Northern Rock: Q1 trading statement

7:37 a.m. Mon 03 Apr 2006

Northern Rock, a bank that is primarily a mortgage lender, seems to be continuing with its aggressive lending strategy even as the housing market slows, according to its latest trading update.

The company said net lending in the first quarter of 2006 was 26% higher than last year which the bank said was due to increased market share and better retention of customers. The company’s lending pipeline, as it goes into the second quarter stands at £5.7bn, 15% ahead of the same time last year and 8% ahead of the beginning of 2006.

Our concerns with this stock are with its aggressive expansion at a time of slowing markets. We noted a marginal deterioration in the loan book at the end of December but the trading statement makes little explicit comment on arrears save a statement that “our loan books have shown little movement in their arrears profile since the end of 2005â€?. The company does however admit that there has been a ‘modest’ increase in arrears within the mortgage industry as a whole and in some areas of consumer lending.

Our other concerns were with capital adequacy: there was some deterioration at the end of last year but seems to have stabilised since then. The strong growth in the top line is keeping the cost:income ratio under control.

The bank says it is on target to meet the consensus forecast for the current year’s earnings. Our principal worry is that in the medium term bad debts will rise, even as loan growth slows.

The share trades at 1181p, on a prospective PE (2006 earnings) of 12.3x, in line with the sector with a yield of 3.1%.