Sept. 14 (Bloomberg) -- Northern Rock Plc got emergency funding from the Bank of England, the biggest bailout of a British lender in 30 years, after rising credit costs left the mortgage provider unable to make new loans.

Northern Rock shares plunged 31 percent to a six-year low after the company said today that the central bank will provide an unspecified amount of credit. The Newcastle, England-based bank, whose roots date back to 1850, is the U.K.'s third-biggest lender by gross mortgages with loans worth 17.4 billion pounds ($35 billion) as of June 30.

The rescue stoked concern among investors and depositors that other financial firms relying on short-term credit rather than deposits may be vulnerable because the rate they borrow at exceeds the amount they earn from lending. The Chancellor of the Exchequer Alistair Darling authorized the move, saying the Bank of England will step in as the lender of last resort ``where institutions face short-term liquidity difficulties.''

``This is a set of circumstances that I've not seen in 25 years,'' Chief Executive Officer Adam Applegarth said on a call with journalists. ``It's a substantial program, it is at a penalty rate. The facility will provide a solid ground base.''

European stocks fell the most in a week, with the Dow Jones Stoxx 600 Index declining 1.2 percent to 367.88 in London. HBOS Plc, Britain's biggest mortgage bank, fell the most in more than four years and Bradford & Bingley Plc, which makes one in five loans to U.K. landlords, dropped the most since 2000.

Bank `Solvent'

``Northern Rock is solvent, exceeds its regulatory capital requirement and has a good quality loan book,'' the Bank of England, U.K. Treasury and Financial Services Authority said in a joint statement. The decision to support it ``reflects the difficulties that it has had in accessing longer term funding and the mortgage securitization market, on which Northern Rock is particularly reliant.''

Northern Rock gets 73 percent of its funding from wholesale markets rather than customer deposits, higher than its major rivals.

A month ago, it offered flexible fixed-rate mortgages at an annual rate of as low as 6.19 percent, according to a press release. Since then, the rate financial institutions pay to borrow pounds for three months has climbed to 6.82 percent from 6.28 percent, eroding profit.

The Bank of England hasn't had to bankroll a U.K. lender since the 1973 collapse of Cedar Holdings, a pioneer of second mortgages, triggered a crisis of confidence that threatened to unravel the banking system. That rescue cost about 3 billion pounds, with the central bank providing about 100 million pounds.

Borrowing Rate Climbs

In 1984, the Bank of England took over the insolvent banking unit of Johnson Matthey Plc, paying a nominal 1 pound for the company. In 1995, the central bank declined to bail out Barings Plc after wrong-way bets bankrupted the U.K.'s oldest merchant bank. ING Groep NV eventually bought the firm, also for 1 pound.

The central bank stepped in to help Northern Rock as commercial banks have become reluctant to lend to each other. The European Central Bank loaned cash to banks in seven special auctions since Aug. 9. The U.S. Federal Reserve cut its discount interest rate and abandoned its bias toward fighting inflation.

At least 16 U.S. lenders have been forced into bankruptcy since investors shunned adjustable-rate and subprime mortgages. Germany's Landesbank Sachsen Girozentrale and IKB Deutsche Industriebank AG are getting emergency bailouts after losses from asset-backed securities. Bear Stearns & Co., Goldman Sachs Group Inc. and Barclays Plc are among firms that have stepped in to prop up investment funds in the past three months.

`Severe Liquidity Squeeze'

Pretax earnings at Northern Rock will be between 500 million pounds and 540 million pounds this year, missing analysts' estimates of 647 million pounds, the company said today.

It blamed a ``severe liquidity squeeze'' and rising short- term interest rates, saying it won't make new loans that are unprofitable in current markets.

Northern Rock suffered from ``a classic case of overtrading,'' Royal Bank of Scotland Group Plc analysts wrote today. Net lending surged 43 percent in the first eight months of the year, ``faster than the bank's balance sheet could sustain.''

``It leaves Northern Rock desperately hoping that something comes along to restore confidence,'' said Colin Morton, who helps manage 14.4 billion pounds including Northern Rock shares at Rensburg Sheppards Plc in Leeds. ``At the moment their funding costs are higher than what they get from people who are buying a house from them.''

Credit-default swaps based on Northern Rock's debt rose 25 basis points to 155 basis points, according to Deutsche Bank AG prices. Standard & Poor's and Fitch Ratings downgraded its credit ratings by one step to A, five levels above non-investment grade.

Takeover Target

Northern Rock is the U.K.'s worst-performing bank stock this year. Its shares fell 46 percent through yesterday, compared with the 12 percent drop of the nine-member FTSE All Share Banks Index. The stock slid 201 pence to 438 pence in London today, valuing the lender at 1.84 billion pounds.

HBOS fell 3.6 percent to 860 pence. Bradford & Bingley lost 7.7 percent to 329.75 pence. Alliance & Leicester Plc, another U.K. commercial and consumer bank, sank 6.9 percent to 873 pence.

``The outlook for Northern Rock as an independent entity does not look good,'' said Sandy Chen, a London-based analyst at Panmure Gordon & Co., who has a ``sell'' rating on the stock.

The bank is an ``increasingly likely'' takeover target, Credit Suisse Group analysts wrote today. The decline in the stock price already made it ``attractive,'' MF Global Securities Ltd. analysts said earlier this week.

`Only Viable Alternative'

``Northern Rock will struggle to fund any new growth without the backing of a larger financial partner,'' Merrill Lynch & Co. analyst John-Paul Crutchley wrote in a note to clients today. He has a ``buy'' rating on the stock. A partnership or acquisition is ``the only viable alternative if Northern Rock is to return to writing significant new business volumes,'' he wrote.

The shares were downgraded to ``underperform'' by analysts at Cazenove and to ``hold'' by Landsbanki Islands hf.

Northern Rock was formed from a merger between two building societies and the initial public offering of Northern Rock Building Society in October 1997.

The ``substantial'' amount that Northern Rock can borrow is capped by the collateral it is able to provide, CEO Applegarth told reporters, without giving details of the quantity or the penalty rate that the bank will pay. A Bank of England spokeswoman said the loan was given at a penalty rate and declined to give further information.

`Freeze, Thaw'

The interim dividend will be paid as planned on Oct. 26, Applegarth said. The bank, which has 6,000 employees, this year won't replace all of the 15 percent of employees who typically leave annually.

``Looking forward, I can't see when the global liquidity freeze is going to end,'' Applegarth said. ``The thaw will only come when banks make it clear what they hold on their balance sheets.''

British-born Applegarth, 45, has spent his entire career at Northern Rock, having joined the bank in 1983 from England's Durham University. He become a general manager 10 years later and CEO in 2001 after working in the lending, insurance, technology, marketing and corporate affairs units.

The Bank of England yesterday relaxed restrictions on financial institutions, encouraging them to lend more to each other as it tries to reduce overnight borrowing costs that are threatening to crimp economic growth.

The action by the U.K. central bank was its first to help credit markets since the subprime market collapsed. Governor Mervyn King has indicated the bank won't go as far as the ECB and the Fed because policy makers can't afford to ``encourage excessive risk taking.''

`Horrified'

Commercial banks, which agree to hold a specific amount of money at the Bank of England at the end of each month-long maintenance period, can now undershoot that target by 37.5 percent to free up cash if needed. That compares with the usual limit of 1 percent.

Hundreds of Northern Rock customers crowded into branches to pull out their savings. William Gough, queuing with about 30 people outside the Maddox Street branch in London's West End, said he was ``horrified'' to hear about the request for funding.

``I am going to take out the lot, every penny,'' said Gough, 75, from Belfast, Northern Ireland.

To contact the reporter on this story: Ben Livesey in London blivesey@bloomberg.net; Jon Menon on jmenon1@bloomberg.net.

Last Updated: September 14, 2007 12:27 EDT