Northern Rock - Taxpayers’ risk, shareholders’ reward?
The Treasury's proposals to provide funding for private sector bids for Northern Rock (announced here) look something like this:
- billions of £s of the Rock's assets (mortgage loans etc) would be sold to a special purpose vehicle;
- the SPV would issue bonds, secured on the assets and guaranteed by the Treasury (ie the taxpayer), raising say, £30bn;
- the money raised from the bonds would be paid to Northern Rock (to buy the assets moved into the SPV);
- Northern Rock would repay the loans it has had from the Bank of England.
Staightforward so far - the assets and liabilities are taken off Northern Rock's books and the Bank of England loans are turned into government guarantees. The securitisation does look suspiciously like the CDOs we have seen suffering in the capital markets in recent months, but at least the bonds will be gilt-edged.
There is more:
- to ensure the bonds are fully secured and to reduce the risk to the taxpayer if asset values fall (eg if residential property values fall or loan arrears rise) - in other words, to keep the SPV solvent - the value of assets transferred from the Rock will be more than the amount raised from the bonds and the difference will be a loan to the SPV from Northern Rock;
- Northern Rock will also provide the Treasury with a guarantee, secured on its remaining assets;
- Northern Rock has to raise additional equity capital and the Treasury will have an equity stake.
Not terribly appealing requirements for Virgin, Olivant et al.
If the SPV were to go bust, the Treasury would have recourse to the net assets of Northern Rock. How much would they be worth? It's difficult to say, but it's not hard to imagine them being exhausted if market conditions are such that the SPV has failed. But remember the shareholders' capital will be very much less than the value of the government guarantee.
It's the taxpayer who pays the bondholders if everything goes wrong.
If everything goes right, what happens?
- The Treasury is paid fees for its guarantees, which are released over a period of, say, 5 years; and
- Northern Rock's shareholders take the profits.
The negotiations will be fascinating. Despite the government's reminders that nationalisation remains an option, it is clearly politically unattractive. How much of an equity stake will the Treasury be able to persuade the private sector bidders it should have? Will the Treasury's upside return properly reward its downside risk?
Robert Peston implies here that a successful private sector bid is not a foregone conclusion.
Would the Lloyds TSB deal on offer in early September have meant less cost and risk for taxpayers? Even the Treasury Select Committee isn't sure (see our post on their conclusions here), but they did suggest that this restructuring lacked a key ingredient - early decisive action.
Date: 29th January, 2008
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