Senior debt said "safest play" on Northern Rock

By Natalie Harrison

LONDON (Reuters) - Senior bonds of Northern Rock NRK.L are the safest bet for investors as speculation swirls about the fate of the mortgage lender, with holders of lower-ranking debt facing possible losses, analysts said.

The possibilities range from the sale of the lender to another bank -- likely to be the most favourable option for all bondholders -- to a run-off or sale to financial investors, which may bear more risk for subordinated debt.

"Senior debt is the only safe way to play the Northern Rock game as there are three chances of getting your money back: government, takeover or a proportional (maybe 100 percent) recovery in a wind up," said RBS credit analysts in a note.

Short-dated issues offer the best chance for investors to take advantage of the government guarantee on Northern Rock bonds, while longer-dated debt has the largest discount to par and therefore is likely to rally harder on a takeover.

"Sub debt remains a high risk and a pretty much binary trade -- great upside if taken over in full but a deeper downside in a wind up," RBS said.

Credit rating agencies are at odds over the bank's outlook, with Standard & Poor's cutting Northern Rock's subordinated debt to "junk" status, while Moody's Investors Service and Fitch Ratings have kept it in investment grade.

Fitch analysts said on a conference call on Monday Northern Rock faced a liquidity issue, not a solvency problem, and that senior creditors should rank equally in the event of liquidation or a takeover.

Other classes of debt holders, such as subordinated or tier I bondholders, cannot rest so easy.