Northern Rock, Britain’s fastest-growing mortgage lender, has stepped up its assault on the mortgage market despite fears that rising interest rates will hit the housing market, Adam Applegarth, its chief executive, said yesterday.

The Newcastle-based bank yesterday unveiled flat pretax profits of £296.1 million for its first half, missing market expectations, after being hit by the increased cost of borrowing in the wholesale market.

Mr Applegarth said yesterday that he expected the Bank of England to raise interest rates at least twice more. “You can expect arrears and losses to increase on credit cards and unsecured lending,” he said. “I would expect residential [mortgage] arrears to tick up, but they’re coming from a low base and I don’t really see a credit crunch on residential lending.”

Northern Rock increased its share of the residential mortgage market from 8.7 per cent in the second half of last year to 9.7 per cent for the six months to June 31.

Mr Applegarth said that although the move – grabbing market share when he could not fully pass on to customers his increased borrowing costs – would hit Northern Rock’s results this year and next year, it would pay off in the following years.

He said: “The reason we did it was because we retain 80 per cent to 85 per cent of these customers when their product periods are up. Therefore, for medium-term earnings, it was good news. We took a squeeze this year and next year in order to drive up earnings in 2009 and 2010.”

Shares in Northern Rock closed up almost 2 per cent at 817p, after investors, battered by the bank’s profits warning last month, were comforted by the prospect of a 30 per cent dividend increase and a forthcoming share buyback.

Mr Applegarth said that new rules on the amount of capital that banks must hold to support their business meant that Northern Rock would be able to free up about £600 million, which would be used to increase its interim dividend to 14.2p per share, up from 10.9p in the first half of last year, as well as to fund more lending.

Under the same rules, Northern Rock will sell some of its higher-risk commercial and unsecured loans, releasing a further £300 million to £400 million, which will be used to pay for a share buyback.

Analysts tended to be positive about the interim results, despite concerns about future trading. Mike Trippitt, of Oriel Securities, described yesterday’s announcement as “a marginally better performance than feared”, while analysts at Merrill Lynch maintained their “buy” recommendation, but predicted a second half that faced “headwinds”.

Northern Rock shocked the market last month when it admitted that it would miss profit expectations after it failed to hedge against the rising cost of wholesale borrowing.

Because it is not a deposit bank, and thus does not have large pools of cash to draw on, Northern Rock borrows from the capital markets to fund its mortgage lending. The cost of wholesale borrowing rose more quickly than the Bank of England increased the base rate, which meant that the higher cost of borrowing could not be passed on to retail customers.

At the same time, the cost of buying two-year forward swaps, which banks use to protect themselves from a discrepancy between the cost of borrowing in the capital market and the level of interest paid in the retail market, hit a ten-year high. It takes banks such as Northern Rock about two months to dripfeed the increased cost to customers.

Mr Applegarth said that the wholesale market had already anticipated at least two more increases in base rates, so Northern Rock’s borrowing costs were unlikely to increase further.

Bank’s first half

30.5% Increase, to £19.3bn, in Northern Rock’s gross lending in its first half

47.3% Increase in net lending, to £10.7bn

9.7% Northern Rock’s share of mortgage market

26.6% Increase in underlying pretax profit, including gains on disposals, to £346.6m

Source: Northern Rock