Northern Rock mulling debt buyback - source

LONDON, June 16 Tue Jun 16, 2009 10:21am EDT

LONDON, June 16 (Reuters) - Nationalised British lender Northern Rock (NRKx.L) is contemplating a bond buyback aimed at reducing its need for government funding, a source familiar with the matter said on Tuesday.

The source said the plan was at an exploratory stage and was just one of a number of options under consideration as the bank strives to complete an overhaul under which it could eventually return to private ownership.

A buyback of Northern Rock's debt could reduce its dependence on government money by freeing up capital earmarked for interest payments, potentially helping the bank win European Union approval for its state-assisted restructuring.

"It does have the potential to raise capital and therefore reduce the amount of capital required as part of a state aid package," the source said.

Any buyback would likely be financed using government money, temporarily increasing the size of Northern Rock's government loan.

A spokesman for the Treasury, Britain's finance ministry, said it was not working on any plan to repurchase Northern Rock debt. Northern Rock declined to comment.

Analysts said a buyback could be good news for Northern Rock's bondholders. "This offers some ray of hope for investors," BNP Paribas analysts wrote in a research note.

"While any tender is highly uncertain and the pricing unclear, it could leave subordinated bondholders in a much better position than initially anticipated."

GOOD BANK, BAD BANK

Under a restructuring plan awaiting EU approval, Northern Rock is expected to split itself into two entities -- an operating company taking on the bank's deposits and lending activities, and an asset company containing its mortgage book.

Last week, analysts at ratings agency Fitch downgraded Northern Rock's subordinated bonds, citing concerns they could be allocated to the asset company and used to absorb losses on bad mortgage loans.

The Times newspaper reported on Tuesday investment bankers were working on a scheme under which Northern Rock could make separate offers to holders of different categories of debt. No talks have yet been held with bondholders, the paper said.

Other banks have in recent weeks taken advantage of depressed bond prices to buy back notes from investors at a discount, improving their capital position.

Part-nationalised British lender Royal Bank of Scotland (RBS.L) said in April it expected to make a 4.5 billion pound ($7.4 billion) profit from a bond buyback and exchange programme, while rivals Lloyds Banking Group (LLOY.L), Barclays (BARC.L) and Standard Chartered (STAN.L) have also swapped or repurchased bonds since the beginning of the year.

Northern Rock became the first major British casualty of the credit crunch in September 2007 after rising wholesale borrowing costs left it unable to fund itself.

The bank was nationalised in early 2008 after efforts to find a private sector buyer for the group fell through. (Additional reporting by Jane Baird; Editing by David Holmes)

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