N.Rock says tide turns after deposit pledge

LONDON (Reuters) - British bank Northern Rock NRK.L said "the tide had turned" in its battle to restore confidence among customers on Tuesday after a government pledge to protect deposits took the sting out of a run on the bank and a sell-off in its stock.

Northern Rock's shares rose 8 percent to 306 pence -- although they have still more than halved since Friday -- and fears of a widespread banking crisis were soothed as regulators said they would consider overhauling the safety net for all UK savings.

The tone was aided by hopes of a concerted effort to boost liquidity in capital markets, where a credit crunch has raised funding costs and sparked the crisis at Northern Rock.

"Saying depositors are guaranteed still means equity holders can lose everything," banking analyst Alex Potter at Collins Stewart said. "What this will do is stem the outflow (of savings). It doesn't fix their problem without a reversion to normality on the wholesale markets."

Shares in rival bank Alliance & Leicester AL.L leapt 32 percent to retrace most of a sharp fall on Monday when speculation swirled that it could also seek funding help -- which it later denied.

UK finance minister Alistair Darling surprised investors on Monday by saying if necessary the government and the Bank of England would guarantee all existing Northern Rock deposits in a move to halt the worst run on a major UK bank's savings in recent memory.

Britain's financial watchdog on Tuesday backed up the unprecedented step and said limits on the current safety net for deposits may have contributed to the uncertainty that prompted thousands to withdraw their savings and should be reviewed. Darling was due to meet the Financial Services Authority and the Bank of England later on Tuesday.

Under the current UK arrangement, guaranteed compensation is limited to 31,700 pounds -- below, for example, the U.S. 100 percent guarantee for deposits up to $100,0000.

CONTAGION FEARS

Customers at Northern Rock, which provides one in 13 British home loans, are estimated to have withdrawn over 2 billion pounds ($4 billion) since Friday, when the Bank of England stepped in with emergency funding. Some media estimates said withdrawals have topped 3 billion pounds.

But Northern Rock said 80 percent of customer calls it received early on Tuesday were to reinvest money in accounts. "The picture is quite obviously changing," a spokesman said.

Queues formed at some of its 76 branches again early on Tuesday, but lines were far shorter than on Friday, Saturday and Monday, when customers waited hours to withdraw their cash.

"(The government is) doing something by public demand, they should have done something before," said one saver in her 50s who flew in from Italy to withdraw her savings.

"The horse has bolted. It's too late to try and close the stable door now," she said outside a London branch.

The bank had just over 24 billion pounds of retail deposits before the current turmoil, and assets of 113.5 billion.

There have been mounting concerns that Northern Rock's problems would spread across the industry, and the government's move on Monday helped shares rebound across the sector. The Treasury also reiterated that no other banks beyond Northern Rock had asked the BoE for help.

Britain's biggest lender HBOS HBOS.L rose 4 percent and smaller rival Bradford & Bingley BB.L rebounded 6 percent.

The cost of insuring UK mortgage banks' debt against default fell in credit markets, with five-year credit default swaps on Northern Rock tightening 33 basis points to 165 basis points.

Credit analysts said it was still unclear what the outcome would be for other obligations, including for bondholders.

"By law, senior creditors are pari pasu with depositors but you can bet that the government has no intention of underwriting NR's debt," Royal Bank of Scotland analysts said in a note. "Upside for bondholders remains a full bid -- outside of that, sub debt looks vulnerable even at these levels."

The liquidity crunch on the credit markets and ensuing turmoil at Northern Rock have left the bank's wholesale funding-focused strategy in tatters, and analysts agree it is now likely to be taken over -- should a buyer be found.

An industry source said Merrill Lynch is sounding out interest in the company's mortgage book as it evaluates appetite from potential buyers.

The bank said late on Monday that it was not in any talks but would consider all strategic options.

(Additional reporting by Mathieu Robbins, Maya Thatcher and Katherine Baldwin)