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Fears of a housing crash in the UK are threatening to scupper the sale of Northern Rock, pushing the stricken mortgage lender ever closer to nationalisation.
Any rescue will depend on the £10bn-£15bn of funding that investment banks Citigroup, Deutsche Bank and Royal Bank of Scotland have offered to inject, but they are said to be growing increasingly reluctant to secure their loans against Northern Rock's assets.
Separately, Goldman Sachs – which is advising the UK Government – is still pressing ahead with its own efforts to find an alternative funding syndicate.
Although the bulk of Northern Rock's mortgages are good, the UK Treasury is insisting the banks take as collateral a slice of the entire book - including lower quality mortgages. As a result, they are having to revalue Northern Rock's assets to reflect the prospect of declining property prices and rising levels of arrears.
One banker close to proceedings said: "The deterioration in the housing market does make it harder [to sign off on funding]. There has been a significant worsening in the outlook for UK housing since September [when the crisis erupted]."
Another insider said that getting the banks behind a deal is proving "tricky because its very hard to value the bits of the book that are not so good... valuations are sliding and they keep having to revalue it".
Since the crisis began in September, UK house prices have slumped from growth of 0.7 per cent month-on-month to a 0.8 per cent fall in November and 0.5 per cent dip last month, according to Nationwide. Also last month, the International Monetary Fund warned of a looming "sizeable impact" on property prices.
The issue is particularly acute at Northern Rock, which acquired business extremely aggressively in the first half of 2007 - now seemingly the peak of the boom. Despite having just 7.6 per cent of the market, it accounted for one in five of all mortgages sold.
More than 10 per cent of the 87,393 residential mortgages on Northern Rock's books are now considered to be higher risk. Of its total 6,181 buy-to-let mortgages, 1,455 were sold in the first six months of last year. In the same period, a further 3,300 mortgages were sold with a loan-to-value ratio of more than 90 per cent. It also has £7.83bn of unsecured loans.
Funding problems may jeopardise the two proposals on the table - from Sir Richard Branson's Virgin Money and Olivant, the group led by former Abbey chief Luqman Arnold. One senior source said talks are in trouble because the lending banks are demanding bidders put up at least £1.2bn-£1.4bn of equity capital, as a cushion to absorb the first effects of a possible housing slump.
Olivant is proposing an equity injection of no more than £800m. Virgin, while pledging £1.2bn, faces questions about its business plan which hinges on the UK mortgage market growing this year.
Insiders say they do not expect a proposal in time for the special shareholder meeting called for January 15.
Fears about the housing market have now replaced concerns about the cost of funding as the single largest obstacle to a deal. Three month interbank lending rates (Libor) have fallen to below 6 per cent from nearly 7 per cent last year, but bankers said they would be reluctant to lend to Northern Rock at anything less than a significant premium to Libor.
One said: "With Northern Rock when you take it to the credit committee you know you are lending to a borderline bankrupt company and you can price it accordingly."
The problems increase the likelihood of a public sector solution, possibly through some form of nationalisation. The taxpayer has already provided guarantees worth £57bn, including a loan from the Bank of England for £26bn. (The Daily Telegraph)
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