Northern Rock defends its aggressive lending strategy

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NORTHERN Rock, kicking off the bank reporting season with a 20 per cent rise in underlying profits, yesterday defended its decision to keep aggressively lending against a backcloth of five interest rate rises since last August.

Chief executive Adam Applegarth, who unveiled a profit warning last month that wiped 10 per cent off the mortgage bank's shares, said the decision was deliberate even though it had now flagged reduced profit growth of 15 per cent for 2007 and 2008.

"We knew it would squeeze 2007 and 2008, but we decided to grab land now in order to drive up earnings in 2009 and 2010," Applegarth said.

"We are confident we can do this because we have a record of retaining 80 to 85 per cent of our customers when their fixed-rate mortgages are up. That is against an industry average retention rate of 25 to 30 per cent."

The explanation from Northern, plus a 30 per cent leap in the divi to 14.2p and news of a 300m to 400m share buyback programme, partly mollified the City.

Northern's shares rose 4 per cent before later closing up 1.9 per cent or 15p at 817p.

Including gains from disposals, the bank's profits rose 27 per cent to 346.6m, while Applegarth said the dividend payout ratio would rise from 40 to 50 per cent of underlying earnings.

Between them, the big five banks are expected to have made about 20bn in profit in the first six months of the year, but the figure most customers are looking for will be the cost of settling reclaimed penalty charges. Some have estimated that cost at about 4bn, with others speculating the real figure will be half that.

Royal Bank of Scotland reports on 3 August, with profit estimates at 5bn, while HBOS delivers its figures on 1 August, profits expected around 2.3bn.

Applegarth said the divi and buyback largesse were a result of less capital being required in the business under the Basle 2 agreement.

Northern's immediate problems are because, unlike rival lenders such as Halifax, which fund most of their mortgage lending from other customers' savings, Northern borrows most of its funds from the wholesale markets. That leads to its margins being squeezed as interest rates rise but most of its borrowers remain on lower fixed-rate mortgages for a time.

Applegarth said things would get worse before they got better because so far only about a third of borrowers had been affected by the rate rises since last summer.

Northern's share of gross mortgage lending rose from 8.5 to 10 per cent in the six months.

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