Provisional Northern Rock

Restructuring Plan: Executive Summary

31 March 2008
 Provisional Northern Rock
Restructuring Plan: Executive Summary

A. Background to Temporary Public Ownership

B. Objectives and strategic priorities
C. Achieving strategic priorities
D. Working within the Competitive Framework
E. Key figures and milestones
around 75% of Northern Rock’s total funding
A. Background to Temporary Public was sourced from the non-retail money markets
with £53.8 billion of total non-retail funding
Ownership and the Restructuring Plan balances of £80.5 billion, i.e. two thirds, raised
from securitisations and covered bonds.
The core business of Northern Rock plc (the
“Bank”) is secured residential mortgage lending. Concerns about credit exposure in financial
markets began to surface in the summer of
During the first half of 2007, Northern Rock’s 2007 and credit spreads (the cost of credit)
operational performance was in line with increased. The announcement by a major US
previously stated strategic targets, with asset investment bank of difficulties in one of its
growth of 12.4% over the six months to 30 investment conduits and subsequent similar
June 2007. However, financial performance announcements by other banks led to a serious
was impacted by margin pressure experienced disruption in the medium term funding markets
in the first half of 2007, due in large part to the on 9 August 2007. This quickly led to severe
prevailing interest rate environment as well as restrictions in the liquidity of the short term
the Bank’s timing of transacting hedges for fixed wholesale markets. In the week commencing 10
rate mortgages. This resulted in a downward September 2007 it was necessary to arrange a
revision to profit guidance in June 2007. facility to provide liquidity for Northern Rock in
the event that medium term and securitisation
Northern Rock raised £12.1 billion in aggregate markets failed to reopen. This facility was
in the first half of 2007 to support growth provided by the Bank of England at a premium
through the four funding channels of wholesale rate of interest.
funding, securitisation, covered bond issues and
retail deposits. The Bank also sold a tranche of In the days that followed the grant of the
commercial secured loans in June 2007 with Bank of England facility, there were significant
further tranches sold in the second half of the withdrawals by Northern Rock’s retail depositors
year. These transactions provided additional reflecting customers’ concerns as to the security
funding for secured residential lending of their savings. The substantial amount of retail
amounting to £1.46 billion. As at 30 June 2007 deposits withdrawn following the grant of the

Northern Rock Restructuring Plan during Temporary Public Ownership 3

 loan facility, together with the impact of maturing requirements. It sets out the basis for the
wholesale funding, contributed to Northern removal of financial support provided by HM
Rock having to draw on the Bank of England Treasury and the Bank of England through
facility. the creation of a smaller, more focused and
financially viable mortgage and savings bank
On 17 September 2007, the Chancellor of that will be returned in due course to the private
the Exchequer announced that, should it be sector.
necessary, arrangements would be put in place
to guarantee all existing deposits in Northern Those elements of the Plan which are likely to
Rock during the current instability in the impact on Northern Rock’s workforce remain
financial markets, which significantly slowed the subject to consultation with representatives
level of customer withdrawals. The guarantee of Unite and other employee representatives
arrangements were clarified and extended before any final decisions are taken.
by HM Treasury on 20 and 21 September, 9
October and 18 December 2007 to include all
unsecured retail products, all uncollaterised
derivative transactions and all obligations of the
Company to make payments on the repurchase
B. Northern Rock’s objectives and
strategic priorities
of mortgages under the documentation for the
Granite securitisation programme. In order to
Northern Rock’s prime objectives are the
minimise any unfair commercial advantage to
repayment of the Bank of England debt,
the company, Northern Rock has agreed to
the release of HM Treasury guarantee
pay a fee to HM Treasury for the guarantee
arrangements and a successful return to the
arrangements. Consent was obtained from
private sector.
the European Commission for the provision of
support for the six months from 17 September,
The Bank will pursue four strategic priorities in
in accordance with European law.
order to achieve these objectives by creating a
smaller, more financially viable mortgage and
Following a strategic review with its advisers
savings bank. These are to:
Northern Rock, having consulted with the
Tripartite Authorities (HM Treasury, the Bank
 Repay the facilities provided by
of England and Financial Services Authority)
the Bank of England, principally by
acting in their respective capacities, explored
contracting the business to become
a range of options for the business; these
smaller and more sustainable – reducing
included proposals put forward by both
the balance sheet from around £107
management and third parties. On 17 February
billion in 2007 to about £50 billion by
2008, the Chancellor of the Exchequer
the end of 2011, and withdrawing from
announced that this process had failed to
several non-core businesses
reach a solution that adequately safeguarded
taxpayers’ interests and that the Government
 Align the organisation and operation
had decided to take Northern Rock into a
of Northern Rock under a new
period of Temporary Public Ownership. A further
executive management team with a
submission to the European Commission
proposed downsizing and reshaping
in relation to the longer term restructuring
of the organisation, while supporting
proposals was made 17 March 2008 and the
employees through this process
existing arrangements may be maintained while
this submission is considered.
 Build a stand-alone funding and
capital position that will facilitate the
The Tripartite Authorities have set out their
earliest possible release of the HM
objectives for Northern Rock during the period
Treasury guarantee arrangements
of Temporary Public Ownership: to protect
and a return to the private sector, with
taxpayers, to maintain wider financial stability
retail deposits representing a greater
and to protect consumers. Northern Rock’s
proportion of total funding (although at a
Provisional Restructuring Plan (the “Plan”) has
lower absolute level than before the 2007
been developed to achieve these objectives in
crisis)
a way that complies with State aid

4
 Strengthen the risk and control 1. Repay facilities provided by the Bank
environment throughout the Bank by of England and contract to a smaller,
means of improved risk organisation, sustainable business
capabilities and processes
Northern Rock’s planned commercial strategy
The overall effect of the Plan, under a base has as its priority the repayment of the Bank
case scenario, would be an improvement in of England debt through the contraction of
profit before tax from a substantial loss in 2008 the balance sheet from £107 billion in 2007 to
to break-even in 2011 followed by progressive around £50 billion by 2011. Under the Plan,
profit improvement. In 2008 the business repayment will come primarily from accelerating
is expected to be significantly loss-making, the pace of consumer mortgage repayment
as a consequence of both the anticipated (redemptions) and proposed withdrawal from
one-off restructuring costs, which are likely to non-core lending activities. In parallel, modest
be substantial, and higher funding costs. In the development of the Bank’s retail savings base
years following this, and reflecting a lower cost will create a more balanced funding platform for
base, the Plan anticipates that Northern Rock future growth.
will achieve sustainable profitability and
a financial structure sufficient to obtain a Accelerate mortgage redemptions
 
stand-alone credit rating of at least A- and In order to reduce the size of its balance
a return to the private sector. sheet to a sustainable level, Northern
Rock will work to achieve a considerably
Section C provides details of Northern Rock’s higher level of mortgage redemptions than
strategic priorities and the actions the Bank has historically been the Bank’s practice.
proposes to deliver these. Management expects that, by ceasing the
Bank’s proactive retention programme
The Plan also recognises that Northern and encouraging and helping existing
Rock cannot take advantage of the support it customers to transfer their mortgages to
receives from Government during the period of other lenders shortly after the customer’s
Temporary Public Ownership to compete on a fixed or discounted period expires,
basis that is unfair or that introduces competitive redemption levels of some 60% can be
distortions into the markets in which it operates. achieved.
The basis on which the Bank intends to
compete over this period will therefore be The redemption programme will involve
constrained by adherence to a set of self- contacting those customers with mortgage
imposed competitive restrictions. These are products approaching the end of their
set out in Section D. fixed or discounted period and helping
them find a new mortgage product
elsewhere. Customers will be directed

C. Achieving Northern Rock’s back to a panel of selected mortgage

intermediaries who will assist them in
finding a new mortgage with another
strategic priorities
lender. The company will also explore
The Plan, which has been developed on arrangements to provide mortgages
a six year horizon, sets out the Board’s directly to some customers on behalf of
present assessment of the actions most likely other lenders. This would enable Northern
to achieve Northern Rock’s four strategic Rock to improve its service to customers
priorities. As the market environment evolves, and help achieve the desired level of
the management team and the Board will redemptions.
periodically assess progress and adapt the
Plan as necessary, subject to the approval of It is proposed that, generally, customers
HM Treasury under the governing Shareholder who remain with Northern Rock once
Framework Document. Any adaptations to the fixed or discounted periods come to an
Plan which may impact on Northern Rock’s end will move onto the standard variable
workforce will be the subject of consultation with rate. The redemption programme will
representatives of Unite and other employee provide customers with sufficient notice of
representatives. their product maturity and new payment
details, at all times observing regulatory
requirements to treat customers fairly.

Northern Rock Restructuring Plan during Temporary Public Ownership 5

 Develop Northern Rock’s savings
  market averaging £5 billion per annum
business of gross new lending from 2008 to 2011
It is critical for the future viability of the (compared to a total of around £30 billion
Bank to achieve a more balanced mix in 2007). New mortgage lending will also
between retail and non-retail sources assist the management of overall credit
of funding. In order to do this, Northern quality and the maintenance of Northern
Rock plans to rebuild its retail savings Rock’s financing programmes (such as
business, as other funding sources Granite) in a prudent manner.
contract, to create a sustainable mix. The
Bank will achieve this with gradual growth Lending will be offered predominantly
in its retail funding base from its present to high credit quality customers with
market share of around 1.0% – although standard residential mortgage products.
it will remain substantially below the The “Together” product (100%+ loan-to-
Bank’s pre-crisis level of 1.9% of UK retail value lending) has been discontinued
deposits stock. This approach aims to for new customers. Credit quality will
increase the proportion of retail funding to be managed with more selective credit
around 50% of the Bank’s total funding by quality standards and lower loan-to-value
2012 (compared to 15-20% in 2008). ratios for all new business taken on.

Northern Rock will aim to recapture many New lending will be originated mostly
of its recently lost customers, develop a through intermediaries, maintaining
better mix of high value and low balance this distribution channel and especially
depositors, and encourage a higher Northern Rock’s panel representation
percentage of accounts under £35,000. with key intermediary organisations.
Northern Rock plans to offer a broad The intermediary channel is strategically
product range and utilise all of its existing important to Northern Rock: historically,
channels (postal, branch, online and it has represented approximately
telephone) to attract savings. In particular, 90% of lending volumes. The planned
Northern Rock’s branch network has intermediary channel lending envisaged
an important role to play in attracting, under the Plan represents approximately
servicing and retaining savings accounts. 15% of Northern Rock’s historic volumes
The Bank’s branch network will be through this channel.
maintained at its present size throughout
the Plan period, although, having regard Re-establish the Northern Rock brand
 
to the requirement to moderate its and revitalise marketing
competitive impact, the network will not The “Northern Rock” branding will
be extended. be retained. Although retail customer
confidence has eroded, recent research
The Irish and Guernsey savings on behalf of the Bank indicates continuing
businesses will be retained, providing loyalty to the brand (in particular in the
important funding diversity. Northern north-east of England and among IFAs).
Rock’s share of the Irish market has A continuing research programme will
always been small and will remain below confirm the validity of this strategy and
0.8% until 2011. assist the development of appropriate
marketing activity to support the Plan.
Under the Plan, it is proposed that normal
non-retail funding activities will very  Discontinue non-core business lines
gradually recommence from 2008 to Northern Rock has already announced
2012 as Northern Rock’s financial profile the run-off and closure of its Danish
improves, investor appetite returns and savings operations in 2008. In addition
available terms become more attractive. the Bank will discontinue unsecured
lending (2007: £4.0 billion closing
Retain a reduced core lending
  balances) and allow these loan books to
business run down over the period of the Plan.
In order to facilitate its return to the
private sector as a mortgage and Subject to consultation with
savings bank, Northern Rock plans to representatives of Unite and other
retain a footprint in the new mortgage employee representatives over the

6
 coming weeks, Northern Rock proposes to Temporary Public Ownership. Together
to discontinue commercial lending (2007: these changes have significantly adjusted
£1.3 billion closing balances including the composition of the Board, bringing
commercial buy-to-let) and to allow this new leadership and additional valuable
loan book to run down over the period to experience and expertise.
2011.
Within Northern Rock, the executive team
Earlier sale or other options to liquidate will take steps to further strengthen the
these portfolios will be considered organisation’s capabilities, in particular in
alongside any proposals put forward risk, internal audit, finance, treasury and
by Unite or the other employee human resources.
representatives.
 Restructure the organisation
and reduce operating costs
2. Reconfigure Northern Rock’s organisation Under the Plan, Northern Rock will
and operations to reflect the new become a more focused and smaller
commercial strategy business in order to facilitate a return to
the private sector as rapidly as possible.
In order to achieve its objectives, Northern The achievement of a viable and efficient
Rock’s organisation and operations must business in the future will require a lower
change as follows: cost base and reconfigured operations.

 Strengthen leadership and capabilities The Plan targets a reduction in underlying

The Plan envisages a major restructuring operating costs of about 20%. It
and carries with it a significant number envisages about a one-third reduction
of financial and operational risks. Its in staff levels over the next three years
successful delivery, particularly in based on projected business volumes
the context of a challenging market with the majority of the reduction
environment, requires additional occurring in the first year. The timing
experience and strengthened leadership and nature of the proposed downsizing,
of the Bank. including any redundancy arrangements,
will be subject to consultation with
In addition, Northern Rock will strengthen representatives of Unite and other
its risk management and controls and employee representatives.
take additional steps to manage risks
entailed in the downsizing strategy. Northern Rock is committed to open
communication with staff and to
The leadership of Northern Rock has providing them with substantial support
been strengthened with the appointment during the restructuring. The Bank will
of two new executive Board members: continue to work closely with Unite,
Ron Sandler, Executive Chairman, and One NorthEast and other agencies and
Ann Godbehere, Chief Financial Officer. stakeholders to minimise the impact of
Andy Kuipers has continued as Chief the proposed downsizing on staff and
Executive Officer working with the new local communities; this includes providing
Executive Chairman and Chief Financial outplacement services to help staff obtain
Officer. alternative employment in the region.

The Government, in consultation with  Review performance management
Ron Sandler, has appointed three The Plan includes a proposed review
new non-executive directors: Stephen of Northern Rock’s performance
Hester (Deputy Chairman and Senior management practices and changes to
Independent Director), Chief Executive incentive programmes. A staff incentive
of British Land and former COO of Abbey scheme will be introduced linked to
National plc; Philip Remnant, chairman of achievement of the Tripartite Authorities’
the Shareholder Executive and a former objectives under Temporary Public
banker; and Tom Scholar, a senior HM Ownership.
Treasury civil servant. Several Board
directors have retired during the transition

Northern Rock Restructuring Plan during Temporary Public Ownership 7

 3. Build a stand-alone funding and deposits (~50% of funding); a return to
capital position profitability and the end of support from
HM Treasury and the Bank of England.
Under the Plan, Northern Rock’s financial
strategy will focus on rapid repayment of The Granite securitisation vehicle,
Bank of England funding and release of HM a funding arrangement created and
Treasury’s guarantee arrangements while operated by Northern Rock, has been an
developing a sustainable stand-alone funding important source of funding for Northern
and capital position with appropriate controls Rock at an attractive overall cost. The
and risk management. modest amount of new mortgage lending
 Repay the Bank of England debt will assist the orderly operation of
by 2010 Granite over the Plan period. Substitution
The priority for Northern Rock’s financial of mortgages into Granite will be
strategy is the rapid repayment of the substantially reduced from 2009 onwards.
Bank of England’s facilities. While
the timing will depend to a degree on Ensure adequate capital is held under
 
developments in the UK housing and all scenarios
mortgage markets, the Plan envisages The Plan anticipates that Northern
that in the base case, these facilities will Rock will comply with FSA requirements
be repaid before the end of 2010. A back- regarding capital adequacy and liquidity
up liquidity facility may remain for a longer at all times.
period until sufficient alternative liquidity
arrangements are in place. 4. Strengthen the risk and
control environment
Complete the release of HM Treasury
 
guarantee arrangements by 2011 The Board and the management of Northern
The intention of the Plan is that HM Rock have commenced a substantial review
Treasury’s guarantee arrangements will and strengthening of risk management and
be released as the Bank’s financial and controls within the Bank both at the enterprise
strategic positions progressively improve. and operational level across all major risk
While release may be achieved earlier, categories.
it is prudent, given regulatory capital
requirements, to expect that this will not The risk and control review has
 
be completed before the end of 2011. commenced with a broad scope.
Given the limited practical experience
of the consequences of releasing The review addresses enterprise risk
 
state guarantees of Bank deposits management as well as an in-depth
and wholesale liabilities, the viability of review of major business risk categories –
the Plan’s proposals for release of the market, credit, operational and regulatory.
guarantee arrangements will be kept
under review in the light of customer The review will develop a programme
 
feedback, market circumstances and the to strengthen Northern Rock’s risk and
requirements of the FSA, as regulator, for control environment covering governance,
adequate capitalisation, liquidity and free organisational issues, policies, processes
assets. and reporting.

Establish a stand-alone funding

  The review commenced during March
 
strategy with balanced retail/non-retail 2008 and is expected to move into
funding and managed contraction of implementation during June/July 2008
the “Granite” funding structure following Board and management
The Bank aims to achieve a long-term approvals.
credit rating of at least A- on a stand-
alone basis following repayment of the In addition, the Board and management have
Bank of England loan and release of assessed the sensitivity of the proposals in
guarantees. This will be based on the the Plan by stress-testing it under different
achievement of a significantly improved scenarios. They will take additional steps to
financial profile: a halving in balance manage the execution risks involved in its
sheet size; a greater proportion of retail implementation.

8
 The stress-testing has included consideration
  competitive differentiation through service and
of key execution challenges to the Plan as innovation; (e) treats all customers fairly; (f)
well as the impact of hypothetical market regularly monitors and reviews adherence to the
risks (for example, a mild downturn or a framework.
severe recession).
Specific commitments within the framework
Under all scenarios the Bank remains
  include the provisions that Northern Rock will
compliant with the current FSA capital limit its share of retail deposit balances to 1.5%
requirements set for the Bank. in the UK and 0.8% in Ireland, and its share
of gross new mortgage origination to no more
The Board is taking measures to manage
  than 2.5%, and accept constraints on its ability
the risks to timely execution of the Plan to compete among the top 3 rankings in major
while managing business risks and ensuring retail savings market categories. Details of
regulatory compliance. the Competitive Framework are contained in
Appendix I.
Regular stress-testing is planned to be
 
performed in the future.

The timing and method of releasing the HM

 
Treasury guarantees will always be subject
to Northern Rock’s obligation to remain
compliant with FSA capital requirements.

D. Working within the Competitive

Framework
Northern Rock recognises the responsibilities
it has during State aid period and the need to
avoid competitive distortions in the markets
in which it operates. With this in mind, the
Bank has committed itself to a “Competitive
Framework” to provide stakeholders and market
participants with confidence that it will not use
its support from HM Treasury to compete on an
unfair basis during this period.

The Competitive Framework comprises a public

set of principles and specific commitments,
capable of external monitoring, which are
designed to minimise risk of competitive
distortion while at the same time allowing
the Bank the flexibility it needs to compete
tactically and respond to customer demand and
competitor activities as necessary. Northern
Rock has developed a monitoring regime to
ensure adherence to the framework.

The principles of the framework provide that

while in receipt of State aid Northern Rock:
(a) does not promote the Bank’s offering
on the basis of Government guarantee
arrangements; (b) does not sustain a prolonged
market leadership in any product category;
(c) maintains market shares at well below
historic levels; (d) seeks to achieve greater

Northern Rock Restructuring Plan during Temporary Public Ownership 9

 E. Key figures and milestones under the Plan
2006 2007 2009 2011
Balance sheet Actuals Actuals Plan Plan

Total assets, before fair value adjustment, £bn 101 107 61 49
Retail funding, £bn 23 10 15 20
Retail as percentage of all funding, % 24 10 26 43
Government funding, £bn 0 27* 1 0
Securitised funding, £bn 40 43 27 14


UK market share of stock, % 2006 2007 2009 2011

Mortgage 7.1 7.5 3.7 2.4
Retail 1.8 0.8 1.0 1.2


Debt repayment & guarantee targets T
arget Date

25% of facilities provided by Bank of England repaid 2008
75% of facilities provided by Bank of England repaid 2009
Facilities provided by Bank of England fully repaid 2010
Release of all HMT guarantee arrangements, subject to FSA requirements 2011

* Excludes open market repo arrangement

10
Appendix: Northern Rock
Competitive Framework
Overview

Northern Rock is determined to return to private ownership as rapidly as possible, as a viable,

competitive bank, requiring no support from Government.

We are aware that during the period of temporary public ownership, Government support could
enable us to compete, or be seen to compete, on an unfair basis.

We are determined to ensure that we will not take unfair advantage of Government support during
this interim period as it is not in our long term interests to do so.

We are committing to this framework of principles and commitments while in receipt of State
aid. These will be kept under review and remain subject to the requirements of the European
Commission.

Our Principles

 We will not promote our Government guarantee arrangements in any market.

We will not sustain a prolonged presence as a market leader in the marketplace or in

 
any product category.

 We will maintain market shares below historical levels while in receipt of State aid.

We will strive to differentiate ourselves on the basis of service and innovation.

 

 We will at all times treat our customers fairly.

We will regularly review our competitive offering and performance to ensure adherence
 
to the framework.

Our Commitments

 We will not explicitly refer to Government ownership in marketing literature.

We will not allow our share of retail deposit balances to exceed 1.5% in the UK and 0.8%
 
in Ireland (well below our historic levels of 1.9% in the UK and 1.3% in Ireland).

We will limit our share of gross new mortgage origination to no more than 2.5% in any
 
calendar year.

We will not rank within the top 3 in any one of the defined 15 Moneyfacts retail deposit
 
categories for the remainder of 2008.