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Northern Rock rescue stalled by scale of emergency loans

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7th Nov 2007
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Northern Rock has signalled that finding an acquirer will be a long and difficult process, even though few analysts now believe the bank can stay in business without finding a buyer, and at least three have expressed an interest. Discussions have already been held with private equity firms JC Flowers and Cerberus, and with Virgin Money (also with private equity backing). Lloyds TSB remains a contender, even though its initial offer in September foundered on the extent of public guarantees it was demanding. But NR fears its present share price of less than 190p substantially undervalues it, enabling bidders to make aggressive offers that it will have to refuse.

CEO Adam Applegarth remains caught between the Rock and a hard place, since the Treasury is equally concerned to get the bank into new ownership so that it can start to recover the public money that has kept it afloat since financing fears began a run on its deposits two months ago. To meet those redemptions, with its accustomed securitisation sources dried up, NR has had to borrow more than £20bn from the Bank of England. Independent projections show that its total liabilities to the Bank could eventually reach £30bn. Prospective buyers would be expected to take on that debt, and have discounted their offers accordingly.

Financial confidence too fragile for shareholders to be soaked…
If neither depositors nor the central bank are to be left out of pocket, then shareholders would normally take a hit. As guardian of the public purse, the Treasury would like to avoid bailing out investors who in principle were aware of the risks they were taking. When lossmaking rail network operator Railtrack threatened to inflict a sizeable hole in the public finances, the government allowed its share price to collapse in order to renationalise it at minimum cost, letting shareholders take the strain.

But as a guarantor of financial sector stability, along with the Bank and the Financial Services Authority, the Treasury cannot afford to punish those investors unduly. Doing so might panic other shareholders of mortgage banks, making their fundraising more difficult at a time when the Bank is trying to assist it without being able to reduce its interest rates. So although NR’s share price has also collapsed (from over 1200p at its peak), the government supports its board in wanting offers well above the 285p that has reportedly figured in initial discussion.

… and housing market too fragile for radical downsizing…
The Treasury is understood to have asked NR to look again at a possible acquisition by Lloyds, fearing that private equity buyers might be looking to break it up. This suspicion was reinforced by yesterday’s announcement that another private equity group, Blackstone, has been added to the team advising NR on its sale strategy. However, if Lloyds were to make a better offer, it would only be because of the greater synergies it anticipates from integrating the Rock’s branch and call centre networks and back-office operations.

So even if a sale to Lloyds (the fifth largest high-street bank) escaped competition commission concerns, it might mean significant branch closures and job losses for the Newcastle-based target. The government wants to avoid any downsizing not only because which many of the losses from the workforce of 6,000 would be in sensitive constituencies, but also because the crumbling of the Rick – the UK’s fifth largest mortgage lender and the biggest source of new loans at the start of 2007 – is already being blames for the recent slump in new loan approvals and its downward impact on house prices.

…but public finances too stretched to write off the bank’s present debt
NR’s borrowing from official sources is already equivalent to more than 50% of this year's projected public borrowing, and equivalent to around 10p on income tax. The sum it withdraws could eventually stop not far short of the £32.5bn which represented the whole of the central government’s net borrowing for 2006/7. This makes it imperative for the government to recover its funds by passing on the cost. The Treasury knows that most of the funds withdrawn from Northern Rock will be deposited elsewhere in the banking system, giving it collectively the resources to absorb its fallen partner. This is the way the Bank of England resolved previous collapses, notably those of secondary banks in 1973, behind the scenes.

If acquirers refuse to rescue the Rock, the sum will have to be covered by public debt issue – again economically justifiable as a way to soak up those withdrawn savings, but politically difficult for a Chancellor who has promised to obey the 'golden rule' of borrowing only for public investment. To concentrate minds, the Bank of England has said NR's unlimited credit facility will run only until February 2008. But unless a line is drawn under the Rock’s problems sooner than that, there are growing concerns that its instability could spread.

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