Lloyds TSB will offer mortgages to Northern Rock customers when their deal with the nationalised lender runs out, in a three-year agreement signed between the two banks today.

Northern Rock's mortgage customers will receive a letter when their current fixed-rate term is close to its end, offering them an opportunity to apply for a fixed-rate Lloyds TSB loan. The offer will only be made to customers who meet the right credit criteria.

Lloyds TSB attempted to buy Northern Rock when the Newcastle bank's funding dried up last August but the deal was scuppered by the Bank of England and the Treasury over competition concerns. This agreement will allow Lloyds TSB to cherry- pick the loans that it had wanted from the Rock's books.

It is also likely to ease fears that thousands of Rock borrowers will be hit by rocketing repayment costs because the bank will not offer to renew most customers' fixed-rate mortgages when they expire.

Northern Rock borrowed almost £27 billion from Bank of England last year when the bank was on the verge of collapse. It must repay the loan, now down to just over £24 billion, by 2010, which it hopes to do by rapidly downsizing. The Rock had an 8 per cent share of gross new mortgage lending last year but is expected to cut that figure to less than 2.5 per cent in the next four years.

The agreement with Lloyds TSB will come into effect next month. Customers who do not want a Lloyds TSB mortgage will have the choice of staying with the Rock on a higher interest rate, or finding another mortgage in the market. The deal is expected to save the jobs of about 100 Rock staff who would otherwise been made redundant. About 2,000 jobs will be cut from the Rock's workforce over the next three years.

Ron Sandler, the Rock's executive chairman, appointed earlier this year to oversee the bank while it works its way out of public ownership, said that the arrangement would improve the bank's ability to manage its mortgage redemptions. "It also gives some of our customers an additional option to consider when seeking to transfer to another lender and, under this arrangement, they will be able to do so in a smooth and simple manner, using our dedicated mortgage review service," he said.

Helen Weir, head of UK retail banking at Lloyds TSB, said: "This transaction is great news for all parties involved and is an innovative example of how we continue to deliver on our organic growth strategy and maintain the high quality of our mortgage book".

The European Commission, which had to approve the Government's nationalisation of the Rock, said yesterday that it wanted the bank to reduce in size even faster than currently proposed to repay the Bank of England loan before 2010. The commission announced that it would do a in-depth investigation of Mr Sandler's restructuring plans. Interested parties have until July 3 to submit their comments to the investigation.

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