Arrears have almost doubled since the end of last year after the bank encouraged customers to remortgage elsewhere. The move left it with riskier borrowers who could not find deals elsewhere on its books.

Overall credit quality remained in line with the bank's plans, but mortgages three months or more in arrears made up 0.95 per cent of the total at the end of April, up from 0.57 per cent at the end of December.

The group is in the process of shrinking its mortgage lending market in order to focus on savings which rose during the first quarter.

Retail savings balances stood at £12.8bn at the end of the quarter, up from £10.5bn in December. The group is keen to increase savings so it can reduce its dependence on the wholesale market for funding and it plans to halve its mortgage book by 2011.

Executive chairman Ron Sandler, who took over the running of the bank three months ago, said: "It is early days and the market outlook is clearly uncertain, but we are encouraged by our progress to date."

In the first trading update since the bank was brought into public ownership, Northern said gross residential mortgage lending shrank to £1.2bn in the first quarter. The group aims to limit this figure to £5bn a year, just one sixth of the £30bn it lent last year.

The bank is setting up a panel to help borrowers whose mortgage deals are about to expire to find new mortgages with other lenders.

It warned that a tough UK mortgage market, with falling house prices and higher lending rates, could make it difficult to meet its aim of shrinking the mortgage book still further.

"This environment presents Northern Rock with challenges, especially as regards the company's ability to meet its targeted mortgage redemption levels in the future. Nevertheless, given this backdrop, the company's progress against its plan to date is encouraging," said Mr Sandler.

He brushed aside complaints that the bank's state support is undermining competition, saying that Northern Rock's rates are "far from market leading".

Northern Rock, which owes the Bank of England £24.1bn, expects to make a significant loss in 2008. Nonetheless it aims to repay the £24.1bn by 2010. The Bank of England loan has been reduced by 2.8bn since the end of 2007 when it stood at £26.9bn and the loan facilities are continuing to be repaid in line with expectations.

Yesterday the bank confirmed plans to cut its staff numbers by 2,000, around a third of its workforce, by the end of 2011. The bulk of the cuts will be made this year.

Northern said that while it welcomed recent actions taken by central banks to improve the functioning of financial markets, the outlook for the UK mortgage industry remains highly uncertain. The company does not expect market conditions to normalise in the short term.

Mr Sandler said: "We remain firmly focused on our business priorities of repaying the Government debt, releasing the guarantee arrangements and, in due course, returning Northern Rock to private ownership."

Northern was bailed out with public cash after a funding crisis last September. It was crippled by last August's freeze in money markets, where it borrowed most of its cash for lending.

The Government faces opposition from Northern Rock's former shareholders, who are taking legal action over compensation to investors.