City gets Northern Rock wrong

Posted on 27 June 2007 by Ray Boulger

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The City took fright today at Northern Rock’s pre close statement and the shares closed 12% down on the day. This says more about the analysts in The City, or the “teenage scribblers” as Norman Lamont once famously called them, and in particular their understanding of the UK residential mortgage market, than it does about Northern Rock.

There were both negatives and positives in the statement, with the most negative in my view being a reduction of 18 – 20 basis points in the gross interest rate spread. Northern Rock blamed this on “increases in Libor, swap rates, delays in retail repricing and the loss of interest from asset disposals”. This is all very well but in a rising interest rate environment all these factors were predictable and it suggests that Northern Rock’s Treasury operation got the timing wrong more often than they got it right.

However, despite this Northern Rock are forecasting their net profit for the year will increase by 15% and the main reason for the sharp fall in the share price appears to be that the “teenage scribblers” had been forecasting on average an increase of 17%, although the spread of forecasts for the size of the profit increase was very wide at 10 - 24%. Any company which at the halfway stage gets its profit forecast for the year right to within 2% is doing pretty well on the forecasting front and so the final result for the year could well hit the 17% forecast, or indeed fall short of Northern Rock’s official forecast.

BBC online are quoting Richard Hunter of Hargreaves Lansdown Stockbrokers as saying "Today's effective profit warning, which has battered the share price in an already nervous market, could hardly have come at a worse time." To call a forecast of a 15% increase in profits a profit warning just because some analysts had overcooked their forecasts is an interesting definition of a profit warning!

Analysts at Keefe, Bruyette & Woods took a different line, again quoting from BBC online, and said the announcement reflected "a period-specific strain in 2007 and does not indicate the business model is not working.

They continued "While today will be painful, we recommend investors look through the near-term interest rate strain and at a business model that can clearly deliver superior returns at lower risk." This seems to me a much more sensible reaction.

The comment in the pre close statement which particularly caught my eye was the stunning performance on net lending. Northern Rock said that in the first 5 months of 2007 their share of UK gross mortgage lending was around 10%, up from 8.3% in the whole of 2006. However their share of net lending was a phenomenal 19%, compared with last year’s 13.4%, itself an excellent figure, bearing in mind that Northern Rock’s share of UK mortgage assets at the end of 2006 was 7.1%.

As far as the holy grail of UK mortgage lenders is concerned, i.e. tackling the retention issue, Northern Rock is clearly streets ahead of any other major lender. That seems to have escaped the stock market’s attention, or perhaps the “teenage scribblers” don’t understand the mortgage market well enough to appreciate the significance of this point!

Finally, it is interesting to compare and contrast the HBOS and Northern Rock pre close statements. HBOS blamed a failure of their retention policy for the collapse in their net market share and it is pretty clear from the Northern Rock statement where a lot of HBOS’s mortgages have migrated to, although obviously it is not as simple as that. HBOS’s share of UK mortgage assets is about 20% and Northern Rock’s just over 7%, a total of 27%. HBOS’s estimated their share of net mortgage lending in the first half of 2007 was 8% and Northern Rock’s figure is 19%, a combined total of 27%. Funny that!

Categories: Mortgages, Interest rates

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