Rock buys time
There has been a disturbing outbreak of common sense at the Treasury. It has announced this morning that it will provide Northern Rock with the kind of stable funding and protection for depositors that should allow the bank’s board to avoid selling the business at a knockdown price in a fire sale.
In fact, Northern Rock now has till February 2008 to decide whether it makes sense to sell itself. It’s odds on that the bank will be sold, but at least the Rock now has the time to judge the seriousness of the multiple expressions of interest it has received from putative buyers.
The Treasury’s big decision – made after consulting the Bank of England and the Financial Services Authority – is to provide full protection for all retail deposits made at Northern Rock after September 19.
This probably makes Northern Rock the very safest place for anyone to put their cash in these uncertain times.
If such succour turns out to be controversial, it will be because Northern Rock’s competitors – especially the smaller banks like Alliance & Leicester and Bradford & Bingley – may feel that the Rock has now obtained an unfair advantage.
Why would anyone not put their cash into Northern Rock right now, unless it starts paying a dreadfully low interest rate? Whatever today’s pre-budget report discloses today about a deterioration in the public sector finances, Northern Rock’s guarantor, HMG, is not going bust.
Now Northern Rock is paying an arrangement fee to the Treasury for this insurance, which will remain in place until normal market conditions resume.
And it would also pay to the Bank of England a small percentage of any new deposits it takes – in order to deter it from offering a crazily attractive interest rate to woo customers.
But whatever that arrangement fee and payment to the Bank of England turn out to be, they are by definition not commercial terms for the insurance – for the simple reason that Northern Rock simply could not obtain such insurance in the marketplace.
So in the interests of maintaining a level playing field for banks, I wonder if the Treasury would be able to refuse to provide the same insurance on the same terms to other banks, if they demanded it.
The Treasury says it would turn them down – unless they were in dire straits.
And I guess no bank would want to admit it needed such state insurance, because that would be a dangerous admission of fragility which would alarm customers.
Even so, it is plausible that the protection for Northern Rock constitutes unfair state aid, of the sorted prohibited by the EU.
Also agreed today is a widening in the range of collateral Northern Rock can pledge to the Bank of England in return for the emergency loans it is drawing for the Bank.
This has been done to help Northern Rock take advantage of the £10bn or so of commercial funding on offer from Citigroup, the world’s biggest bank.
At the moment, the Rock cannot borrow from Citi or any other commercial lender who may make funds available, because the Bank has taken a charge over all Northern Rock’s prime assets.
But now that the Bank has agreed to lend against the security of assets of lower quality, the Rock can pledge the better stuff to Citi.
It all means that – with copious state support – Northern Rock can plot a course towards perhaps becoming a normal commercial operation again one day.
This won’t happen overnight. As of now, it has borrowed almost £11bn from the Bank of England in emergency support. And it may be forced to borrow another £10bn or so from the Bank in coming months, as its existing liabilities come up for renewal.
That said, Northern Rock’s shareholders can breathe a small sigh of relief that the Treasury is no longer trying to get the troubled bank off its books at a speed that would squish the value of its equity to zero.
However don’t be fooled into thinking the rescue is without very serious costs for Northern Rock and its owners. There will be an incremental one-off charge of up to £50m in the results for the year to December 31 just in respect of an indemnity to pay all costs incurred by the Treasury, the Bank of England and the Financial Services Authority in respect of their work on Northern Rock, plus the pickings of the Rock’s own advisers.
And that hit to profits does not include any of the punitive interest charge levied by the Bank of England.
Make no mistake, the Rock’s shareholders are paying a very steep price for the crisis at their institution.