Anatomy of a Deal: Northern Rock in a hard place
21 February 2008
At 26bn and counting, the rescue of Northern Rock is the deal everyones talking about - and one you need to be up to speed with.
The one name and one deal that has been dominating the City landscape for the past six months is Northern Rock. In any interview firms will be assessing your commercial knowledge.
Our guide to the drama surrounding Northern Rock will give you all the background you need to demonstrate your acumen.
At the beginning of last summer Northern Rock was a FTSE100 darling. But by Christmas several potential bidders for what had become the Governments biggest headache were refusing to make any further offers for the Newcastle-based lender. Several protagonists in the seemingly never ending saga have played their parts - only to make swift exits from the action. So where are we at now?
At the time of going to press just two bidders were left in the running for 'the Rock. The first is a consortium led by Sir Richard Bransons Virgin Group, which also comprises insurance giant AIG, hedge fund Toscafund and Hong Kong-based First Eastern Investment Group. The second is an in-house team from Northern Rock. The only other credible bidder, investment group Olivant, dramatically abandoned its bid for the stricken lender just hours before deadline for interested parties to submit their bids to the Treasury.
The Virgin consortium wants to take over the bank and rebrand it as Virgin Money. Under this proposal Virgin would inject 1.25bn of fresh capital, of which 500m would be generated through a rights issue priced at 25p per share. The remaining 750m would be structured as a 500m cash injection from the consortium partners and a 250m contribution from Virgin Money.
Olivant, on the other hand, did not want to own the Rock. Rather, it proposed that its executives worked alongside the banks management in return for a 15 per cent stake. Northern Rock would get to keep its name and brand. Olivant said it would repay 15bn of the Rocks loans immediately, with the rest of the 26bn loan being repaid by 2009.
The problem is that the bidders were finding it hard to get financing for their respective offers. They still needed other banks to lend to them to pay off the debt the Rock owes the BoE. Banks are not that keen on lending any more - either in 'paltry amounts to you or me, with mortgage and loan rates rising, or especially in the billions of pounds to other banks or institutions. This is both a cause and effect of the credit crunch (see box).
In the event of the two remaining bidders being unable to stump up the cash for their bid, the only option that might be available is to nationalise the bank. That is not ideal for many reasons: it might contravene European state aid rules (the laws that prevent governments from propping up otherwise sickly and inefficient businesses) and the taxpayer would be faced with Northern Rocks liabilities. Plus, angry shareholders might start suing.
Then there are conflict of interest issues. If it is the BoE that nationalises the Rock, would that mean the BoE can be regulated by its fellow member of the Tripartite Authorities, the Financial Services Authority (FSA)?
Chancellor Alistair Darling has said that, if he does have to nationalise the Rock, it would only be for a short period of time before it would be broken up and auctioned off. An added headache is that activist hedge funds RAB Capital and SRM, which have together amassed 18 per cent of the banks shares, called an extraordinary general meeting (EGM) on 15 January in a bid to persuade other shareholders to vote on a measure that would see Northern Rock needing to get approval to sell more than 5 per cent of its assets at any one time.
However, the funds have since softened their stance and said they are willing to work with the bank to find a private sector solution.
As recently as 11 January Northern Rock sold off a portfolio of its mortgages, worth 2.2bn, or 2 per cent of the companys assets, to investment bank and Eversheds client JPMorgan. Northern Rock is going to use the proceeds to pay off some of its loan.
Also on 11 January, US investment bank Goldman Sachs, which is advising the Treasury on what to do about Northern Rock, came up with a plan that would see some of the Rocks 26bn BoE debt turned into bonds that can be sold to investors.
Sovereign wealth funds (funds that pool national assets and then invest them) particularly those in the Middle East, might want to buy these, especially if the bonds were guaranteed by the BoE in some way.
What is clear is that the Northern Rock debacle has been toxic for the UK economy. For the past decade or so, the UKs star as a capital market and as an axis for finances best and brightest has been rising. Northern Rock could wipe out that reputation. In early January Goldman Sachs issued a report that suggested betting against a fall in the pound sterling. This was all the more embarrassing because of Goldman Sachs advisory role to the Treasury.
Law firms, too, have not been immune. Setting aside for a moment the questions over conflicts of interest that have been raised (see Lawyer2B.coms feature 'Whose Side are You On?, 14 November 2007), there has been a very real fallout. Newcastle headquartered firm Dickinson Dees, whose biggest client is Northern Rock, had to make 17 staff in its mortgages business redundant last November.
Expect a denouement in the next month or so. The BoE first threw Northern Rock a lifeline in mid-September, and a few days later the Treasury guaranteed all deposits there (see timeline).
Under state aid laws, emergency help from the Government can only be granted for six months. The one question that remains to be answered is whether the saga is a tragedy or a farce - you decide.