Oct. 9 (Bloomberg) -- Northern Rock Plc, the U.K. mortgage lender bailed out last month by the Bank of England, said the government will guarantee deposits until financial markets become less volatile. The shares rose the most ever.

Chief Executive Officer Adam Applegarth is struggling to keep the company in business as buyout firms including J.C. Flowers & Co. consider bids. A surge in borrowing costs forced the company to seek a rescue from the Bank of England on Sept. 13. Customers withdrew more than 2 billion pounds ($4.1 billion) in the next three days, the first run on a U.K. bank in more than a century.

``This may make Northern Rock easier to sell,'' said Philip Shaw, chief European economist at Investec Bank in London.

Northern Rock, based in Newcastle, England, said in a statement today that money deposited after Sept. 19 will now be covered by the Bank of England, the U.K. Treasury and Financial Services Authority. The authorities previously only protected deposits made before then.

The shares gained 20 percent to 207 pence as of 12 p.m. in London, valuing the company at 872 million pounds. The stock fell 71 percent through yesterday since the company said Sept. 14 it was unable to make new mortgage loans.

The Treasury initially refused to protect deposits made after Chancellor of the Exchequer Alistair Darling offered his original guarantee, saying that would be ``unfair'' to other companies.

Takeover Talks

Northern Rock said the deposit guarantee and central bank funding will enable it to hold takeover talks until February. ``Discussions continue with selected parties,'' the company said. Northern Rock will pay a fee to ensure that it ``does not receive a commercial advantage,'' the Treasury said in a statement.

``It gives them more breathing space in a difficult time,'' said James Hutson, an analyst at Keefe, Bruyette & Woods Ltd. in London, who has a ``market perform'' rating on the stock.

Today's arrangement will remain in place ``during the current instability in the financial markets,'' the Treasury said in its statement. The plan covers all retail deposits including future interest payments, movements of funds between accounts and term deposits. Northern Rock said it will pay costs of about 40 million pounds to 50 million pounds through Dec. 31.

``These are very much emergency measures,'' said Guy de Blonay, who helps manage about $41 billion at New Star Asset Management Group Plc in London. ``The environment we have been through has been extremely difficult. It really has been the worst-case scenario.''

`U.K. Reputation Damaged'

The company had expanded its lending book without attracting more savers, forcing it to tap markets for short-term cash to fund long-term mortgages. The bank increased its share of U.K. mortgage lending to 18.9 percent in the first half of the year from 12.2 percent in the same period a year earlier.

The case has been ``damaging'' for the reputation of the U.K., Financial Services Authority Chairman Callum McCarthy told the Treasury Select Committee of lawmakers today. Still, it was ``impossible'' to predict closure of the markets both for securitization and for short-term repurchase agreements, he said.

``We didn't identify the probability of that happening,'' McCarthy said. ``No regulator anywhere around the world succeeded in predicting that.''

The crisis in confidence in Northern Rock has exposed the government to criticism about the oversight arrangements created by Prime Minister Gordon Brown in 1997 when he was finance minister, and prompted a review of U.K. deposit protection rules.

`Ducker and Diver'

Sion Simon, a Labour party member of the committee, said he had heard that relations between the FSA and the Bank of England were ``poisonous'' and compared McCarthy to a boxer.

``You are the Sugar Ray Leonard of the financial-services sector. You are a world class ducker and diver.'' Simon told McCarthy. ``There was a run on the bank, the nation was a global laughing stock, and you say the provisions worked?''

On Oct. 1, Darling extended a guarantee on cash deposits in banks and building societies to 35,000 pounds, whatever the causes of financial distress, as ``a first step before more fundamental reform.''

Darling, who presents an update of economic prospects and spending plans through 2011 in Parliament today, said last month that the government may guarantee as much as 100,000 pounds of savings under a framework similar to the protection given in the U.S. The program would be funded by a levy on banks and other financial institutions, Darling said.

Northern Rock has appointed Citigroup Inc. to work alongside Merrill Lynch & Co. to advise on takeover negotiations. Dallas- based buyout firm Lone Star Funds is also weighing a bid, the Financial Times reported today citing an unidentified person familiar with the matter.

J.C. Flowers and Cerberus Capital Management LP have held detailed discussions with Northern Rock and its advisers, the Wall Street Journal reported on its Web site yesterday citing people close to the matter. U.S. buyout firms, Blackstone Group LP and Apollo Management LP last week expressed interest in buying the bank, the paper said.

To contact the reporters on this story: Ben Livesey in London blivesey@bloomberg.net ; Jon Menon in London jmenon1@bloomberg.net .