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Olivant out of the race

• Robert Peston
• 4 Feb 08, 05:06 PM

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, - 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.

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Rock: the leak is staunched

• Robert Peston
• 4 Feb 08, 07:55 AM

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.

In 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 , one from , 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 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 , 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.

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