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Market Ponders Life for Granite After Northern Rock
Asset Securitization Report--SourceMedia (October 8, 2007)

Jacob Gaffney

The embattled U.K. bank, Northern Rock, is living on borrowed time. All signs point to a takeover, even if the bank itself continues to send out mixed signals and is rumored to have appointed an administrator in the event of a breakup or a wind-down. Questions remain, however, about the future of the Granite Master Trust.

Northern Rock is determined to present itself as a "business as usual" entity, despite its recent loss of retail customers. Last Thursday, Northern Rock introduced a simplified mortgage-product lineup to draw more customers. The bank has simplified its LTV tier rates and withdrawn its 18-month fixed rates for all types of mortgage products except buy-to-let.

Meanwhile, the company continues to rebuff press enquires. It did, however, post a message on its Web site, which says it has received a number of approaches regarding a variety of potential transactions, "including the possibility of an offer being made for the Company, although no price has been referred to.

"The Company is in preliminary discussions with selected parties but emphasizes that there can be no certainty as to the outcome of such discussions," the company said. J.C. Flowers & Co., the New York-based private equity firm, recently raised nearly $31 billion for an apparent takeover bid and is the frontrunner among several U.S. firms to buy out Northern Rock, say market sources.

This outcome would further ease investor fears of insolvency, which would be an unlikely ending for Northern Rock at this point, according to Adel Satel, a managing director of EMEA banking at Moody's Investors Service. Insolvency would mean a nonasset trigger event for Granite, which would likely see a widening of spreads, particularly in lower-rated tranches that are exposed to extension risk. This scenario would also be likely should Northern Rock try to survive on its own, according to analysts at Barclay's Capital.

"A purchase, providing it would enable Northern Rock to continue to originate new business and obtain funding at a rate that would ensure this is profitable, would be positive for all debt holders," reported analysts at Barclays. "The alternative of administration could trigger the non-asset trigger and the associated changes in redemption profile for the notes."

In the case of a so-called nonasset trigger, such an event would lead to a realignment of the cash flow priorities between different classes of notes, according to Neal Shah, a managing director of RMBS structured finance at Moody''s.

Scenarios such as these have been incorporated into Moody's cash flow analysis," he said, "so we would not expect any change to existing RMBS ratings as a consequence of any of these potential trigger breaches."

Were Northern Rock purchased as a whole entity, then there are "possible structural solutions to maintain the trust as is," said Barclays analysts. However, the "spread direction depends on the strength of the potential bidder for Northern Rock and its commitment to securitization.

But while the Granite structure is designed to withstand even a default of Northern Rock, there are parts of the structure which will be affected if further downgrades below a certain level occur, in particular the basis swap between Northern Rock and Granite and the GIC accounts," the Barclays analysts added. Recent downgrades of Northern Rock by Fitch Ratings and Standard and Poor's, however, have not had a direct impact on the ratings of the Granite RMBS notes so far.

At any rate, takeovers such as this take time, and it will likely be a few more weeks before the situation becomes clear.. This is good for Northern Rock, say market observers.

We think the most likely scenario is that Northern Rock remains a stand-alone entity in the short term and that its ratings will be key in determining the outcome for Granite RMBS investors, said Barclays. "In the longer term, we think that the any more permanent solutions for Northern Rock will be complicated by the large amounts of funding needed for Granite over the next 12 months.

But while the fate of Northern Rock, as well as its products and its customer base, comes into clearer focus, the implications of what happened will ring in the ears of many for years to come, say market sources.

"It seems sad that the subprime crisis in the United States bled over to Northern Rock, and now maybe to Granite, which is not believed to have subprime exposure, said one market source.

In a speech last week at Reuters in Canary Wharf titled Financial Stability and the Challenges of Globalization for the U.K., Chancellor of the Exchequer Alistair Darling evoked the name of Northern Rock and hinted at future legislation to avoid another bank run. While such a move would be considered overtly political by some, since the Bank of England reaction to Northern Rock was criticized - and there are rumors that Her Majesty's Treasury is considering stripping some authority from the Bank of England - Darling said that each option must be carefully considered first.

"We will not rush into heavy-handed reforms that we later regret, a temptation we rightly resisted in the past," said Darling in his speech. "It's important to think first and then act.

(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.



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