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Rock to go for a song?

• Robert Peston
• 13 Nov 07, 03:14 PM

The clever lads at have got hold of the sale memorandum for Northern Rock and put it on their website.

And 鈥� curses 鈥� it doesn鈥檛 include the one really vital piece of information for any bidder, which is precisely what the Rock is paying for its Treasury-backed loan from the Bank of England.

The Government, I am told, regards this detail as too sensitive even to tell prospective purchasers.

All the document says is that "any potential purchaser/investor... will need to have discussions with the Bank of England and its advisers before concluding any proposal."

Too right they will.

The value of the business for shareholders depends almost totally on the length and cost of this borrowing facility.

What the sale memo does disclose is that the Rock expects to have borrowed 拢24bn from the Bank as of Jan 1 2008 (though, curiously, the Bank of England believes it may well have lent 拢30bn by then).

The memo talks about this loan being refinanced 鈥� though it is not explicit about whether such a refinancing would continue to involve Government support.

However those involved in the sale process tell me it is simply impossible for this facility to replaced by a pure commercial deal in the foreseeable future.

So we are talking about the Government loan rolling on to the horizon. And according to the sale memo, even in 2010 the Rock will need to be in receipt of 拢6bn from what it calls a Replacement Facility 鈥� which, as I say, is in effect the current Bank of England loan by a different name.

Anyway, the memo outlines three possible different destinations for the Rock:

• sale of the whole company;
• sale of the basic physical infrastructure of the business, viz. the branches, IT and call centre, which might or might not also include Northern Rock鈥檚 拢13.5bn of retail deposits and matching assets;
• sale of the infrastructure plus all those securitised mortgages, leaving behind a rump of assets and liabilities for orderly run-off.

Now, it looks to me as though the jobs of most of the Rock鈥檚 6,000 employees should be retained, under these scenarios.

But if I were a Northern Rock shareholder I would be alarmed, because the possibility of retaining the Rock as a listed company in its current form is simply not mentioned as an option.

And the point about the status quo is not that it is necessarily the best option. But you would expect it to be the base case for any examination of what should happen to the company 鈥� such that any deal would only be done if it created more value for shareholders than sustaining the current structure and ownership.

The implication therefore is that Treasury simply wants to get shot of the business 鈥� though it would deny any such intention, largely because it can鈥檛 be seen to be pulling the strings for fear of being forced to take more formal responsibility for the Rock鈥檚 welfare as a shadow director.

Also it won鈥檛 wish to be seen to be short-changing the 150,000 or so small shareholders in the Rock, many of whom acquired their shares when it converted from a building society and saw their stake as a retirement nest egg.

But the contents of the sale memo imply that the initiative put forward by Luqman Arnold and his Olivant financial business is going nowhere. This credible former boss of Abbey National and UBS believes he can stabilise and grow the Rock as a going concern. His plan would be to retain the Rock鈥檚 listing and inject some new capital into it in return for a stake of less than 20 per cent.

Unsurprisingly, a number of the Rock鈥檚 larger shareholders 鈥� including the hedge fund, RAB 鈥� believe Arnold deserves a proper hearing. So they won鈥檛 be pleased if he鈥檚 already been effectively ruled out.

In the memo, the Rock is given the cutesy codename "Blackbird". Its shareholders will hope that鈥檚 not because a decision has already been taken that this bank is going for a song.

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The debt weight

• Robert Peston
• 13 Nov 07, 09:01 AM

I鈥檓 feeling gloomy. Here鈥檚 why.

1) Stock on the books of British estate agents jumped almost 9% in October, when new agreed sales were at their lowest level since the first started polling their members. If that鈥檚 not a rush for the exit鈥�

2) In the US, the chief operating officer of Blackstone, the world鈥檚 biggest private equity firm, who has his ear pretty close to the market, 鈥渢he mortgage black hole is, I think, worse than anyone saw. Deeper, darker, scarier.鈥�

3) Analysts at Morgan Stanley estimate that the cost of borrowing money for British consumers, as a result of this summer鈥檚 seizing up of financial markets, has risen by 70 basis points, or 0.7% (against a 0.15% rise for companies). They say this would reduce consumption by 1.4% (all else being equal).

4) The price of junk bonds has plummeted, yields have soared, so that on November 8 the average junk yield was almost 5 percentage points above US Treasuries. That implies a default rate of around 5%. What it means is that the debt markets expect a sharp enough US economic slowdown to cause significant damage to US companies.

5) The debt of several British buyouts completed in the past year 鈥� at the peak of the private-equity boom 鈥� is already trading at well below 100 pence in the pound, which implies that they are already running into repayment difficulties.

6) Only one listed high-street British bank, HSBC, had tangible equity of 4% or more as a proportion of assets at its last half-year end. At this stage of the banking cycle, it is that kind of equity cushion which any prudent bank would want. Only two others, HBOS and Bradford & Bingley had 3% ratios. As we approach the season of writedowns on past lending mistakes, the relatively low level of tangible equity within the British banking system is cause for concern. It means the banks鈥� ability to provide credit may become even more constrained, as they endeavour to rebuild those equity-asset ratios (and, of course, their share prices will remain under pressure).

What does it all mean? Well, debt markets are saying there will be a sharp economic slowdown in the US and UK, far worse than what equity markets are currently discounting. So either debt-markets will enjoy a miraculous recovery or the stock market will slump. For what it鈥檚 worth, Morgan Stanley yesterday sided with the debt-market bears.

As for the wider economy, the brakes are being slammed on and we鈥檙e going to feel less prosperous pretty soon. Which is why I was slightly bemused that the Bank of England didn鈥檛 cut interest rates (though apparently no one else was), to prevent us being bruised excessively by the jolt. Keep your seatbelts fastened.

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