Rock collapse left many in a hard place

Northern Rock collapsed five years ago this week, one of the first victims of the growing financial crisis. FT Money looks at the consequences for investors, savers and mortgage borrowers.

Investing

When Northern Rock reported half-year results in July 2007, it was able to boast that first-half net lending was £19.3bn, a new record and 18.9 per cent of all UK net lending. “The medium-term outlook for the company is very positive,” said chief executive Adam Applegarth, announcing a 30 per cent increase in the interim dividend.

Less than two months later, the company became the victim of the first run on a UK bank for over a century, and within a year it had collapsed into the arms of the state. More turmoil followed in 2008, when Lloyds and Royal Bank of Scotland were partially nationalised.

The company’s rapid fall from grace confounded investors. The first thing to go was that dividend which was “deferred” – indefinitely, as it turned out – later the same month. Others weren’t far behind. In 2007, the banking sector accounted for 21 per cent of all UK dividend income, according to data from Capita Registrars. By 2009, that had fallen to 10 per cent and in 2011 it was 9.7 per cent.

Although Barclays, HSBC and Standard Chartered still pay dividends, they have been “rebased” to lower levels. Any distributions to shareholders remain firmly off the agenda at RBS and Lloyds, so long as they remain wards of the state.

Share prices have also slumped – Barclays is down from over £7 to just over £2, while Lloyds shares peaked at over £3 but now trade at around 35p, half the price at which the government acquired its 41 per cent stake. But least they’re still trading; investors in Northern Rock are unlikely to receive any meaningful compensation for the nationalisation of the company.

Despite the turmoil, bank shares remain heavily traded by private investors. “Lloyds shares have been our top buys and sells by volume since 2009,” said Stuart Welch, chief executive of TD DirectInvesting, a leading online stockbroker. “In 2009 and 2010, it was all about traders. Bank shares were quite volatile and there was a pattern of rising and falling,” he added. From an investor’s point of view, banks remain a recovery story. “They expect – or hope for – some kind of turnround in the long term.”

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Paul Kavanagh, a partner at stockbroker Killik, says there are signs of such a turnround. “Historically, bank shares have traded at price-to-book-value ratios of 1 to 1.5. They’re at about 0.5-0.7 now. Another couple of years of steady, good performance and I think that gap will start to close.”

Immediate prospects are better in the subordinated debt market, which is dominated by permanent interest bearing shares (Pibs), a form of perpetual subordinated bond considered ideal for risk-averse income seekers and widely held by private investors. But in May 2009, Bradford & Bingley became the first UK bank in modern history to miss an interest payment on its debt. Lloyds was also forced to suspend interest payments on its preference shares because of state aid rules.

“There is some value left here,” said Mark Glowrey, head of retail bond sales at Canaccord Genuity. “The situation is much more balanced and people are more aware of the risks. As a consequence, prices are higher and yields are lower.”

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Savings

The past five years have been disastrous for savers as low interest rates and relatively high inflation have combined to erode the purchasing power of cash. The only consolation, according to savings experts, is that it could have been much worse.

With access to the wholesale money markets severely constrained and more stringent capital requirements on the way, banks and building societies have had to compete fiercely for retail deposits. They’ve done this primarily by using short-term bonuses.

Advisers say that bonus rates offer customers the only chance to keep pace with rising prices, so long as they remember to switch their money out once the bonus period comes to an end.

“Savers have clearly lost out since Northern Rock collapsed,” said Mark Giddens at accountancy firm UHY Hacker Young. His research found that savers are losing nearly £18bn a year thanks to record low interest rates and the higher cost of living.

“In the old days, interest rates ran above inflation, but I think the situation for the next few years will remain as it is now and savers will struggle – which will be particularly hard for those who rely on their savings income, such as pensioners.”

Reports suggest that the Bank of England is considering a further cut in interest rates to 0.25 per cent, which could lead to a knock-on reduction in baseline cash savings rates.

According to research by Moneyfacts, savers who kept their money in easy access accounts were earning an average return of more than 4 per cent in 2007. Today they earn just over 1 per cent – and inflation is higher too.

The best return available in an easy-access cash account is 2.9 per cent from ING Direct, which includes a 2.36 per cent bonus.

The number of providers has fallen too. Prior to the financial crisis the best buy savings tables were dominated by a range of international banks, including Icelandic banks offering 6 per cent plus returns.

Following the banking crisis the sector has contracted, leaving fewer building societies and banks to choose from.

However, money put into foreign banks operating in the UK is now more likely to be covered by the UK’s Financial Services Compensation Scheme than it was in 2007.

The FSCS was set up in 2001 and would have protected up to £31,700 of every individual’s money saved in Northern Rock (100 per cent of the first £2,000 and 90 per cent of the next £33,000), regardless of government guarantees. Following the crisis, the amount protected was increased, first to £50,000 and then £85,000 and the scheme has worked hard to make itself more visible in order to make savers feel secure.

“The run on Northern Rock and the bank failures of 2008 are still a vivid memory for many people,” said Mark Neale, chief executive of FSCS. “Over the last five years there has been a significant improvement in FSCS protection for people’s deposits.”

All banks and building societies must now state whether or not they are members of the FSCS and there are plans to create a Europe-wide compensation scheme, though it is not yet clear whether or not the UK will be included.

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Mortgages

Getting a mortgage has become significantly harder in the five years since the Northern Rock crisis, with lenders becoming increasingly risk averse.

Banks and building societies have introduced stricter acceptance criteria and cut the number of deals available drastically, particularly for borrowers with small deposits.

Five years ago there were thousands of low-deposit mortgages offered by lenders, including hundreds of deals for borrowers with no deposit, with some banks – such as Nothern Rock – offering 125 per cent loan-to-value mortgages.

Today, the picture is very different. While there were 238 mortgages available for borrowers with no deposit in September 2007, there are now only five. Those with a 5 per cent deposit had a choice of 986 deals five years ago but just 67 today, according to Moneyfacts, the financial data provider.

“The biggest immediate effect of the Northern Rock crisis was that the main high street lenders severely restricted loan-to-values as a result of the money supply drying up,” said Nigel Bedford, senior partner at Largemortgageloans.com, the mortgage broker. “What they did have to lend, they logically lent to the lowest risk customers.”

The situation worsened the following year when Lehman Brothers collapsed, and the securisation market effectively closed. Mark Harris of SPF Private Clients, the mortgage broker, believes this was the final straw for the mortgage market. The total number of mortgages approved fell from about 2.5m in 2007 to 1.5m the following year, and then down to just under 1m in 2009.

“In the aftermath it was difficult to borrow even 75 per cent loan-to-value,” noted Bedford. “When the world didn’t end and every bank didn’t collapse, we gradually saw lenders return to the market and offer higher loan-to-values.”

The outlook is slowly improving for borrowers with small deposits. The number of 95 per cent loan-to-deals has risen from just nine in 2009 to 67 today. However, experts believe the market has seen the last of risky 125 per cent mortgage deals – although most observers consider this to be no bad thing.

But there remains a big divide in today’s mortgage market. The reduction of the Bank of England base rate to 0.5 per cent has benefited many existing homeowners who took out variable rate deals, which track base rate, and saw their monthly payments fall. Lower wholesale funding costs in the past year, partly driven by quantitative easing and the announcement of the government’s Funding for Lending scheme (FLS), has resulted in historically low-priced fixed-rate deals for new homebuyers and movers. Low-risk borrowers can now secure long-term fixed-rates of below 3 per cent.

Higher-risk borrowers, those with small deposits and first-time buyers, continue to struggle. New rules proposed by the Financial Services Authority aimed at curbing irresponsible lending, have resulted in lenders imposing stricter criteria, making it harder for those with interest-only or self-certification mortgages to move home.

“What all this means is we have a split population, on one side the fortunate who are not paying much to borrow, and who lenders will fight to attract and retain: and on the other, there is a group that is stuck or simply can’t borrow at all,” explained Ben Thompson of L&G Mortgage Club.

The outlook does appear to be improving. Although it is early days, the FLS, introduced by the government last month to encourage banks to lend to homeowners and small businesses, has already helped lower mortgage costs for some borrowers.

“We are still waiting for lenders to introduce more five and ten per cent deposit mortgages as rates are still quite expensive,” said Aaron Strutt of Trinity Financial, the mortgage broker. “The market would certainly pick up if there were more than four or five lenders offering five per cent deposit rates.”