Hedge Funds Circle Ailing Northern Rock

As the embattled bank searches for a way to pay off interim loans, hedge fund investors are said to be planning a joint offer below face value

Northern Rock's embattled management is working against the clock on a funding strategy to tide over the troubled mortgage lender until a bidder emerges. With refinancing due on billions of pounds of debt issued to support mortgage loans, Adam Applegarth, the bank's chief executive, and his team will use the next two weeks to decide on funding options.

One option is to use the Bank of England's emergency funding facility. Northern Rock has borrowed almost £3bn under the arrangement, according to New Star Asset Management's analysis of the Bank of England's balance sheet. Northern Rock declined to comment.

But Northern Rock hopes with the Bank of England's backing it will be able to attract investors to refinance short-term commercial paper debt that is due for repayment in the next few weeks. "The guys are working hard and the focus is very much on funding to get that sorted out," a source familiar with the bank said. The bank hopes with funding in place the business will stabilise and bidders will re-emerge.

Northern Rock has been the bank hardest hit by the credit crunch as investors have fled the markets it used to fund its business. The Newcastle-based bank has since tried to attract bidders but the most serious suitor, Lloyds TSB, withdrew two weeks ago and Northern Rock was forced to go to the Bank of England for help.

Northern Rock's shares closed at 194.3p on Friday, less than one third of their value when Lloyds TSB was considering buying it. But there is no sign of a trade buyer for the business, whose brand is tarnished after thousands queued to get their money out before the Government intervened with a public guarantee of savings.

Price is not the problem for a buyer. The risk lies in the funding requirements of Northern Rock's balance sheet, with more than £100bn of assets funded by little more than £20bn of retail deposits. The bank had used securitisation -- packaging up its loans and selling them as bonds -- to fund much of the shortfall, but investor appetite for these bonds has dried up. Analysts estimateNorthern Rock needs to refinance almost £3bn of securitisations by the end of March.

Northern Rock's position is the most extreme, but all Britain's banks are hoarding cash to meet demands imposed by the credit crunch. This is why Lloyds TSB asked the Bank of England to support Northern Rock's book on favourable terms if Lloyds TSB bought it, a request that was turned down. The Bank did offer to extend its emergency funding at a penal rate to Northern Rock's book if it was sold.

The only option may be for the bank's loan book to be sold off and carved up. Hedge fund investors were said to be plotting yesterday a joint bid for the mortgage book at below face value. The potential investors are thought to include Chris Flowers, a former Goldman Sachs banker.

Northern Rock plans to pay its interim dividend of 14.2p a share next month, despite its financial woes. The bank declined to comment on whether Mr Applegarth and other directors would take their dividend payouts.

The bank announced a 30 per cent increase in the dividend on 25 July, even after its funding started to come under strain. MPs on the Treasury Select Committee want to know why this was done and why the Financial Services Authority allowed it. They will question the FSA's chairman, Sir Callum McCarthy, and Hector Sants, the regulator's chief executive, on 9 October.