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The Case of Northern Rock
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Table of Contents 1 Scope of Study 3 2 Introduction to the Northern Rock Debacle 3 2.1 Introduction to Northern Rock’s Business Model 4 3 Internal Analysis 7 3.1 Analysis of Northern Rock’s Balance Sheet 2006 7 3.1.1 Northern Rock’s Sources of Funding 7 3.1.2 Asset and Liability Maturity Mismatch 2006 8 3.1.3 Peer Group Ratio Comparison to Assess Northern Rock Liquidity Risk 2006 9 3.2 Exposure to Low Probability High Impact (LPHI) Risk 10 4 Analysis of Market Condition 10 4.1 U.S Sub-prime Mortgage Market Crisis 10 4.2 Consequences of U.S. Sub-prime Mortgage Market Crisis 11 4.3
Also, stripped off its heavy regulations as a building society, Northern Rock was able to expand its source of funding, instead of relying customers’ deposits and is not limited to serve residents only from their community – thus increasing Northern Rock’s scale of business. This allowed Northern Rock to have a comparative advantage over its competitors as it consistently provided the best mortgage rates in Britain due to its sheer size. | 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | Securitised Finance ($bn) | 0.6 | 2.3 | 4.7 | 9.3 | 14.8 | 22.1 | 31.2 | 40.2 | % of Customer's loans | 3 | 11 | 18 | 27 | 34 | 40 | 44 | 46 | YOY increase ($bn) | 0.6 | 1.7 | 2.4 | 4.5 | 5.6 | 7.3 | 9.1 | 9.1 |
Table 1 Year-on-Year Increase of Proportion of Customer Loans of Securitised Finance

What Northern Rock did was to securitize and package its existing mortgages into mortgage-backed securities (MBS), and sell them to their specially created Special Purpose Entity (SPV) – Granite. Granite in turns breaks these illiquid long term mortgages into smaller and shorter term securities called asset-backed commercial paper (ABCP) and sells them to investors. This process created extra funds for Northern Rock’s mortgage business and increase Northern Rock’s assets considerably.