Northern Rock gets extra £3bn lifeline from Treasury

The Government will be forced to inject up to £3bn of extra capital into Northern Rock to boost the nationalised bank's safety buffer after arrears and bad debts jumped.

The Treasury has agreed to give up to £3bn of the Government's loans to the bank, which will be turned into equity. It will also convert £400m of preference shares into ordinary shares.

The bank is following rivals such as Royal Bank of Scotland, HBOS and Barclays in raising extra capital. The £3bn figure is big for the bank's size but Ron Sandler, the chairman, said European state aid rules meant Northern Rock had to raise the capital in one go and not "drip feed" it according to conditions.

"We are being prudent," Mr Sandler said. "We have selected an amount that we believe is comfortable for the whole period of temporary public ownership."

Northern Rock's tier one capital ratio was 5.1 per cent at the end of June, compared with the target of more than 6 per cent set by rivals. Its equity tier one ratio was a thin 2.9 per cent, though the figure was within regulatory requirements. The number of residential mortgages more than three months in arrears more than doubled from the start of the year to 1.18 per cent of total home loans at the end of June. Repossessions also jumped from 2,215 to 3,710 over the same period as customers struggled with higher living costs. The bank's bad debt charge rose to £191.6m from £56.8m a year earlier.

At the heart of the troubled loans are Together mortgages, which allowed housebuyers to borrow up to 125 per cent of the property value by adding an unsecured loan to the mortgage. Together loans accounted for 70 per cent of houses that had been repossessed, Mr Sandler said.

Northern Rock expanded its mortgage lending aggressively before it nearly imploded in September but it always claimed that its loans were better quality than the industry average.

Mr Sandler said that the economy and housing market had worsened sharply but that conditions were within the range of expectations used to draw up Northern Rock's business plan. "We are clearly looking at a housing market which has deteriorated very considerably in recent months," Mr Sandler said. "We do think the economic climate and the housing market is going to be difficult for some considerable time."

The bank had warned that it would make a loss this year. The loss for the first half came in at £585m, boosted by bad debts, the cost of reducing its workforce and a writedown of £70m on toxic structured investment products.

Mr Sandler plans to halve the bank's mortgage book to about £50bn and use customers' repayments to pay back the Bank of England's loans before returning the bank to the private sector by 2011. Repayments of the Bank's loans are ahead of schedule, with £9.4bn paid back this year and £17.5bn remaining.

Mr Sandler said Northern Rock's ability to repay would need redemptions to keep going and that falling house prices would affect customers' ability to find mortgages elsewhere. "The future is going to be governed very considerably by what happens in the wider economy, house prices in particular, and what happens in terms of how house prices flow through to the loan book," he said.

As arrears rise, the bank is more than doubling its number of debt managers to 500 this year. It also announced yesterday that Andy Tate was joining as director of debt management from Royal Bank of Scotland.

'Together' 125 per cent mortgage deals fall apart for borrowers

The Together mortgage was Northern Rock's trailblazing product as the former building society dashed for growth.

Introduced in 1999, it was the first 125 per cent mortgage and allowed buyers to borrow up to 95 per cent of a house's value secured against the property, with an unsecured top-up loan of up to 30 per cent of the value. Many other lenders followed Northern Rock in offering similar products but the Rock was unusual in allowing borrowers, usually first-time buyers, to take out a loan of up to six times their income.

Critics attacked the product, saying it encouraged young first-time buyers to overstretch themselves.

The bank responded that many customers were college leavers seeking to gain a foothold on the property ladder and consolidate existing debts, and that it applied strict affordability tests. Adam Applegarth, the former chief executive, dismissed this by saying: "We are a poor proxy for the industry; we are different."

But the contrast between the performance of the 26,000 Together loans and the bank's standard mortgages was stark in the first half – 2.14 per cent of Together loans were in arrears at the end of June compared with 0.8 per cent for regular mortgages.

The Rock was the last bank to scrap its 125 per cent deal, withdrawing Together in February after nationalisation was announced.

Sean Farrell