Repayment of the Bank of England loan

3.12 By December 2008, the company was ahead of plan in repaying the Bank of England loan. Northern Rock had repaid £11.3 billion compared with a target for the whole of 2008 in the business plan of £8.3 billion (Figure 11 overleaf). As the company experienced an inflow of deposits during 2008, it was able to meet liquidity requirements set up by the Financial Services Authority by placing surplus cash with the Bank and has funded a limited volume of new mortgage lending.

3.13 During 2008, the company implemented a range of measures to encourage mortgage redemptions, including a deal with Lloyds TSB (now Lloyds Banking Group) to offer qualifying customers (loan-to-value ratio, plus other conditions) a range of Lloyds TSB or Cheltenham & Gloucester branded products.

3.14 The redemption programme allowed debt to be paid off more quickly, but carried a risk that good quality customers able to re-mortgage with a new lender would do so, leaving those customers with a high loan-to-value ratio or poor credit histories with Northern Rock. This "adverse selection" would impact on the quality of the loan book. The level of risk posed by adverse selection is dependent on the type of mortgages written and a range of external factors, such as changes in house prices, the availability of loan products from other lenders and the performance of the economy generally.

3.15 At 31 December 2008, Northern Rock's high loan-to-value Together mortgages, described in Box 5, represented around 30 per cent of the mortgage book, about 50 per cent of overall arrears and 75 per cent of repossessions. Northern Rock continued to write these high risk products during the period it was receiving emergency support from the taxpayer, albeit at a reduced volume compared to the period prior to September 2007 (Figure 12). Together mortgages with a capital value of £1.8 billion (secured element only) were written between September 2007 and February 2008, when the product was withdrawn ahead of public ownership. Around £1 billion of these new mortgages reflected commitments made by the company to potential borrowers prior to September 2007. The Treasury told us that mortgage transactions, although not necessarily Together mortgages in particular, were necessary to maintain the business, for example to maintain the company's relationship with mortgage brokers while a longer term solution was sought; and to avoid putting the Granite securitisation vehicle into immediate wind-down since the operation of Granite was dependent on the company continuing to generate new mortgage business (Appendix 4).

3.16  The business plan approved in March 2008 had anticipated some degree of adverse selection to arise but not the level experienced during the second half of 2008, which was mostly attributable to a steeper than expected decline in the housing market. Figure 13 shows that, in the six months to the end of December 2008, the number of mortgages that were more than three months in arrears had more than doubled and that just over 4.5 per cent of Together mortgages were in arrears. Overall arrears were also higher than the industry average.