Northern Rock hit by housing slowdown

Northern Rock has flagged up a slowdown in house price inflation in the second half as it warned that spiralling interest rates will put a dent in full-year profits.

The mortgage lender reported record lending levels for the six months to 30 June, with net lending increasing by 47.3 per cent to £10.7bn. Profits rose 27 per cent to £346.6m, including gains from disposals, while the company's share of home loans increased to 18.9 per cent.

But its chief executive Adam Applegarth said the outlook for the full year has been hit by rising borrowing costs after the Bank of England raised interest rates five times to 5.75 per cent in the past 12 months.

Northern Rock has been slow to pass on these rises to borrowers and continued to offer cheap fixed-rate loans. Mr Applegarth said although the bank knew that aggressively targeting customers with cheap loans would dampen 2007 and 2008, it would be able to retain 80 to 85 per cent of customers when their product periods were up. "This decision was good for medium-term earnings," he said. "We took a squeeze this year and next year in order to drive up earnings in 2009 and 2010." The bank expects profit growth to slow to about 15 per cent for 2007 and not the average growth rate of 17 per cent forecast by the City.

Although the industry average retention rate for mortgages is 25 per cent, Northern Rock has the highest among the major lenders at 80 to 85 per cent.

Mr Applegarth said this was due to offering existing customers the same deals as new customers and employing a dedicated team to keep customers at the end of their period.

Northern Rock said the increases in interest rates were hitting consumer confidence and affecting volumes of housing transactions. Mr Applegarth pointed out that interest rates only started to rise a year ago so many consumers on fixed-rate mortgages will only be one-third through and will feel the pinch next year and the year after. But the value of mortgages was making up for a decline in volumes.

The bank announced a 30 per cent jump in its dividend and said it plans to buy back £300m to £400m worth of its shares in the next three years after a move to Basle II capital requirement reforms to free up capital.

Northern Rock recommended a first-half dividend of 14.2 pence, up from 10.9p last year, and said its dividend payout ratio would rise to 50 per cent from 40 per cent.