Bank Worries Roil Across Europe

The rescue of British lender Northern Rock sparks concerns about the broader economy, causing banking shares to fall in Britain, Spain, Germany, and France

The British and European banking sectors came under more pressure on Sept. 17 when shares in beleaguered mortgage lender Northern Rock (NRK.L) plunged a further 35%, after falling more than 31% on Sept. 14. Long lines of customers were seen over the weekend withdrawing an estimated $3.5 billion to $4 billion in deposits from the bank, fearing it might go bankrupt. The panic spooked the market and led analysts to wonder whether other lenders will face similar problems.

The emptying of accounts occurred despite repeated reassurances from politicians and financial regulators that customers' savings were safe. British Chancellor of the Exchequer Alistair Darling said the government would guarantee Northern Rock's deposits if necessary, while the lender itself said it was "actively considering all strategic options," but currently isn't talking with any interested parties.

And the general sense of unease took a big toll Sept. 17 on other midsize British lenders. Bradford & Bingley (BB.L) and Alliance & Leicester (AL.L), for instance, lost 15.4% and 31.3% of their share value, respectively. Justin Bates, an analyst at investment bank Daniel Stewart & Co. (DAN.L) in Manchester, called the downturn a "knee-jerk reaction as people digested the news [about Northern Rock] over the weekend."

The crisis has unfolded at lightning speed. Northern Rock was a fast-rising lender that had used loan securitization and other innovative capital markets techniques to become Britain's fifth-largest mortgage issuer, with a 19% share of the market. It ranked No. 24 on the 2007 BusinessWeek 50 list of growth companies. But late on Sept. 13, Northern Rock called on the Bank of England for an emergency line of credit after it failed to raise the money from other banks. News of the bailout provoked a downward spiral that began Sept. 14.

Effects of Investor Anxiety

Now there's concern the impact could ripple throughout the broader economy. On Sept. 14, consultancy Ernst & Young cautioned that turmoil in the financial markets could reduce Britain's GDP growth to just around 2% in 2008, down from earlier projections of nearly 3%. "The liquidity squeeze has already pushed U.K. three-month rates up to 6.9%," the study says. "The risk is that if this situation persists, banks will attempt to reduce their lending to consumer and corporate borrowers."

Some are already showing the effects of investor anxiety. Shares in Britain's largest mortgage lender, HBOS (HBOS.L) fell 5.5%, while Royal Bank of Scotland (RBS.L), which is in the middle of a $98.5 billion takeover battle for Dutch bank ABN Amro (ABN), dropped 4.3%.

Even banks on the Continent were down on Sept. 14. French financial giants Société Générale (SOGN.PA) and BNP Paribas (BNPP.PA) lost 2.3% and 2.4%, respectively, while German investors could be hit by the fact that funds such as Deutsche Bank (DB) subsidiary DWS Investments and Allianz (AZ) Global Investors both have stakes in Northern Rock's remortgaged debt.

Acquirers in the Shadows?

The contagion also spread to Spain, where Iberian giants Santander (SBP.DE) and BBVA (BBV) each fell around 2% on Sept. 17, while smaller banks Banco Popular (POP.BE) and Banesto (BANE.BE) dropped more than 3% each after a Citibank (C) downgrade.

Now that Northern Rock has lost almost 56% of its value in the last few days, speculation is rife a larger financial institution with deeper pockets will move to acquire the bank. A British rival, such as Lloyds TSB (LLOY.L), might take advantage of the struggling lender's $46 billion deposit base, but a private equity takeover looks less likely due to the rising costs of borrowing.

Whatever happens, no player will throw its hat into the ring until the recent market volatility calms down. "We're not playing by the usual rules of the game," says Bates of Daniel Stewart. "Under regular circumstances you would expect a 20% to 25% bid premium on a Northern Rock takeover, but that looks extremely unlikely at the moment."

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