The Northern Rock is a British financial institution. Having been a building society from its inception in 1965, it became a bank in 1997 and survived until 2008 when the government felt obliged to rescue it from imminent collapse and place it under public ownership.
1. From Building Society to Bank
The Northern Rock Building Society was formed on the 1st July 1965 as a result of the merger of the Northern Counties Permanent Building Society, originally established in 1850, and the Rock Building Society founded in 1865. However like many British building societies, during the 1990s it decided to demutualise and became a public limited company in October 1997, and thereby became a bank, albeit one which specialised in the provision of mortgages.
Whether as a building society or a bank the Northern Rock was primarily a regional business, based in the north-east of England with its headquarters in Newcastle-upon-Tyne and with a network of seventy or so branches. In 1998 it had £18 billion of assets which grew at a respectable rate to £25 billion by 2002, however it then discovered an ambition to become a major player in the British banking sector, and over the next five years quadrupled its assets to over £100 billion in 2007. The architect of this expansion was Adam Applegarth, who became Chief Executive in March 2001, and much of this growth was achieved through what was referred to as "aggressive pricing"; which is to say, its willingness to lend on multiples of as much as six times a borrowers annual salary, and its readiness to advance to first-time buyers as much as 125% of the value of the property being acquired. However since it had a relatively small branch network the Northern Rock relied on selling its mortgages through various independent financial advisers and mortgage brokers, whilst given its limited ability to raise retail deposits, it financed its lending through mortgage securitisations and by raising funds in the wholesale market.
In particular much of its new business was being securitised through a Jersey-based entity called Granite Finance Holdings; indeed by 2006 it was parcelling up some £5 billion of mortgage loans every three months through its Granite operation. Following common practice in the banking industry, Granite was a charitable trust established in 1999 to benefit the Down's Syndrome North East Association. This was news to the Association, described by The Guardian as a "small charity run by volunteers from a semi-detached house on the outskirts of Newcastle", which was entirely ignorant of this arrangement and had never received a penny from Granite. There was however, nothing unusual in such arrangements as this was indeed how banks ran such securitisation programmes, and used (or indeed abused) charity law in order to ensure that such securitised lending wasn't legally theirs, at least for the purposes of capital adequacy rules. (Accountants play by different rules, at least in the United Kingdom, and insist that such securitised lending is included on the bank's balance sheet.)
However it was Northern Rock's use of securitisations that enabled it to grow its business at such a rapid rate. Whereas it had a mere 2% of the British mortgage market back in 1997 when it first became a bank, by the second half of 2006 it was advancing 14.5% of all new mortgages in the country, and in the first six months of 2007 its market share reached almost 19%. The Northern Rock therefore succeeded in becoming Britain's fifth-largest mortgage lender, and in January 2007 became one of the first British banks to comply with the new Basle II capital adequacy rules. As a result it was judged to need less capital to support its business, which led to speculation that it might become a takeover target, and its share price reached a high of £12.51 in February 2007, which according to the BBC News was a reflection of "the strength of its loan book and confidence in its future prospects". When the Northern Rock duly reported interim profits on the 25th July 2007 it expressed its confidence in its future business prospects, and despite some words of warning about the likely future direction of the housing market, confidently predicted that the company would make profits in excess of £500 million for the full year.
2. The Sub-prime Crisis
The roots of what is now known as the Sub-prime Crisis are to be found over in the United States of America, and in particular with the decision of the Federal Reserve to sharply reduce interest rates in the wake of 9/11 in order to keep the economy moving. Lower interest rates encouraged individuals to take on debt, and perhaps more to the point it encouraged certain financial institutions to seek out new borrowers, many of whom did not possess the normal characteristics of sound borrowers, and were therefore regarded as being sub-prime or 'trailer trash' as the vernacular would have it.
For many years this was not generally regarded to be a problem, as in banking terms lending money to a borrower who might possibly fails to meet their repayments is not necessarily an issue, so long as the borrower has provided security which can be seized and then sold to repay the debt. And since the security in this case was residential property, and property prices inevitably move only in an upward direction, there was obviously no problem at all. Unfortunately having hit a peak in 2006, US house prices then fell over the cliff and the impossible happened as the nation experienced its first absolute decline in housing prices since the Great Depression of the 1930s. Since interest rates had now risen, a number of borrowers began experiencing problems in meeting their repayments, thus giving rise to what has become known as the 'Mortgage Meltdown', which has given birth to the foreclosure wave which is about to sweep the United States as the 'Grim Repo' stalks the land.
At one time a defaulting borrower simply meant that the banks who made the loan would have suffered the loss, however many American banks and mortgage lenders had been following what became known as the 'originate and distribute' model, which is to say that they set up the mortgage and then sold it to somebody else. Just as the Northern Rock was doing in Britain, these lenders took their mortgage debt both prime and sub-prime, securitised it and sold it to other institutions, often using various special purpose vehicles that mixed up this debt with other financial securities which were then repackaged as collaterised debt obligations or CDOs. These CDOs were attractive to investors as they offered a higher yield than on ordinary bonds, however they tended to obscure the presence of sub-prime lending within the mix. Indeed, notwithstanding the large salaries paid to the individuals concerned, many had little idea of what they were buying, or the extent to which the payment of interest and principal were dependent on the financial well-being of the aforementioned 'sub-prime' borrowers. The problem was that when the house market crashed and sub-prime debt became bad debt, no one had the slightest idea of how much sub-prime debt these CDOs contained, with the result that the market in them effectively disappeared.
During the first few months of 2007 there was a steady stream of bad news emerging from the United States. The shares of New Century Financial (one of the largest American sub-prime lenders) were suspended on the 12th March 2007; in July Countrywide Financial (the largest overall American mortgage lender) reported a big fall in earnings; whilst American Home Mortgage filed for bankruptcy on the 6th August. Oddly enough however the actual trigger for what became known as Subprime Crisis, was the announcement by the French bank BNP Paribas on the 9th August 2007 that it had suspended trading in three of its investment funds, explaining that due to the problems with US sub-prime mortgages, it was unable to value certain assets because the market in them had disappeared. It was this news that led to a general fall in world wide stock markets, followed rapidly what was referred to as "extreme conditions in global liquidity" otherwise known as a global credit crunch, otherwise known as "the day the world changed".
Since that time there has been a long list of prestigous American banks such as Merrill Lynch, Morgan Stanley, JP Morgan Chase, Citigroup all reporting billion dollar write downs. Citigroup was even forced to go cap in hand to the sovereign wealth funds of Kuwait and Saudi Arabia and raise new equity to keep itself in business. Neither was the problem confined to domestic American banks, as these CDOs together with other mortgage securties had been traded on a global basis. Two German banks, IKB and Sachsen Landesbank failed and had to be bailed out, and both Commerzbank and Deutsche Bank announced similar billion dollar write downs as their American counterparts, as indeed did sundry other European banks. Even the Bank of China was forced to write off $9 billion, whilst losses at the Swiss bank UBS reached $18.4 billion and it was forced to approach the Singapore Government Investment Corporation and an unidentified Middle Eastern investor in order to repair its tattered balance sheet. Not to mention the fact that Bear Stearns effectively collapsed in March 2008, and after being bailed out by the Fed was acquired by JP Morgan Chase.
The Securities and Exchange Commission has opened about three dozen investigations into the collapse of the sub-prime market
even the FBI has become involved and is looking into allegations of accounting fraud and insider trading. There is probably further blood to be spilt on Wall Street and its international equivalents. There are in excess of $1 trillion dollars worth of "garbage loans" floating about the system and no one really knows the extent of the losses that will eventually emerge from this sorry mess, only that the final figure is likely to be larger than the number first thought of.
3. The Run on the Bank
Despite the bad news from across the ocean, back in the United Kingdom there were those that claimed that none of this was of any consequence; the British housing market was doing very nicely thank you very much, whilst British banks had, on the whole, been far less enthusiastic than their German or Japanese counterparts in acquiring funny money American CDOs. Privately however it was a different matter. Northern Rock had for some time been promoting itself as "Open for subprime business", and since it became the general consensus that the British housing market had reached a cyclical peak in 2007, there were naturally concerns that the Northern Rock had been stuffing its books full of lending that might well turn out to be problematic if and when the housing market took a downward course. Of more immediate concern of course was the fact that the Northern Rock had built itself up on the mortgage securitisation market which having now become tainted by the sub-prime crisis, had effectively ceased to exist.
Naturally the Northern Rock wasn't the only bank doing this, and there were other mortgage lenders such as the Bradford and Bingley and Paragon were just as reliant (if not more so) on the wholesale markets. They had however sought more long-term funding and appeared to have factored in the possibility that the wholesale markets might be unavailable at some point in time. The Northern Rock on the other hand, had largely financed its lending by issuing bonds with a ninety day maturity, which meant that it essentially had to refinance its business every three months. In the new market conditions that prevailed following the global credit crunch it became clear that doing so would prove to be something of a challenge.
In the circumstances the Financial Services Authority (FSA) duly began monitoring Northern Rock on the 9th August, and on the 14th August officials from both the FSA and the Treasury warned the Governor of the Bank of England, Mervyn King, of the potential impact of the global credit crisis on Northern Rock. Naturally this bad news did not remain in secret for very long, at least within the City of London, and Northern Rock shares became the subject of prolonged bouts of short selling. Indeed the volume of short selling of Northern Rock stock was such that the fees demanded by institutions for borrowing stock became so high that many found it preferable and cheaper to pay the fines for failing to complete the trade. So much so that later on the 13th November the London Stock Exchange even felt obliged to issue a warning to dealers, reminding them to ensure that clients selling Northern Rock shares actually had the stock to sell, since so many shares had been sold short that there was a large backlog of incomplete trades. Which is to say that there were those that made a great deal of money as the Northern Rock share price fell.
At the beginning of September 2007 the Northern Rock had £5 billion of mortgages ready to roll through Granite into the mortgage securitisation market. The trouble was that there was no market; no one was interested in buying mortgage backed bonds, which left the Northern Rock with a £5 billion hole in its cashflow. Worse was to come, as on the 4th September Libor reached its highest level for almost nine years, (indicating a distinct lack of available funds on the interbank market), and it became clear that the Northern Rock would be unable to refinance itself through the wholesale market. On the 13th September the Northern Rock therefore approached the Bank of England, who agreed to act as the 'lender of last resort' and to provide what is technically known as a Liquidity Support Facility for the bank. It was then decided to issue a statement that evening which was designed to reassure customers and draw attention to the fact that Northern Rock was solvent. Some of us remain mystified by the fact that anyone could believe that a statement that a bank is in financial difficulties could be seen as reassuring to the public, but nevertheless the announcement was duly made. On Friday 14th September the newspapers where full of reassurance; as the Daily Telegraph announced, 'Northern Rock customers should not panic', and explained that depositors shouldn't worry, their money was perfectly safe, and that the Northern Rock was perfectly solvent. Which just goes to show that even financial journalists can sometimes be as dim-witted as banking regulators.
A significant number of depositors took no notice whatsoever of such reassurances and long lines formed outside Northern Rock branches on the morning of the 14th September even before the counters had opened for business. Customers withdrew around £1 billion that Friday with another £500 million disappearing on the Saturday (it would have been more only the branches closed at midday). There were reports of the police being called to help bank staff deal with "boisterous customers" at branches in both Glasgow and Sheffield, whilst the bank's website was clearly struggling to cope with the demands of customers seeking to withdraw their funds, and phone lines to the Northern Rock call centre appeared to be permanently engaged. One former hotelier from Gloucestershire named Christopher Howard was so frustrated at his inability to access the Northern Rock website and withdraw the £1m he had deposited, that he went to their Cheltenham branch and virtually held the manager hostage until the police were called, and the bank promised to process his withdrawal. This was all of course, terribly exciting as the British hadn't seen a run on a bank since the banking firm of Overend, Gurney & Co crashed in 1866.
On the stock market Northern Rock shares fell by 32 per cent on Friday 14th September, and by the Sunday the press had woken up to the fact that, notwithstanding the reassuring noises previously made about the company, it was now in serious trouble. As the Sunday Telegraph put it 'Angry savers force Northern Rock to be sold' whilst explaining to everyone 'Why Northern Rock was doomed to fail'. The Sunday Times similarly concluded that the business had "little future as an independent entity" and suggested that the business was likely to be sold off in a piecemeal fashion to other British banks.
On Monday 17th September the bank's shares fell by another 35 per cent, and the mass withdrawals continued. There were signs that fear was spreading as 30% was wiped off the value of Alliance and Leicester and 15% off that of the Bradford and Bingley. There were clear expectations that the government needed to 'do something', which led to the usual "frantic behind-the-scenes negotiations", and on the Tuesday evening the Chancellor of the Exchequer Alistair Darling duly made a public statement to the effect that "Should it be necessary, we, with the Bank of England, would put in place arrangements to guarantee all the existing deposits in Northern Rock during the current instability." (This being what the Times called "A £28bn cheque to stop the panic".) On the following day full-page advertisements appeared in the national newspapers featuring 'A message from Northern Rock' in which the chief executive Adam Applegarth sought to reassure savers, explaining to his customers that the "simple fact now is that the chancellor has made it clear that all existing Northern Rock deposits are fully backed by the Bank of England and are totally secure during the current instability in the financial markets."
Having taken the unprecedented step of issuing an explicit guarantee of the debts of a private company, the goverment breathed a sigh of relief, when it proved sufficient to halt the panic and stem the outflow of funds. It also appeared to reassure the stock market and led to a slight recovery in Northern Rock shares, and a more significant rally in both the Alliance and Leicester and the Bradford and Bingley.
The irony was that, as The Independent pointed out on the 30th September 2007, the whole run on the Northern Rock turned out to be the biggest payday in the bank's history, as in their rush to close accounts depositors had been forced to pay out more than £100 million in penalty charges
4. How to rescue a dead bank
Notwithstanding the repeated claims by the Government that the Northern Rock was 'solvent', to all practical intents and purposes the Northern Rock was bust at the beginning of September 2007, being that it was, of course, simply a a bank that had run out of money. It later became clear that the directors of the Northern Rock were aware of the fact that they were presiding over an ex-bank and had already tried to offload their business to Lloyds TSB. These negotiations reached a climax over the weekend of the 8th and 9th September, when the Lloyds TSB, mindful of the financial position of the Northern Rock, requested that the Bank of England provide a loan facility of up to £30 billion to tide them over. Unfortunately whilst the FSA were in favour of this arrangement, the Bank of England was against it, since the Bank had always maintained that the bailing out of failed banks created a "moral hazard", and believed that mismanaged banks should therefore be allowed to fail. The Treasury, or to be more exact Chancellor Alistair Darling, decided to support the Bank of England, and so the Lloyds TSB broke off negotiations on the 10th September.
It is not clear why Chancellor Darling, having decided that the Northern Rock should be permitted to go into administration,
then changed his mind a few days later, over-ruled the Bank of England, and insisted on the provision of the Liquidity Support Facility. Cynics detected the hand of Gordon Brown behind it all, and noted that the Northern Rock sponsored a number of local sports teams such as Newcastle United (football), Newcastle Eagles (basketball) and Newcastle Falcons (rugby union) as well as Durham County Cricket Club. It also handed out money to various arts organisation such as Opera North, was viewed by many in the north-east of England as being 'our bank', and was in any case the largest private-sector employer in the region. It was therefore suggested that given that Mr Brown was at the time planning to hold a General Election, it might well have proved detrimental to his chances of winning said election were there to be thousands of recently announced redundancies in the region generally viewed as being amongst the Labour Party's 'heartlands'.
However whilst the combination of the Liquidity Support Facility provided by the Bank of England, and the Government's guarantee provided a short-term solution to the fate of the Northern Rock, some solution needed to be found for the longer term. The search was therefore on for a white knight prepared to rescue the beleagured bank. However it rapidly became clear that no one was in the slightest bit interested. Indeed the combined efforts of the Bank of England, the FSA and Northern Rock’s corporate adviser, Merrill Lynch, quite failed to find a single buyer willing to put the Northern Rock out of its misery. A long list of institutions including HSBC, Royal Bank of Scotland, Barclays and Lloyds TSB, Santander, Crédit Agricole, Anglo Irish and Allied Irish as well as ING all said they were not interested. Which led to such headlines as 'Banks shun Northern rescue' (Sunday Times) or 'Northern Rock runs out of likely British rescuers' (The Observer). Nevertheless the Government persisted in seeking bids for the company and simply cast the net wider.
Strangely enough despite its financial difficulties, Northern Rock intended to proceed with the payment of its interim dividend of 14.2p a share due in October and distribute the sum of £59 million to shareholders, although shortly after the stock market closed on the 25th September Northern Rock disappointed shareholders when it announced that it would not, after all, be paying an interim dividend. Adam Applegarth struggled on as chief executive until the 16th November when he finally resigned, although apparently he did so with the intention of carrying on as a consultant until the crisis was resolved, it was later announced on the 13th December 2007 that he had left the company, despite the lack of any such resolution.
With no major bank displaying the slightest interest in acquring what Private Eye had now dubbed the 'Northern Wreck', it seemed for a time as if the field would be left clear for the ubiqitous hedge funds who were now contemplating whether or not there was any profit in the break-up. However various other parties also emerged to express an interest, the most promiment being Richard Branson's Virgin Group which came forward as a candidate on the 12th October, whilst Luqman Arnold, the former chief executive of Abbey National, set up Olivant Advisers which proposed acquiring some 10%-20% of the company, and inserting its own management team to take control, soon to be joined by other interested parties included the US private equity groups JC Flowers and Cerberus.
The nominal official deadline for bids was set for Friday 16th November 2007, and it appeared there were at least eight and possibly ten indicative proposals from potential bidders. In addition to both Virgin and Olivant other interested parties included the Tyne Consortium, led by the US buyout firm Five Mile, and another consortium of US investment funds led by the Welsh entrepreneur Alfred Gooding. According to The Independent on Sunday of the 18th November the bids were higher than expected at around the £5 to £6 billion mark, but this report soon turned out to be no more than wishful thinking. As BBC News reported on the Monday 19th November the only two "definite proposals" received were from the Virgin Group and Olivant Advisers, both of which were "materially below" the bank's current share price. All the other parties were only interested in acquiring some of Northern Rock's assets, and effectively valued Northern Rock shares at nothing. This news naturally sent the share price tumbling; having reached a new all-time low of 104.2p on the 19th, it then fell as far as 60p before closing at 97p on the 20th.
On the 26th November it was announced that Virgin was the preferred bidder, although on the 5th December Olivant threatened to pull out of the deal unless it was granted the same rights as Virgin, and on the 13th December was made joint preferred bidder. Meanwhile on the 7th December JC Flowers announced its decision to withdraw from the race, stating its belief that Northern Rock was "in denial" about the extent of its losses. Indeed by the time that Olivant was granted equal status with Virgin, all the other bidders had effectively dropped out of the race, leaving the Government with a simple choice of two. For a time it was believed that a deal would be struck with one or other of these parties sometime before Christmas, although the days went by without any annoucement being made.
The problem was that it was perfectly clear that existing customers had continued to take their money out, whilst the Northern Rock was experiencing a marked lack of success in attracting any new deposit customers. And of course, as time went on, yet more of its wholesale borrowings became due and had to be repaid, and so forced the Bank of England to take up the slack, and the scale of the support operation became such that the Bank was forced to advance a sum in excess of £25 billion to keep the Northern Rock afloat. Naturally, any new owner would need to repay this sum, and indeed it was also the view of the Bank of England (and indeed the Treasury) was they should at least undertake to immediately repay between £10 and £15 billion of the billions that the Bank had been forced to advance. It was however clear that both Olivant and Virgin were struggling to raise that kind of money in the markets, and were simply unable to proceed with their bids.
5. The Cunning Plan
It was at this point in the story that the Government's advisers Goldman Sachs devised a cunning plan. They put forward a scheme by which the Northern Rock would raise £25 billion or so by selling mortgages and other assets to a financing vehicle, which would in turn fund the purchase through the gradual sale of bonds to private investors "as and when market conditions permitted". Northern Rock would pay the Treasury a fee in return for the Government guaranteeing the bonds and it would use money from the bond sale to repay the billions it owed the Bank of England. There were those who pointed out that this was precisely the thing that had got the Northern Rock into trouble in the first place, the only difference being that the Government was guaranteeing the bonds this time round.
In any event during the course of a three-day official visit to China on the 18th January 2008 Gordon Brown came forward to endorse this proposal. By a complete coincidence Richard Branson was with the Prime Minister in China where he was accompanying Mr Brown as part of Britain's delegation. Asked on the 19th January whether he'd discussed the question of Northern Rock with Branson, Brown replied in the affirmative, although he insisted they had not talked "in any detail". Which naturally gave rise to speculation that the Labour government were more than happy to hand the Northern Rock over to their good friend Richard on a plate. In any event the Goldman Sachs plan was duly unveiled by Chancellor Darling on the 21st January, although he felt obliged to mention the fact that if a sale to a private buyer could not be agreed, then ultimately the Northern Rock would have to be taken into public ownership, albeit temporarily. Shares in the company rose 40% that day as investors cheered the news, which was quite something since the rest of the stock market was in free fall. However this all meant that the whole bidding process was to start over and a new deadline of the 4th February 2008 was set for the second round.
By this time a third bidder had emerged in the form of the Northern Rock's own management team led by Paul Thompson, who were putting forward their own plan to maintain the Northern Rock as an independent entity. The Government also hoped that other bidders might come forward, and in particular that previously interested parties such as JC Flowers and Cerberus would be motivated to re-enter the contest. Certainly in the worse-case scenario the Government expected to receive at least three bids, only to find that Olivant pulled out less than fifteen minutes before the deadline. The problem apparently being that Olivant was informed on Friday 1st February that any bidder would be expected to repay the value of the government-backed bonds within three years rather than five year they'd been working on, and simply decided it wasn't worth continuing with their bid. As the BBC's business editor Robert Peston put it, this was "very bad news for Northern Rock and very bad news for the Treasury".
To be perfectly honest, the chances of the Government backing a plan by the very management which had brought the Northern Rock to its knees in the first place were always pretty close to zero, which meant that the Government were now left with a choice of one. Which essentially undermined their whole strategy, which was based around the idea of playing off bidders against each other to ensure that the Government got what it wanted, which was basically to get its money back as quickly as possible. In the circumstances the Government did its best, and as the BBC News reported on the 12th February, although Virgin had been told that its bid was "significantly superior" to the in-house proposal, it was also told that it still wasn't good enough. Virgin duly come forward with an improved offer, as indeed did the management team, although neither went as far as the Government wanted, and as the Daily Telegraph put it on the 16th February (quoting one source), "the figures weren't even in the right ballpark".
The result was a "weekend of frantic meetings" as Gordon Brown was forced to cancel a planned weekend holiday and return to London to deal with the crisis, and at 4.00 pm on Sunday 17th February Chancellor Alistair Darling duly made the announcement that the Northern Rock would indeed be nationalised, since it had now been decided that neither of the two bids received offered the taxpayer "sufficient value for money", or as he later explained to BBC News "the best thing to do was to take the bank into a period of temporary public ownership before ultimately trying to return it to the private sector". Naturally Richard Branson wasn't happy, having received the news during what was described as an "acrimonious conversation" earlier that day with Alistair Darling.
Once the announcement was made, the government was able to move fairly rapidly, as according to press reports the government had set to work drafting a nationalisation bill for Northern Rock as far back as the 5th December 2007, and it had been known since the 12th January 2008 that the Treasury had already signed up Ron Sandler, otherwise known as Rocket Ron, as their man to run the Northern Rock. The Banking (Special Provisions) Bill was therefore introduced in the Commons on Tuesday 19th February, although it contained two particular surprises. The first was that it would allow the Government to nationalise any financial institution, and the second was that the nationalised Northern Rock would be exempted from the requirements of the Freedom of Information Act.
The only people who appeared to be happy about this news were the Liberal Democrats, who had been arguing that the Northern Rock should have been nationalised from the beginning. Although on the 20th February the Liberal Democrats suddenly woke up to the fact that much of the £100 billion of the Northern Rock's assets were in fact owned by the Jersey based financing vehicle Granite, and Vincent Cable emerged to claim that there had been "an asset-stripping operation" in effect and that the taxpayer would now be left with "the poor quality assets". All of this should, of course have been apparent to Mr Cable months previously, and only demonstrated that perhaps his party should have thought a little bit harder about the matter in the first place. But despite their recently acquired doubts, the Liberal Democrats felt obliged to go along with the government, although the Conservative Party were against the whole thing. As the Shadow Chancellor George Osborne explained, "We don't know what we're buying, we don't know how much we're paying for it, and we also don't know how long we're buying it for."
The Banking (Special Provisions) Act 2008 duly gained royal assent at 23.06 pm on Thursday 21st February 2008, and order bringing about the transfer of the Northern Rock to public ownership was made one minute later.
6. Harsh truths and economic reality
The Northern Rock had grown from being a £25 billion bank in 2002 which employed 3,800 staff to a £100 billion bank in 2007 which employed 6,500. It achieved this off the back of the mortgage securitisation market and it was perfectly clear in the new market conditions of 2008 that said mortgage securitisation market had ceased to exist. Therefore, as the Financial Times made clear on the 31st January, it was inevitable that any survival plan depended on reducing the level mortgage lending and shrinking the Northern Rock back down to the size it was a few years ago. Naturally this would also mean shrinking the company's staff levels as well. Whilst The Guardian reported on the 16th January that the Government was "battling to avoid nationalisation" because of the concern it would "conjure up images of old Labour and remind voters of the extent of taxpayers' exposure in the crisis", the real reason was that a nationalised Northern Rock would be faced with the exact same economic reality and would therefore be forced to make staff redundant. Naturally the Government was desperate to find a third party to bear that particular responsibility, and having failed to do so was, as the Daily Telegraph put it, "faced with the prospect of doing all this dirty work itself."
The Northern Rock's new chief executive, Ron Sandler, had already gone on record saying that the Northern Rock had to be "reduced to a sustainable size", and thousands of job cuts were therefore anticipated. Neither there any prospect of a rapid turnaround in the bank's fortunes, or as Sandler put it, "We are clearly talking about a period of some years". The government's promise that the bank would be run "at entirely arm's length from government" would therefore be best interpreted as an attempt to avoid being blamed for the future inevitable job losses. Confirmation of these harsh facts later arrived on the 18th March 2008 when it was widely reported that Rocket Ron's preliminary business plan envisaged shrinking the business and getting rid of 2,000 jobs by 2011.
It is at this point that some of us feel that we have experienced a Monty Python Moment and feel under an obligation to refer to the Northern Rock as being deceased, dead, and pining for whatever dead banks pine for. (Perhaps the good old days of Minimum Lending Rate and the Building Society Cartel.) The fact remains is that the Northern Rock was a bank which ran out of money, a state of affairs which is problematic for most businesses, and generally speaking fatal for a bank where money is its stock in trade. Naturally for an economy dependent on the success of its financial services, the sight of people queuing around the block to withdraw their money from a British bank rather undermined the reputation of the City of London as a financial centre, but once the deposit guarantee was in place, there was no particular reason why the Northern Rock could not have been left to its own devices.
According to The Guardian of the 20th February the Government's advisors Goldman Sachs had told Alistair Darling way back in September 2007, shortly after the run on the bank, that he faced a simple choice between nationalisation and administration, and explained that it would be extremely difficult to find a private-sector solution. Despite this advice the government persisted in dithering about for five months in a Micawberish fashion in the hope that something would turn up and save them from actually having to make a decision. Indeed nothing changed during those five months other than the fact that various financial and legal advisers racked up costs in the region of £100 million.
The problem the government always faced was that once the Northern Rock had become the Northern Wreck, it was just seventy or so branches and a mortgage processing centre. Anyone who was really interested in buying such assets could have found plenty of alternatives that were not burdened with a brand name that had become a national joke. Or as the former Chancellor Nigel Lawson (now Lord Lawson) put it in the House of Lords; "There is no public interest involved here. It is not as if we are short of mortgage-lending institutions in this country. It is not as if there is any strategic national interest in maintaining one more such institution".
On the 1st January 2008 the Financial Times posed the question, 'Where will Northern Rock be this time next year? Does it matter?' to a number of economists and analysts. Most weren't quite as blunt as Willem Buiter who replied "Don't know; don't care", but the general consensus of opinion was that the Northern Rock didn't matter. It was a mortgage bank, Britain already had dozens of them, and one less didn't matter in the slightest. Neither were most of them terribly impressed by the idea that the Northern Rock could be revived by the government, as Peter Spencer, the economic adviser to the Ernst and Young Item Club later explained;
"I think the Government is still in denial and will have to come to its senses. It cannot resurrect this business. It's commercial folly. The entire business model is a busted flush. I think any private buyer would have found it extremely difficult to have run it, and I think it will be almost impossible for the Government to float Northern Rock as a going concern again. The more I look at this, the more I come to the view that sadly Northern Rock really cannot be resurrected and has to be run down. The Government must realise the inevitability of a run-down. They are playing for time and they will run it down and it's a shame because the costs of keeping it going are going to be met by the taxpayer."
The Virgin Deal
Led by the billionaire Richard Branson, the Virgin consortium included a number of parties such as the American investor Wilbur Ross, AIG, Toscafund, and First Eastern Investment Group, and had received financial backing from both the Royal Bank of Scotland and Citigroup. What Branson was proposing was a a reverse takeover whereby Northern Rock would acquire the existing business Virgin Money at a valuation of about £200 million, after which the consortium would the inject a further £800 million, and then launch a discounted rights issue to raise another £800 million of fresh equity, leaving the members of the consortium with around 55% of a new rebranded Virgin Bank.
As it turned out the actual offer made on the 16th November 2007 valued Virgin Money at £250 million, and proposed that the consortium would inject £650 million and raise another £650 million by the right issue, whilst the 4th February offer of £1.25 billion involved a £500 million rights issue and a £500 million cash injection, although this was sweetened by the proposal to offer the Government warrants in the new stock that would allow it to cash in any future improvement in the share price. Asked to improve the value of this bid, on the 15th February Virgin increased the value of its capital injection to £700 million and also announced some improvements to the terms of the warrants it was proposing to issue to the Government. Whatever the merits of these various bids, there were those that claimed that the valuation placed on Virgin Money was always somewhat generous, whilst other major shareholders in Northern Rock expressed their opposition these terms, on the basis that it would have diluted their stake in the bank, and were unimpressed that the new bank would have to pay Branson a £10 million annual royalty payment for the use of the Virgin name.
The fate of the Shareholders
Shares in the Northern Rock were suspended on the morning of Monday 18th February having closed at 90p on the previous Friday, a far cry from the 1251p they had reached only a year previously. With the nationalisation of the bank they were left awaiting the news of what price the government's independent valuer would put on their shares. Many were unhappy about this turn of events. Robin Ashby, the founder of the Northern Rock Small Shareholders' Group, said that he was "shocked and appalled" at the decision to nationalise the bank, and "disgusted" that proper consideration had not been given to the latest offer from the bank's management. By this time the two major shareholders in the Northern Rock were the Monaco based hedge fund SRM and RAB Capital, investing on behalf of its Cayman Islands based Special Situations Master Fund. Both these institutions had been bottom fishing and buying up Northern Rock shares and together now controlled some 20% of the equity. These two investors had already made one attempt to ensure that the Northern Rock put their interests first and called an Extraordinary General Meeting held at the Metro Radio Arena in Newcastle on the 15th January 2008, when they tried (but failed) to pass a number of resolutions that would have restricted the ability of the board of directors to dispose of assets.
Certainly from the shareholders point of view, it would have been preferrable to have put the Northern Rock into administration, close it to new business, and run it down whilst squeezing the maximum return from its existing assets. They might therefore expected to have recovered at least the book value of the assets, being roughly £1.5 billion or about 360p a share. Of course this option became unavailable due to the government's decision to nationalise the bank, at which point the government appointed an independent valuer to determine the compensation to be paid to Northern Rock shareholders. However since the Northern Rock Compensation Order 2008 stated that any such valuation should be made on the basis that the bank was not a going concern, it was widely interpreted as meaning that the shareholders would receive little or nothing in the way of compensation.
This left the government claiming that on the one hand, the Northern Rock was "solvent" and that its mortgage book was of "good quality" in order to disarm critics of its decision to nationalise the bank, whilst on the other that it was "insolvent" and "worth nothing" when it came to paying compensation to shareholders. It would therefore appear to be almost a cast iron certainty that this will result in legal action at some point in the near future.
SOURCES
Based on reports from BBC News, The Guardian, The Times, The Daily Telegraph, The Independent, and their Sunday equivalents in the period between September 2007 and March 2008, together with other accounts published in the financial press such as Money Week and the Financial Times and of course the City Slicker column in Private Eye.