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Archives for February 2008

Bothered and bewildered by RBS

Robert Peston | 11:19 UK time, Thursday, 28 February 2008


In a banking world beset by uncertainty and anxiety, Royal Bank’s results on paper look as good as could have been expected.

Sir Fred Goodwin in front of RBS logoProfits have grown, the dividend is up, and the balance sheet is stronger than might have been anticipated.

What’s most striking is that RBS appears to have hoovered up almost every spare fiver held by Britons: growth in its UK retail deposits is remarkable.

RBS – or rather its NatWest subsidiary – seems therefore to have been the main beneficiary of savers’ flight out of Northern Rock.

But RBS does not help its cause by the way it presents its annual results – which is somewhat confusing, to put it mildly.

It says that the figures to focus on are for RBS minus the big chunk of ABN which it acquired last autumn.

There is some logic to that, in order to obtain a sense of underlying progress.

abnamro_203afp.jpgHowever buried away on page 47 of today’s announcement is the disclosure that ABN’s contribution to RBS’s statutory results was actually a loss.

Now it’s all very well to ignore that loss for the purposes of seeing what happened at the rest of RBS.

But hang on a second, who actually owns ABN? Let’s be clear: that loss (albeit a small one of just £16m) belongs to RBS and its shareholders.

Also, Sir Fred Goodwin, the bank’s chief executive, wants it both ways.

He would prefer us to take no account of the real negative contribution made by ABN last year, but does want us to be enthused by the yet-to-be generated incremental profits he expects to make from the acquired operations.

Sir Fred also argues that substantial write-downs on collateralised debt obligations linked to sub-prime and on leveraged finance finance are “one-offs” and therefore can be dismissed when measuring “underlying performance” – which seems a little eccentric.

For RBS, dealing in CDOs and providing leveraged finance to private-equity deals was hardly a marginal activity. And if some of it has gone wrong, well that’s just the rough that followed the years of smooth.

It’s not just me who is a bit bewildered. Analysts at JP Morgan, the giant US bank, described the figures as “some of the poorest disclosure we’ve seen.”

In these strange times, RBS would surely have inspired greater confidence in its shareholders and counterparties if there had been a little bit less bluster and swagger.

Bank boom ends

Robert Peston | 09:37 UK time, Wednesday, 27 February 2008


I am not surprised there has been a sharp fall in the HBOS share price this morning. The squeeze on its margin in retail banking was very pronounced. Profits of its retail banking business fell pretty sharply and are now smaller than those of its corporate banking operation (which is astonishing for a bank whose core is the old Halifax building society).

Halifax bank branchWhen you add that to what Hector Sants, chief executive of the Financial Services Authority, said to me this morning about how the cost of money for banks has risen on a permanent basis, well it all adds up to a pretty gloomy outlook for banks’ profitability.

Predictably, shares in Alliance & Leicester and Royal Bank of Scotland (whose results are tomorrow) also fell pretty sharply.

For banks dependent on providing mortgages, loans and other banking services to millions of British consumers, there has not just been a downturn in the cycle – but, as Sants pointed out, the prospects for them have become altogether more dull on a permanent basis.

Sants himself is rather pleased about that. The end of the era of cheap debt means that fewer of us will be tempted to borrow too much.

But it probably means that the owners of banks, their shareholders, will receive lower returns. And it may well slow the growth of the economy for some years.

FSA and bankers' bonuses

Robert Peston | 06:42 UK time, Wednesday, 27 February 2008


In his interview with me for this morning's Today Programme, the leader of the City's pack of watchdogs came intriguingly close to saying that the economic mess we're in stems from bankers' greed and the foolishness of those who negotiate their remuneration. (You can listen to the interview here.)

Hector SantsHector Sants, the chief executive of the Financial Services Authority, said that the way bankers are rewarded is not helpful to financial stability and magnified risks for their respective firms.

Which, from an habitually cautious regulator, represents a sound ticking off for the City.

What bothers him is the so-called assymetry of bankers' rewards.

Bankers received fat bonuses, often running to millions, for their deals, most relevantly the parcelling up of dodgy loans for sale as supposedly rock-solid bonds to international investors.

But when those bonds turned out to be radioactive duds, foisting big losses on their holders - including the banks that employed the clever-clogs bankers - there was no way of reclaiming those bonuses.

The creators of the toxic investments had already trousered their fat wedges - and there was no way to reclaim any of this cash.

In crude terms, they had been given the banks' capital to gamble in a game of global roulette. Before the wheel stopped turning, they were rewarded as though their bet on red had come good. But when the ball finally kerplunked in a black slot, well they and the moolah were long gone.

As Mr Sants says, these systems for incentivising bankers were - ahem - a bit too short-termist.

So what should the FSA do? Should it, as some commentators believe, directly regulate bankers pay, to prevent this kind of dangerous silliness.

Mr Sants - who in his previous life as a successful investment banker received rather more than a bob or three in bonuses - thinks not.

He would hope that the banks' owners, their shareholders, would insist that bonuses were linked much more closely to the long-term performance of individual bankers.

But if shareholders fail to act, so be it. He believes it would not be appropriate for the FSA to intervene in a commercial, competitive issue of this sort.

It's every banks' fundamental right, the FSA seems to believe, to be gulled by its brightest and best employees.

Many would agree. Too much nannying is bad for us all - although arguably banks' licence to be foolish should be restricted as and when that foolishness harms all our economic prospects, as it may have done in the debt bubble that has just been burst.

A non-dom at Rock

Robert Peston | 14:23 UK time, Tuesday, 19 February 2008


If anyone thinks the Treasury has it in for non-doms, those who reside here but shelter their overseas income and assets from UK tax, then I have a resonant example to the contrary. In fact I have a couple.

ron_sandler_ap.jpgBecause I have learned that Ron Sandler, the former insurance executive appointed by the Treasury to be executive chairman of the Rock, is a non-dom.

He has lived and worked here since the mid 1980s - and he pays tax on what he earns here. But he was brought up in Zimbabwe, has a German passport and holds assets overseas.

What's more, the woman he has chosen to be his chief financial officer, Ann Godbehere, is currently resident for tax purposes in Switzerland and is also likely to adopt non-dom status.

Sandler is being paid £90,000 a month at the Rock, and Godbehere's monthly salary will be £75,000. They are both intending to pay tax in the UK on their Rock remuneration.

So what does Sandler think about the Chancellor's plan's to levy a £30,000 yearly charge on all non-doms who have lived here for seven years? He won't be drawn.

And can you blame him for resisting the temptation to wade into the fraught debate about whether the Treasury's plans to raise taxes on non-doms will be good or bad for the economy? There'll be quite enough politics on his plate running the Rock as a nationalised bank.

Barclays: can't win

Robert Peston | 10:30 UK time, Tuesday, 19 February 2008


Barclays share price has fallen by more than 40% over the past year.

The value of its business has dropped by about £20bn in that period.

This is a business which investors believe is in some difficulties.

And who can blame them?

Barclays logoAfter all, its investment banking arm – Barcap – has been up to its neck in the business of turning smelly sub-prime loans into investments, collateralised debt obligations, that were supposed to smell of roses but turned out to be garbage after all.

But Barclays believes investors – especially short-selling hedge funds, who have been betting on a black hole emerging at Barclays – have got it plain wrong.

The bank’s annual results, the most eagerly awaited corporate health check of the year so far, describe a big international bank in reasonable shape.

And compared to its dumber-and-dumber international peers, Citigroup of the US, UBS of Switzerland and SocGen of France, it really doesn't look too bad at all.

Earnings are flat on a statutory basis and down a non-lethal 15% on its preferred "economic profit" measure.

Capital remains at adequate levels.

Some businesses, such as Barclaycard, are doing a bit better than might have been expected.

But there are quite a few buts.

First, its sub-prime related losses of £1.6bn are by no means life threatening, but can't be dismissed as trivial.

Second, the outlook for this business - as for all global banks with the bulk of their operations in the western economies - is rather worse than it was.

Third, Barclays retains billions in exposure to sub-prime, various forms of asset-backed securities and structure-finance products, monoline insurers, private-equity debt, or - to generalise - stuff that could yet turn bad.

And we had a timely warning today that even the biggest and most sophisticated banks can get their sums wrong, as Credit Suisse has announced a £1.5bn reduction in the value of asset-backed, structured-finance positions.

The chilling bit of Credit Suisse's statement was that it had identified mismarkings and pricing errors by a small number of traders.

Or to put it another way, the people at the top of Credit Suisse didn't have a firm grip on what its brainbox traders were really up to.

It's that kind of failure which explains why investors have so little faith in any big and sophisticated bank right now.

And it goes some way to explain why Barclays' shares have actually fallen today - even though it defied the doom-mongers and raised its dividend by 10%, rather than doing what many feared, which was to raise new capital.

Its shares are yielding around 8%. And all that tells you is that the market still believes that the risk in owning the shares remains pretty high.

Rock: a reverse run?

Robert Peston | 18:20 UK time, Monday, 18 February 2008


What is the future of Northern Rock as a state-owned bank?

Well its new chairman, Ron Sandler, has told the existing management of the troubled bank that he likes their rescue plan and intends to nick many of their ideas.

So he's expected to rapidly shrink the Rock's mortgage operation.

That would be achieved by putting up the cost of mortgages - which would encourage borrowers to repay by taking out loans with other banks.

The good news is that the proceeds of these redemptions would reduce the loans to the Rock from taxpayers.

And, on the forecasts of the Rock's existing management, the value of mortgages on the Rock's books could be reduced by up to £50bn over four years.

The Rock would become a much smaller business and would need to employ many fewer than the existing 6000 staff - perhaps half that number.

But if the bank is to have a profitable long term future, so that it can be privatised in a few years time, it needs to attract billions more in retail deposits.

The Rock's managers were aiming to almost double these deposits by 2012.

What does it all add up to?

First that banking rivals may cry foul about what they may claim is unfair Government-subsidised competition for savings.

Just think of it: there could be a reverse run, with savers stampeding to put their money into the new gilt-edged Rock, perhaps the safest bank in the world.

However banking competitors will be delighted that one of the most aggressive discounters of mortgages in recent years could be almost out of the market - which would allow them to put up their mortgage rates.

So increases in the Rock's mortgage rates could be painful for millions of homeowners, not just the Rock's customers.

And it would also be a nightmarish prospect for the Government.

Gordon Brown would not like the notion that his decision to nationalise Northern Rock could lead millions of us to pay more for our homeloans.

Rock: risk doubled

Robert Peston | 08:05 UK time, Monday, 18 February 2008


Although Northern Rock has been heading for nationalisation for some time – and I wrote and broadcast last Tuesday that the Treasury viewed public ownership as preferable to either of the rescue plans – the formal announcement was still momentous.

brown_rock203pa.jpgIt is the biggest decision made yet by this prime minister (except perhaps for opting not to have an autumn general election).

And it will reverberate for months and years – not least because shareholders are planning to sue for very substantial reparations.

The decision seems to have been made for two reasons.

First, neither the Virgin consortium nor a management team were offering as much as the Treasury wanted in fees for tens of billions of pounds of continuing taxpayer support.

I am told there was a £40m gap between what Virgin said it could afford to pay and what the Treasury was demanding, which is big as an absolute number but is peanuts in the context of the Rock’s £110bn balance sheet.

Second, the Treasury was unhappy that Virgin and its co-investors would have made a profit of about £1.2bn – a return of around 75% – before taxpayers received a penny in capital gains for all the financial help we would have been giving.

So although an ultimate profit of about £200m to taxpayers – which is what Virgin thought it could deliver – may seem attractive, the Treasury thought it inadequate give the scale of the risks that would have been shouldered by the Exchequer on behalf of us all.

Northern Rock signThe prime minister has in the end decided that if taxpayers are going to provide financial support to the Rock for years to come – which we would have done, on the basis of either of the rescue plans on the table – then we deserve all the potential rewards.

The only way to secure those potential rewards is to nationalise.

Put like that, it sounds like common sense.

But here is why nationalisation could turn out to be the boldest decision that the prime minister will ever make.

If he wants all the rewards for all of us, he has to take all the risks.

In nationalising, he has increased the liabilities of taxpayers from £55bn – in direct loans through the Bank of England and guarantees to other Rock lenders – to £110bn, or the entirety of the Rock’s balance sheet.

He has doubled the financial risk for all of us to just over £3,500 per tax payer.

Now the point about the Virgin and management plans is that they would have significantly reduced the risks for taxpayers.

They each offered a cushion of new equity, so that – if the worst came to the worst – they would have suffered in any first round of losses, if the Rock’s business were to run into difficulties.

In Virgin’s case, it would have put in £1bn of new cash equity and the management team was promising £700m.

Given that this cash would have been exposed to potential losses – and would have provided protection to taxpayers against those losses falling back on all of us – they understandably wanted first dibs on any profits that would be made.

So let’s not fall into the trap of assuming that somehow the potential rescuers were rejected because they were being appallingly greedy.

They needed to make a return to justify the substantial investments they were proposing.

If anything, their rejection shows that Gordon Brown is perhaps less comfortable with a market solution than many might have expected.

There is another way of looking at all of this, which is simply that financial markets are so dysfunctional right now that it was impossible to construct a deal at a de facto price that made good commercial sense for taxpayers.

But that was a judgement that the Treasury could have made weeks ago – and it is therefore vulnerable to the charge that by pursuing negotiations with Virgin et al till yesterday it was guilty of a Micawberish refusal to see the harsh economic reality.

Where do we go from here?

Well it looks as though the management team of a nationalised bank, led by Ron Sandler, will more-or-less adopt the reconstruction plan put together by the Rock’s own management team.

That means he will shrink the size of the bank by more than half.

There are likely to be significant job losses.

And Sandler will probably jack up mortgage rates, to encourage Rock borrowers to take their custom elsewhere.

There would be political dangers for the government in being seen to be responsible for the financial pain of homeowners and job losses in the North East.

But it is difficult to see how it can escape them.

Then there is the £110bn question.

Can taxpayers avoid a loss on all those liabilities?

Well that depends on whether the current gentle downturn in the economy turns into something worse.

If unemployment were to rise significantly, if large numbers of homeowners started to have difficulty repaying mortgages, then the bank which lent most aggressively during the last phase of the bull market in housing would probably be most at risk to losses in the downturn.

That bank, lest we forget, is Northern Rock.

And if it all goes horribly wrong, it is now taxpayers who will pick up the whole bill.

UPDATE 08:48 The Rock is now, arguably, the safest bank in the UK. Will savers now flock to put money back in, to take advantage of its wholly risk-free, fairly high savings rates?

At a time of almost unprecedented unease about the health of the banking system, the Rock has a massive competitive advantage as part of the public sector.

Its rivals will be very unhappy about the competitive threat. They are desperate for funds – and won’t want to see deposits gravitating to what is now an offshoot of HM Treasury.

Rock to be nationalised

Robert Peston | 15:20 UK time, Sunday, 17 February 2008


The Chancellor will at 4pm this afternoon announce that the Rock is to be nationalised.

He and the Prime Minister have finally decided - on the clear advice of the Treasury - that taxpayers interests would be best protected by taking the troubled bank into public ownership.

The decision will be a blow to the bank's shareholders - who will receive next-to-nothing in the short term for their shares.

Emergency legislation to nationalise the bank will be introduced into the Commons tomorrow afternoon.

I will file more on this as time permits later.

Tesco triumphs

Robert Peston | 09:43 UK time, Friday, 15 February 2008


Today’s proposals by the Competition Commission to increase competitive pressure in the food retailing market will, I expect, be seen by many as tinkering.

Tesco trolleyAnd the net effect may be viewed as reinforcing a status quo in which Tesco has double the market share of its nearest rivals.

That should not be seen as a great surprise – because back on October 31 last year, when the Commission published provisional findings, it said that the market was working pretty well both for suppliers and for customers.

The Commission highlighted the potential for Tesco to exercise excessive market power, while saying it was not yet doing so.

It pointed out there was a risk that suppliers might not invest enough in research and new products, if supermarkets persisted with the practice of demanding retrospective payments (for example), but said that right now most suppliers were in pretty healthy shape.

In other words, the Commission was never going to come up with some bold plan to break the power of Tesco or to create some huge new regulatory body to act as the suppliers’ champion.

What it will propose is an independent ombudsman and adjudicator, appointed by the Office of Fair Trading, to resolve particularly intractable disputes between suppliers and the big supermarket chains, under the existing code of practice.

But this won’t be some new regulatory body. There won’t be an OffShop, to add to all those other Offs that dominate the regulatory landscape.

It will be a man or woman and a dog (as it were), whose primary role will be to give confidence to suppliers that there is someone out there who will back them if they really have been brutally beaten up.

In fact, I suspect that the proposals that the Commission makes this afternoon will be viewed as less radical even than those it mooted back in the autumn.

For example, there was an expectation in October that Tesco and other supermarkets could be forced to divest land holdings pretty promptly, if that land was being retained as a spoiler, to prevent competitors getting hold of it.

Well, in the end, the Commission doesn’t seem to believe that kind of defensive investment goes on to any great extent – so I am not anticipating there will be vast forced sales of land by Tesco or any of the other chains.

That said, the Commission will crack down on the use of covenants in land leases and exclusivity agreements in development contracts, whose only point would be to create or protect cosy little local monopolies for one or other of the big supermarket groups.

So in theory, it should become easier for a Sainsbury or an Asda to set up shop in one of the so-called Tesco towns.

But Asda, Sainsbury or Morrison will not gain the power to make serious inroads into Tesco’s daunting 30% share of the market.

The troika of Tesco challengers will take heart at the recommendation from the Commission that there should be an explicit competition test in planning decisions for new supermarkets.

That would mean that if there were already a big Tesco in an area, but no other supermarket group, the planning authority ought to look more favourably on a development plan put forward by an Asda, Sainsbury or Morrison.

But competition will not be the only test. And the Commission has decided not to opine, in the end, on whether there should be abolition of the “needs test”, the stipulation that a new supermarket should only be built if there is a palpable local need for one, irrespective of competition issues.

That means there is no reason to believe that new Asdas, or Sainsburys, or Morrisons will suddenly shoot up all over the place.

So I would anticipate that Tesco’s rivals will be disappointed by the Commission’s recommendations, that small independent shopkeepers will feel that nothing is being done to help them, that suppliers will be marginally encouraged that they now have a shoulder to cry on, and that the anti-Tesco lobby will be pretty miffed.

And over at Tesco HQ, the mood will doubtless be one of quiet satisfaction.

UPDATE 17:15 Food companies and farmers will probably be most pleased with today's recommendations - especially the proposed inclusion of lots more retailers in the code that protects suppliers from bullying.

They will also like the idea of being able to take their woes to an independent ombudsman.

Also, there could be marginally improved opportunities for Asda, Sainsbury and Morrison to set up big stores near a Tesco, if the Commission gets its way on changes to planning processes and on the removal of anti-competitive clauses in land contracts.

But none of this represents a wholesale reform of the way that food is sold to us, and nor will it pose even the faintest threat to Tesco's position as the number one British supermarket group.

B&B: banking omens

Robert Peston | 08:05 UK time, Wednesday, 13 February 2008


You would be forgiven for thinking “banking crisis, what banking crisis?” on a casual reading of Bradford and Bingley’s annual results.

So-called “underlying” profit before tax is up 5% to £351.6m.

The dividend has been increased by the same percentage to 21p.

And the group’s capital ratios – the important measures of the strength of its balance sheet – have improved.

Bradford & BingleySince the B&B figures signal the beginning of the bank reporting season, should we all just breathe a sigh of relief and return to the traditional British sport of bashing the banks for allegedly making excessive profits?

That I think would be a bit premature.

Its actual pre tax profits, the number that the accounting rules determine as the proper one, actually fell and sharply.

In fact statutory pre-tax profit almost halved from £245m to £126m.


And here are some other disclosures by B&B, which ought to make us a little bit anxious about what its bigger brethren will reveal in the coming few weeks.

The cost of raising money for the bank has gone up significantly, so that its net interest margin – the difference between what it charges for loans and pays out for deposits and other forms of funding – has shrunk from 1.19% to 1.1%.

And it expects that margin to shrink further in the current year – which rather explodes the complaint against banks that they are failing to pass on the benefit of lower base rates to borrowers.

Also the number of mortgage borrowers in arrears on their payments by three months or more has gone up by a striking 42% to 6,170.

As a percentage of its loan book, these potential bad loans represent a relatively small proportion, just 1.63%.

But the trend is disturbing.

However it’s the size of the losses on its exposure to sub-prime and structured finance that stand out.

Just a few weeks ago, it did not expect to suffer any losses on its CDO and SIVs.

Now it’s disclosing £94.4m of impairment charges and a further £50m loss on a fall in the market price of derivatives built into an investment in “synthetic” CDOs (don’t ask, please).

So that’s £144.4m of losses that only recently it had not expected to incur.

What does that betoken for RBS and Barclays, whose exposure to CDOs is vastly greater?

Nothing good.

Rock nationalisation 'back on'

Robert Peston | 21:30 UK time, Tuesday, 12 February 2008


A consortium led by Virgin has tonight been told by the Treasury that it is out in front in the contest to take control of Northern Rock - but that at present nationalisation of the troubled bank would be a better outcome for the taxpayer.

The group led by Sir Richard Branson has been told to improve the terms of its rescue plan.

The Treasury wants the Virgin consortium to offer more for the billions in financial support being provided by the Government.

And it also wants a bigger potential stake in Northern Rock for the taxpayer, via a so-called warrant over the bank's shares.

A rescue plan put together by Northern Rock's management has not been killed off.

But the Treasury this evening told the management team that its current proposal is significantly inferior to that put forward by Virgin.

The disclosure will be a bitter blow to the Rock's shareholders - many of whom are very hostile to the Virgin proposal.

They believe the management's plan offers the best prospects of rebuilding the value of the bank's battered shares.

But what may alarm shareholders even more is that if the decision on what to do about the Rock were taken today, the Treasury would opt for full public ownership.

According to a banker close to negotiations, the Prime Minister is calling the shots on what to do about the Rock and is steeling himself to go for nationalisation.

Gordon Brown still hopes that a partial nationalisation deal with Virgin or the Rock management team can be negotiated.

But he is said to be no longer seeking to avoid nationalisation at any price.

"Nationalisation is looking much more likely than it did" said the banker.

AIG: the horror

Robert Peston | 08:54 UK time, Tuesday, 12 February 2008


If you want to understand why the world’s investors and financial institutions are so jittery about the outlook for financial markets, you should click on this link.

It’s yesterday’s announcement by AIG, the vast US insurer, that it has been over-valuing insurance it has provided to bonds linked to US sub-prime lending.

AIG disclosed that it has increased its estimate of losses by just under $5bn for the October and November accounting months for its exposure to sub-prime related investments.

To be honest, you probably would not gather that from a casual reading of AIG’s statement – which is written in the most technical of language, explaining how it uses a “modified Binomial Expansion Technique” to value its portfolio of “super senior credit default swaps”, but seems to have taken too little account of the fall in “cash bond prices for securities in the underlying collateral pools”.

Here is my translation: in valuing the claims that may be made on the insurance it has provided to collateralised debt obligations, it relied too heavily on its own internally generated valuations and loss estimates, and seems to have taken too little account of the market price of asset-backed securities.

In the jargon, it was “marking to model” rather than “marking to market” – and in the process, it was understating losses.

Anyone can grasp the significance of this killer clause in AIG’s statement: “AIG has been advised by its independent auditors, PricewaterhouseCoopers LLC, that they have concluded that at December 31 2007 AIG had a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation” of all that CDO insurance.

What are the implications? Well, here are a few:

1) It suggests that the latitude given to insurers and banks by financial regulators over methods for valuing CDOs and other complex investments may have been misguided and misplaced.

2) It raises questions about whether other banks and insurers have been over-valuing their exposure to sub-prime. There will be particular concerns about those financial institutions which have tended to mark to model rather than to market (you know who you are).

3) It highlights the frightening potential size of the capital deficit at the so-called monoline insurers like Ambac and MBIA which specialised in insuring CDOs and other bonds.

But, for me, what is most important is the declaration of independence by PWC, the auditor. PWC has made it clear that it will not participate in any fudging of the scale of the sub-prime disaster – even where full and painful disclosure has the potential to undermine market confidence.

So in the coming few weeks the very worst of the losses from banks and insurers should be on display for all of us to see in their gory detail – and there may yet be further unanticipated horrors.

Taxpayer's £100bn Rock exposure

Robert Peston | 11:15 UK time, Thursday, 7 February 2008


As I wrote on January 14, the Treasury has been expecting for some weeks that the Office for National Statistics would force it to include all or a big chunk of the Rock’s borrowings on the public sector balance sheet.

northern_rock_pa.jpgThat’s one of the reasons why the Chancellor agreed to provide up to £40bn of new Government-guaranteed bonds to the Rock: he knew that the troubled bank was about to bust Gordon Brown’s cherished fiscal rules, the belt that is supposed to keep the public finances looking trim.

The flab would be hanging out, whatever he did.

But what the ONS has ultimately decided looks odd.

Its statement this morning implies that around £25bn of direct loans to the Rock will come on to the public sector balance sheet, together with about £50bn of liabilities from the Rock’s so-called Granite bond-issuing programme.

So that’s £75bn added to the national debt. Yikes.

Gordon Brown’s sustainable investment rule, which limits the national debt to 40 per cent of GDP, is smashed to bits.

But a further £30bn odd of guarantees given by the Government to other lenders to the Rock seems to be treated as a contingent liability – and would therefore not be included in the public sector balance sheet.

Bankers and accountants tell me this is economically illiterate.

If we as taxpayers are guaranteeing loans, that’s as good as making the loans ourselves – because if the loans were withdrawn, we would have to divvy up the cash.

That said, the ONS insists that international standards prevent it from including the contingent liabilities on the public-sector balance sheet, which means that common sense cannot prevail.

On the other hand, the Treasury thinks that ALL the Rock's liabilities, net of its liquid assets, would be included in the national debt.

So that would be the full £100bn or so, including the contingent liabilities, as an addition to the nation's liabilities.

Clearly I need to get to the bottom of this.

But there's no escaping that the numbers are big.

And the ONS has dropped a further bombshell.

It says the whole of the Bank of England’s balance sheet needs to be included within the public sector finances.

But the ONS thinks that would actually reduce the national debt, perhaps by a few billion, presumably because it nets out the Bank of England's holdings of gilts.

Here’s the big question.

When assessing the fundamental health of the nation’s finances, would be it right to regard the Rock and Bank of England as special cases?

Should they be excluded as special items when making a health check on the public-sector balance sheet?

Or does the ONS’s accounting treatment imply that the financial health of the public sector has in reality been a lot worse than the official figures have been showing.

Well my view would be that the Bank of England should be stripped out as a special case. It doesn’t seem to me that it is any more or less of a risk to taxpayers than it ever was.

But the Rock is different.

The liabilities there are new and real liabilities, so it would be foolish to dismiss the £100bn Rock increment to the national debt as irrelevant.

Most of that £100bn is secured against assets, the mortgages of the Rock’s customers.

Even so, a portion of that £100bn is genuinely taxpayers’ money at real risk of loss, because the value of those assets could turn out to be less than the Government hopes.

However, here’s the grisly truth: it’s impossible to assess that risk of loss with scientific precision.

Update 12.45pm: An ONS article confirms that the addition to the national debt would be around £100bn. It says that, as of the last published annual accounts dated December 31 2006, the increment would have been £90.7bn.

If Northern Rock had been part of the public sector at that point, there would have been a 6.7 percentage point increase in the ratio of national debt to GDP, to not far off 45 per cent.

But Northern Rock issued about £10bn of new bonds in 2007, which would lift the public sector liability to the horribly round £100bn.

Virgin and Rock: Jobs to go

Robert Peston | 07:31 UK time, Wednesday, 6 February 2008


Virgin has abandoned its commitment that there would be no redundancies at Northern Rock in the event that its rescue plan is approved by the Treasury.

The chief executive of Virgin Money, Jayne-Anne Ghadia, told me that job losses would be greater than the group had originally anticipated because of the Treasury's insistence that taxpayer loans have to be repaid within three years.

The Government may be embarrassed by her disclosure that job losses would stem from financial conditions imposed by the Treasury.

When Sir Richard Branson announced last year that he wanted to be Northern Rock's white knight, he said he was confident there would be no redundancies at the troubled bank.

But Jayne-Ann Ghadia, who would run the Rock for him, has had to retract that.

If Virgin were to end up controlling the bank, it would reduce staff numbers by more than could be achieved through natural attrition.

She won't be precise about it, but employee numbers may come down from 6,000 to about 5,000

Her reasons are embarrassing, for the Government.

On Friday, the Treasury told all potential rescuers that up to £40bn of new Government-backed bonds to be issued by the Rock would have to be repaid in between one and three years.

In order to do that, any rescuer - including Virgin - would have to massively shrink the size of Virgin's mortgage book, from more than £100bn to about £60bn.

And if the bank became that much smaller, it would need fewer people to service the mortgages.

In other words, the chancellor has decided that the priority is speedy repayment of all those taxpayer loans, even if it means job losses in Newcastle.

China, Rio and power

Robert Peston | 09:37 UK time, Tuesday, 5 February 2008


Tonight’s decision by BHP on whether to press the go button on a £61bn takeover of Rio Tinto is not just a big event for these two monsters of the mining industry.

It’s also a big “who-runs-the-world?” moment.

This takeover contest may no longer be decided in a conventional way by the shareholders of the two companies and competition regulators in assorted jurisdictions.

The reason is that on Friday the state-owned Chinese mining and metals group, Chinalco, snapped up 8% of Rio through a daring stock-market raid. And it exercises control over 9% of Rio, through a partnership with Alcoa of the US.

This was more than £6bn of Chinese government money saying no to the BHP deal.

It was the most aggressive intervention in a Western commercial deal ever made by the Chinese.

And it demonstrates a remarkable new confidence – almost a swagger – on the part of the Chinese authorities in throwing their vast capital resources around.

They don’t like the BHP takeover idea for a simple reason.

The Chinese fear that a combined BHP/Rio could have excessive control over the price and supply of the raw materials, such as iron ore, that feed the great Chinese manufacturing machine.

According to a banker close to Chinese ministers, BHP has done too little to allay their concerns.

Now the Chinese have not bought enough shares in Rio to totally stymie a deal – though their stake would allow Chinalco and Alcoa to prevent Rio and BHP being integrated in a way that would maximise returns to BHP.

That said, Chinalco may buy more Rio stock.

So what will BHP announce when the Australian stock market opens tonight?

Well, it would look a little foolish if it walked away with its tail between its legs, having stalked Rio for months.

But, perhaps more importantly, its negotiating position with its important Chinese customers would be enfeebled if it scurried off in the face of the Chinese state pressure.

It’s a high-stakes choice for the company, and also for all Western commercial interests.

And don’t expect this to be the last or biggest investment by the Chinese in a British business.

The message that the Chinese took from Gordon Brown’s recent trip to China is that most UK companies are in the shop window – and so long as the Chinese pay the proper price for them, they can have them.

Olivant out of the race

Robert Peston | 17:06 UK time, Monday, 4 February 2008


Olivant says it pulled out of the contest to rescue Northern Rock because the Treasury demanded that a rehabilitated Northern Rock should be able to do without all those tens of billions of pounds in taxpayer guarantees for new bonds within three years.

The financial group – which is led by the former chief executive of Abbey National, Luqman Arnold - could not see how it could make a decent profit on those terms.

However a Rock management team and a consortium led by Virgin are still in the game.

They believe they can do without the taxpayer crutch on that timescale.

But the Treasury's hardball tactics will have serious consequences for the bank and for the mortgage market.

According to the Rock's calculations, it can only do without government support in three years or so if the business shrinks in size by almost half.

That will have two consequences.

It means the Rock would employ fewer people.

And it would also mean that the Rock would no longer offer competitive rates for mortgages – the bank would encourage borrowers to switch their mortgages to other providers.

At a time when the cost of credit is going up for all of us anyway, the de facto withdrawal of the Rock as a major competitive force in the mortgage market would represent yet more bad news for homeowners.

UPDATE 19:15 I am puzzled by Olivant's decision to withdraw, since it told me and the troubled bank only yesterday that it was planning to submit a proposal. Also Olivant has known for days that the Treasury was minded to ask for the withdrawal of the guarantee within three years, the Treasury having been convinced by the Northern Rock management team that this is do-able. All a bit odd.

Rock: the leak is staunched

Robert Peston | 07:55 UK time, Monday, 4 February 2008


At last some goodish news for the Rock.

For the first time since it went cap in hand to the Bank of England in September, it has stopped leaking retail deposits.

Northern Rock signIn the past week or so it has actually added between £100m and £150m of new deposits.

Some savers, at least, now seem persuaded Northern Rock has a future.

However this recovery is a bit of a double-edged sword.

Although it provides a more benign background for the complicated auction being run by the Treasury to choose a rescuer for Northern Rock, it will put the Rock’s competitors on amber alert.

They are already concerned at the Government’s promise to provide five-years of financial support to the troubled bank by guaranteeing up to £40bn of bonds to be issued by it.

These competitor banks will now be doubly keen to scrutinise whatever rescue package is eventually agreed, to verify that it does not include what they would see as unfair state aid – and they’ve told me they would have no hesitation complaining to the European Commission if they felt disadvantaged by the terms of the Government’s long-term financial support for the Rock.

On today’s D-Day for rescue plans to be submitted to the Treasury, three will be put forward.

There will be a rehabilitation proposal from a consortium led by Sir Richard Branson’s Virgin, one from Olivant, the financial group, and one from a management team at Northern Rock itself.

These will then be evaluated by the Treasury, the Financial Services Authority, the Bank of England and the non-executive directors of the troubled bank itself.

It is impossible to be certain which if any of these will emerge victorious. Not even the Treasury has sufficient information to make that judgement – although some of the bank’s shareholders believe and hope that Olivant has a slight edge over the others.

The final decision on whether to accept any of the proposals, or whether to opt instead for nationalisation, will be made by the Chancellor.

Alistair DarlingAlistair Darling has wrested control of the decision process from the company’s board because he has provided £55bn of financial support to the Rock in the form of direct loans and guarantees to other lenders.

So more than anything else, Alistair Darling will be assessing the proposals to determine which offers the greatest certainty that taxpayers can be repaid in full and without excessive delay.

In order to do that, he needs to be confident of the robustness of the respective groups’ plans to run the bank.

He too needs to be confident that none of the proposals will fall foul of European Union prohibitions on the provision of state aid.

That means each of the potential rescuers will need to be seen to be paying a commercial price for the financial help the Government will continue to provide to the Rock for years to come.

Negotiations with the potential rescuers are likely to be complex and long.

According to officials, they will continue for a good couple of weeks, perhaps till the end of February.

The Treasury has already announced that up to £40bn of taxpayers’ support for the Rock will be converted into bonds backed by the Rock’s mortgages, whose ultimate repayment will be guaranteed by the Government.

This is the equivalent of the Government providing a five year loan to the Rock.

The Chancellor is likely to look favourably on proposals to reduce the extent of the bond guarantee as quickly as possible.

It is understood that Virgin will offer to dispense with the guarantee after three years.

In the Treasury’s eyes, that may give it an edge over the other two possible rescuers.

However they are offering more to shareholders – and shareholders would be furious with the Chancellor if he opted for a plan that offered them least.

Virgin is also offering to put more new equity into the group than the other rescuers, which would provide a greater cushion for taxpayers in the event that the Rock suffered big losses in the future.

Sir Richard Branson’s group would inject around £1bn in cash of new equity, compared to about £800m from Olivant, and between £500m and £750m from the management group.

The management group, led by the former Merrill Lynch MD Paul Thompson, has yet to raise all of its equity, but thinks it would be able to do so.

All three plans are predicated on shrinking the business. The proposal from the management group would lead to the most draconian cuts, with the Rock’s assets being reduced from £100bn to between £50bn and £60bn – partly by transferring mortgages to a so-called special purpose vehicle created to hold the assets that will back the Government-insured bonds.

Yahoo hullabaloo

Robert Peston | 16:45 UK time, Friday, 1 February 2008


The hoots of joy from deal-starved Wall Street could be heard all over New York this morning.

I'm filming a BBC Two documentary here about the causes and aftermath of the credit crunch.

microhoo.jpgAnd the absurd euphoria generated by Microsoft's tilt at Yahoo was not a healthy sign. It sounded to me like a mob of desperate bankers and investors frantically clutching at lifebelts made of straw.

The fact is it's only one deal.

It would be big, though hardly mega.

And Microsoft is one of the few companies on the planet that generates so much cash that it's wholly insulated from the drought in money markets

In other words, it would be silly to extrapolate from this deal anything terribly positive about improvements in business confidence or the possibility that more takeovers are on the way.

The only deals in town - bar this Yahoo one - involve commodity companies like Rio, near-bankrupt banks or insurers and the moneybags state investment arms of Asian or Middle Eastern economies.

And that is not going to change in a hurry.

As the latest US job creation figures confirm, the momentum behind the deceleration in the world's biggest economy is worryingly strong.

The Microsoft bear hug on Yahoo is a model of predatory opportunism.

Yahoo's latest results were seen by many of its shareholders as confirmation that as an independent business it is a wasting asset.

But, in seeming contradiction to that view, it has also become fashionable to suggest that Google's days of total invincibility and dominance of the search business may be drawing to a close

Google's last set of figures were only good by the standards of mortal businesses, rather than superlative.

So the Microsoft message is that Yahoo crunched together with its MSN might just capture some market share.

But, to quote the management consultant's cliche, if the deal happens its success or failure will all be in the execution.

As for Google, it will probably see the deal as an example of what I think of as being a Buffettism, namely that putting together two bad businesses usually creates one very big bad business.

I would verify that I have just re-purposed an Omaha aphorism, but am powerless to do so because my clunking BlackBerry won't let me access Google.

Which tells me that when it comes to the search business, Google is more than just the market leader. It defines its industry in a way that will be hard to break, even for a Yahoo fuelled by Microsoft's knowhow and rivers of cash.

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