The UK Northern Rock was effectively nationalised in 2008 following its collapse as a viable, ‘going concern’ bank. Up to 2008, Northern Rock (a small bank with only 75 branches) had relied heavily for its funding on wholesale (big) deposits from the money market – this is a bank funding technique called ‘liability management’, where banks rely heavily on ‘borrowed funds’ to meet their liquidity needs. When this kind of bank liquidity dried up in the crash as markets imploded, Northern Rock was left ‘high and dry’.
In many respects, Northern Rock epitomised the growing risk appetite and ‘boom and bust’ character of much pre-crisis banking. A UK retail bank experiencing a Northern Rock-type run on it by its own depositors was virtually unthinkable up to 2008. It was these kinds of events that prompted the new UK and Basel 3 international bank regulations that give liquidity at least an equal weighting with capital as a key bank resource needed to withstand possible future stresses.
In January 2010 the UK Government split Northern Rock into two parts – a ‘good’ bank (comprising £17bn of customer deposits and a £12.5bn portfolio of conservative mortgages) and a ‘bad’ bank. It is the ‘good’ bank that is now being sold back into the private sector to Sir Richard Branson’s Virgin Money (which first tried to buy Northern Rock in 2007). It will be rebranded ‘Virgin’. The cost of the deal to Virgin Money is £747m, which could rise to £1bn.
It cost £1.4bn of taxpayers money to bail out Northern Rock. This Virgin deal represents a loss of around £400m for UK taxpayers. However, Northern Rock’s chairman (Ron Sandler) at least is apparently confident that taxpayers will eventually get back all of their money.
The US financier Wilbur Ross (Chairman and CEO of WL Ross and Co and a former Rothschild banker) is the financial and investment banking ‘brains’ behind the deal. Mr Ross put up most of the cash (close to £260m) against £50m supplied by Mr Branson (and another £50mn from the Abu Dhabi sovereign wealth fund, Stanhope Investments). Mr Ross is expected to end up owning 44% of the combined Virgin Money (alongside the 46% stake of Virgin Group).
Mr Ross also injected recently an estimated £257m in the recapitalising of the Bank of Ireland within a private-sector initiative. The Northern Rock and Bank of Ireland investments follow several recent deals that bought into crisis-hit US lenders. The latter were mainly regional banks that had a strong retail customer base. For Mr Ross, the ‘turnaround king’, banking is an especially attractive sector at this time.
Around one-third of the cash needed to fund the deal by Virgin will come from Northern Rock’s own balance sheet. Approximately £250m of ‘excess capital’ will be released from Northern Rock’s resources on completion of the deal (in the New Year). The bank was heavily over-capitalised by the UK government in order to make sure it would make no further calls on taxpayers. An additional £150m could also be released from Virgin Money’s balance sheet via a deal that has yet to be agreed by the FSA (Financial Services Authority).
Richard Branson describes this Northern Rock deal as ‘classic Virgin’. He argues that the banking industry needs new ideas and greater competition. He adds ‘Virgin has a history of entering new sectors to improve service and provide value for customers. We plan to do the same in banking’.
Mr Osborne (the UK Chancellor of the Exchequer) insists that this is the best deal for the country and that the increased Virgin presence will stimulate greater competition in the banking sector. He added ‘It represents a significant step in returning public sector stakes in banking to the private sector’. The new Virgin Money is expected to be profitable by 2013.
Getting out of the other part-nationalised UK banks, Royal Bank of Scotland (RBS) and Lloyds, will be a much tougher challenge for the UK government. These banks are on an altogether different scale than Northern Rock. It has been pointed out in this connection that the UK Government is currently holding a paper loss in excess of £40bn on its RBS and Lloyd holdings. To put this into context it is around £12bn more than Britain’s defence budget (still one of the biggest in the world)!
The Northern Rock sale, though, does emphasise the strong UK (and US) commitment to private enterprise in banking. The financial crisis found several key aspects of this ‘ free market ‘ model badly wanting and in need of urgent overhaul – this needed overhaul is still ‘work in progress’ and far from complete. But the free market model is still apparently the ‘best game in town’ for the efficient allocation of resources and helping to stimulate economic development and growth. Given the scale and severity of the crash, the continued global commitment to this model is impressive.
The challenge now must be to ensure that the required banking and financial market lessons have been learnt from the financial crisis. It remains to be seen what ‘classic virgin’ can do to the Rock.
Professor Ted Gardener