Northern Rock, the UK’s eighth-largest listed bank and third-largest mortgage player, is set to be bought or wound down after the bank became one of the biggest European casualties of the US subprime fallout. The lender suffered a rapid collapse in consumer confidence on 14 September after becoming the first UK financial institution in 30 years to seek emergency funding from the Bank of England.

Northern Rock’s business model has been unable to adapt to the abrupt shift in banking sentiment after the US mortgage slowdown. The lender relies on the wholesale markets for around three-quarters of its funding; in contrast, Lloyds TSB obtains around 28 percent of its funding from wholsesale markets, Royal Bank of Scotland 17 percent and Barclays around 10 percent.

Addressing analysts on 14 September, the CEO of Northern Rock, Adam Applegarth, said: “The world changed on 9 August [when the US market turned] and we cannot see an end in sight to the [credit] freeze.”

Northern Rock’s shares – which traded at a high of £12.58 ($25) on 6 February – plunged by more than 60 percent in the space of two days as investors also lost confidence. Investment bank Keefe, Bruyette & Woods said in a statement: “The only positive, if any, is if a white knight/bargain hunter comes in to rescue what is in essence an excellent asset-gatherer — assuming financial adviser relationships hold.”

As of 30 June this year, Northern Rock had assets of £113 billion – up from £88 billion in June 2006 – against deposits of £24 billion. However, in a highly damaging turn of events, queues of depositors had begun forming at Northern Rock branches as a significant number of worried customers looked to withdraw their cash – with the concomitant concern over a possible bank run. By 17 September, around £2.5 billion of deposits had been withdrawn.

The UK government, financial regulators and various commentators have all sought to dispel a growing sense of consumer hysteria. The British Bankers Association, for instance, said in a public statement: “Northern Rock is a sound and safe bank and there is absolutely no reason for either mortgage customers or savers to worry. Everyone should calm down and refrain from making simplistic comments in a very complex area which just cause unnecessary worry and concern.”

Northern Rock has 76 retail branches, 1.4 million retail depositors and 800,000 mortgage customers. Until the current credit crisis, it had been praised for an innovative approach to its mortgage business. It had enjoyed aggressive lending growth, with an 18.9 percent share of the UK mortgage market in the first half of 2007, up from 12 percent year-on-year.

No funds available

Explaining the reason for the approach to the Bank of England, Applegarth said: “There are no funds available. It is an astonishing thing to see that the three month sterling cash deposit market, which historically has been the most liquid market in the world, has no trades.”

He added: “We have been running a higher proportion of wholesale funding than many of our competitors. With hindsight, if we had seen this coming, we would not have run the same strategy but hindsight is a great thing. I did not see this coming and I have yet to meet someone who did.”

Applegarth had previously predicted a shake-up in the UK mortgage sector taking place within the next five years, and suggested that Northern Rock might have to buy a bigger rival to be among the survivors. Now, an independent Northern Rock, which traces its roots back to 1850, is unlikely.