UK props up wounded Northern Rock

LONDON (Reuters) - Britain's financial authorities stepped in to rescue mortgage lender Northern Rock NRK.L on Friday as the group, which has lent aggressively to home buyers, fell victim to the sharp rise in borrowing costs between banks.

In Britain's biggest casualty of a global financial crisis sparked by U.S. mortgage defaults, customers queued on the streets as they waited to withdraw savings from Northern Rock branches, with some reports of fighting in its north-east England home town of Newcastle.

The British central bank's support -- the first time it has acted as lender of last resort in this way since becoming independent on interest rate policy in 1997 -- puts a prop under Northern Rock, which has been hit by banks' reluctance to lend as they hoard cash to cope with the fallout from bad U.S. loans.

The British government said on Friday it had authorized the Bank of England (BoE) to provide an unspecified amount of liquidity to Northern Rock, which had the biggest share of the new mortgage market in the first half of this year and provides over 730,000 mortgages.

The BoE, which has come under fire from some financial institutions for its hands-off response to market turmoil, said Northern Rock was solvent and only in need of short-term help.

Britain's financial regulator also said Northern Rock met capital requirements and should remain open as usual and analysts said it was not in danger of going bust.

But there were signs of panic among customers and investors, and the bank's shares crashed over 30 percent, one of the biggest falls for a major bank in recent memory.

"You read the headlines in the paper, Northern Rock cash SOS. If you had money in there, what would you do?" said John Duncan, 51, a chartered surveyor who withdrew all his savings from a branch in London.

Finance Minister Alistair Darling told BBC Radio that Northern Rock was the only institution to have called for BoE aid and that Britain's economy and banking system was sound.

"There is plenty of money in the system, the banks have got money ... they are simply not lending in the short-term way that institutions like Northern Rock need," he said.

While it has little exposure to poorer-quality, or "subprime," U.S. mortgages, Northern Rock has been hit by the liquidity squeeze triggered by the crisis in that market because it has a small deposit base and so has to draw most of its funding from money markets.

Interbank lending costs rose to their highest level for nine years this week as banks scaled back lending to each other.

Northern Rock declined to comment on the details of the financial support, though Chief Executive Adam Applegarth told reporters that "clearly a substantial amount is required" and that it would be charged a penalty interest rate.

The firm said higher funding costs and a decision to rein in lending would hit profits this year and next, and that there could be job losses among its 6,500 staff.

It had been a darling of the bank sector in recent years after posting 23 years of record earnings, but now there is a strong chance it will be taken over by a well capitalized rival, analysts said.

"The only potential short-term fillip for the share price would come from an acquisition by a bank with the capability to fund the business on an ongoing basis or a stabilization of the credit markets," said Landsbanki analyst Ian Poulter.

A DIFFERENT BANK

Other banks, like Barclays (BARC.L), have obtained overnight funding under the BoE's standing emergency lending facilities, but the package for Northern Rock was the first time the BoE has been called on for longer-term help during the current crisis.

The BoE made it clear earlier this week that it would not bail out insolvent companies and has come under fire from some institutions for making less money available than other central banks, such as the European Central Bank.

Northern Rock shares closed down 31.5 percent at 438 pence, valuing the bank at 2 billion pounds ($4 billion), down over 60 percent since the start of the year.

Shares in rival lenders Alliance & Leicester AL.L and Bradford & Bingley BB.L fell about 7 percent each and buy-to-let lender Paragon PAG.L fell 17 percent. All three said they had no need for extra funding, but analysts said any bank reliant on money markets for funds could need help if credit market conditions remain tough.

Britain's Council of Mortgage Lenders urged calm.

"Consumers need to understand that the problem for lenders generally at the moment is in raising funds, not in lending quality," said Michael Coogan, CML director general, welcoming the BoE's intervention.

Applegarth said Northern Rock would "hunker down" during the current funding problems and emerge a different bank.

"Our mix of funding will change going forward. Will we have greater dependence on retail deposits? Yes. Will we be growing slower? Yes. It will be a different Northern Rock; we will evolve to adapt to the market conditions," he told reporters.

Northern Rock said it now expected an underlying 2007 pretax profit of 500 to 540 million pounds ($1.1 billion), compared with analysts' current consensus forecast of 647 million.

(additional reporting by Jonathan Cable, Marc Jones, Dan Lalor, Simon Rabinovitch and Christina Fincher)