Shareholder Executive

Northern Rock

Purpose

Northern Rock is a retail savings and mortgages focussed bank based in the North East of England.

Legal Status and Ownership

Following its transition to temporary public ownership (TPO), Northern Rock is a Government owned bank regulated by the Financial Services Authority (FSA). The Treasury Solicitor holds 100% of the share capital of the business.

Government Objectives

The Tripartite Authorities’ (HM Treasury, the FSA and the Bank of England) stated objectives for Northern Rock under TPO are to protect taxpayers, maintain wider financial stability and protect consumers.

Within this framework, the company has the following core objectives:

• reduce the level of Government support
• align shape and size of operations
• strengthen risk and control processes
• build a stand alone funding/capital position
• return to the private sector.

A detailed planning exercise is now being undertaken by the company and further announcements will be made in due course as plans are finalised. At this stage, proposals include the following key factors:

• the company will offer up to £14bn of new mortgage lending over the next two years
• responsible new mortgage lending that will be competitively priced to deliver a commercial return
• the company’s capital base will be strengthened by up to £3bn as previously announced
• to facilitate the new lending, whilst maximising capital efficiency and value for the taxpayer, a legal and capital restructuring of the company will be undertaken.

A business plan that describes how the company intends to achieve the above objectives has been submitted to the European Commission in order to obtain State Aid approval. Discussions with the European Commission remain ongoing.

The Shareholder Executive continues to advise HM Treasury in its ongoing work with Northern Rock to optimise future strategic plans to maximise value for money for the UK taxpayer.

Financial Performance¹

£m	2008	2007	2006
Turnover2	48	899	968
Profit/(Loss) before tax	(1,356)	(168)	627
Profit/(Loss) for the year	(1,310)	(199)	443
Net Cash flow	11,375	(4,882)	1,047
Shareholders' Funds	(402)	1,664	2,175
Dividends3	-	105	132

Dividend policy

Northern Rock is currently operating under the forbearance of the FSA in relation to its regulatory capital requirements. A condition of that forbearance is that no dividends are paid. There are therefore no plans to pay dividends in the immediate future.

Performance targets

In order to implement an effective legal and capital restructuring to maximise value for the UK taxpayer while meeting Government policy objectives, company targets are set around mortgage lending volumes, retail deposit growth, capital adequacy, liquidity and a return to profitability.

Notes

¹ Northern Rock’s year end is 31 December.
² Net interest income plus fee and commission income less fee and commission expense.
³ Relates to ordinary dividends paid within the year.

Commentary

The company remains in temporary public ownership, as per the announcement by the Chancellor of the Exchequer on 17 February 2008.The transfer of all Ordinary, Preference and Foundation shares to the Treasury Solicitor took place on 22 February 2008.

At this time, a business plan was developed that was designed to support the Government’s stated objectives of protecting UK taxpayers, maintaining financial stability and protecting consumers.The plan contained a number of key targets, including repayment of the Government loan by the end of 2010, release of the Government guarantee arrangements (subject to FSA requirements) during 2011, and the creation of a smaller, profitable bank capable of returning to private ownership in due course. It was approved by HM Treasury on 31 March 2008.

However, the external economic environment deteriorated markedly since the plan was agreed in March 2008.The global banking crisis worsened, particularly in the second half of 2008.There was a further contraction in liquidity in the market, lending conditions continued to tighten and the UK housing market declined more rapidly than previously forecast.

In response to the changes in the external environment, a review of the plan was conducted in August 2008. This has been completed, in close consultation with the Shareholder Executive, and a number of revisions to the company’s strategy were announced in February 2009. A legal and capital restructuring of Northern Rock will be undertaken to maximise capital efficiency and value for the taxpayer, and to facilitate the return of the company to private ownership in due course.

The Shareholder Executive continues to advise HM Treasury as it works with the company to achieve the best outcome for all stakeholders.