/12

8

3. Build a stand-alone funding andcapital position

Under the Plan, Northern Rocks financialstrategy will focus on rapid repayment of

Bank of England funding and release of HMTreasurys guarantee arrangements whiledeveloping a sustainable stand-alone fundingand capital position with appropriate controlsand risk management. Repay the Bank of England debt

by 2010The priority for Northern Rocks nancialstrategy is the rapid repayment of theBank of Englands facilities. Whilethe timing will depend to a degree ondevelopments in the UK housing and

mortgage markets, the Plan envisagesthat in the base case, these facilities willbe repaid before the end of 2010. A back-up liquidity facility may remain for a longerperiod until sufcient alternative liquidityarrangements are in place.

Complete the release of HM Treasuryguarantee arrangements by 2011The intention of the Plan is that HMTreasurys guarantee arrangements willbe released as the Banks nancial andstrategic positions progressively improve.

While release may be achieved earlier,it is prudent, given regulatory capitalrequirements, to expect that this will notbe completed before the end of 2011.Given the limited practical experienceof the consequences of releasingstate guarantees of Bank depositsand wholesale liabilities, the viability ofthe Plans proposals for release of theguarantee arrangements will be keptunder review in the light of customerfeedback, market circumstances and the

requirements of the FSA, as regulator, foradequate capitalisation, liquidity and freeassets.

Establish a stand-alone fundingstrategy with balanced retail/non-retailfunding and managed contraction ofthe Granite funding structureThe Bank aims to achieve a long-termcredit rating of at least A- on a stand-alone basis following repayment of theBank of England loan and release ofguarantees. This will be based on theachievement of a signicantly improvednancial prole: a halving in balancesheet size; a greater proportion of retail

deposits (~50% of funding); a return toprotability and the end of support fromHM Treasury and the Bank of England.

The Granite securitisation vehicle,

a funding arrangement created andoperated by Northern Rock, has been animportant source of funding for NorthernRock at an attractive overall cost. Themodest amount of new mortgage lendingwill assist the orderly operation ofGranite over the Plan period. Substitutionof mortgages into Granite will besubstantially reduced from 2009 onwards.

Ensure adequate capital is held underall scenarios

The Plan anticipates that NorthernRock will comply with FSA requirementsregarding capital adequacy and liquidityat all times.

4. Strengthen the risk andcontrol environment

The Board and the management of NorthernRock have commenced a substantial reviewand strengthening of risk management andcontrols within the Bank both at the enterpriseand operational level across all major risk

categories.

The risk and control review hascommenced with a broad scope.

The review addresses enterprise riskmanagement as well as an in-depthreview of major business risk categories market, credit, operational and regulatory.

The review will develop a programmeto strengthen Northern Rocks risk and

control environment covering governance,organisational issues, policies, processesand reporting.

The review commenced during March2008 and is expected to move intoimplementation during June/July 2008following Board and managementapprovals.

In addition, the Board and management haveassessed the sensitivity of the proposals inthe Plan by stress-testing it under differentscenarios. They will take additional steps tomanage the execution risks involved in itsimplementation.


9/12


The stress-testing has included considerationof key execution challenges to the Plan aswell as the impact of hypothetical marketrisks (for example, a mild downturn or asevere recession).

Under all scenarios the Bank remainscompliant with the current FSA capitalrequirements set for the Bank.

The Board is taking measures to managethe risks to timely execution of the Planwhile managing business risks and ensuringregulatory compliance.

Regular stress-testing is planned to beperformed in the future.

The timing and method of releasing the HMTreasury guarantees will always be subjectto Northern Rocks obligation to remaincompliant with FSA capital requirements.

D.Working within the CompetitiveFramework

Northern Rock recognises the responsibilities

it has during State aid period and the need toavoid competitive distortions in the marketsin which it operates. With this in mind, theBank has committed itself to a CompetitiveFramework to provide stakeholders and marketparticipants with condence that it will not useits support from HM Treasury to compete on anunfair basis during this period.

The Competitive Framework comprises a publicset of principles and specic commitments,capable of external monitoring, which aredesigned to minimise risk of competitive

distortion while at the same time allowingthe Bank the exibility it needs to competetactically and respond to customer demand andcompetitor activities as necessary. NorthernRock has developed a monitoring regime toensure adherence to the framework.

The principles of the framework provide thatwhile in receipt of State aid Northern Rock:(a) does not promote the Banks offeringon the basis of Government guaranteearrangements; (b) does not sustain a prolonged

market leadership in any product category;(c) maintains market shares at well belowhistoric levels; (d) seeks to achieve greater

competitive differentiation through service andinnovation; (e) treats all customers fairly; (f)regularly monitors and reviews adherence to theframework.

Specic commitments within the frameworkinclude the provisions that Northern Rock willlimit its share of retail deposit balances to 1.5%in the UK and 0.8% in Ireland, and its shareof gross new mortgage origination to no morethan 2.5%, and accept constraints on its abilityto compete among the top 3 rankings in majorretail savings market categories. Details ofthe Competitive Framework are contained inAppendix I.


10/12

10

E.Key fgures and milestones under the Plan

2006 2007 2009 2011Balance sheet Actuals Actuals Plan Plan

Total assets, before fair value adjustment, bn 101 107 61 49Retail funding, bn 23 10 15 20Retail as percentage of all funding, % 24 10 26 43Government funding, bn 0 27* 1 0Securitised funding, bn 40 43 27 14

UK market share of stock, % 2006 2007 2009 2011

Mortgage 7.1 7.5 3.7 2.4Retail 1.8 0.8 1.0 1.2

Debt repayment & guarantee targets Target Date

25% of facilities provided by Bank of England repaid 200875% of facilities provided by Bank of England repaid 2009Facilities provided by Bank of England fully repaid 2010Release of all HMT guarantee arrangements, subject to FSA requirements 2011

* Excludes open market repo arrangement


11/12

Appendix: Northern Rock

Competitive FrameworkOverview

Northern Rock is determined to return to private ownership as rapidly as possible, as a viable,competitive bank, requiring no support from Government.

We are aware that during the period of temporary public ownership, Government support couldenable us to compete, or be seen to compete, on an unfair basis.

We are determined to ensure that we will not take unfair advantage of Government support during

this interim period as it is not in our long term interests to do so.

We are committing to this framework of principles and commitments while in receipt of Stateaid. These will be kept under review and remain subject to the requirements of the EuropeanCommission.

Our Principles

We will not promote our Government guarantee arrangements in any market.

We will not sustain a prolonged presence as a market leader in the marketplace or inany product category.

We will maintain market shares below historical levels while in receipt of State aid.

We will strive to differentiate ourselves on the basis of service and innovation.

We will at all times treat our customers fairly.

We will regularly review our competitive offering and performance to ensure adherenceto the framework.

Our Commitments

We will not explicitly refer to Government ownership in marketing literature.

We will not allow our share of retail deposit balances to exceed 1.5% in the UK and 0.8%in Ireland (well below our historic levels of 1.9% in the UK and 1.3% in Ireland).

We will limit our share of gross new mortgage origination to no more than 2.5% in anycalendar year.

We will not rank within the top 3 in any one of the defined 15 Moneyfacts retail depositcategories for the remainder of 2008.


12/12

Documents

Northern Rock Provisional Restructuring Plan March 31 2008