Tuesday, 24 July 2012

Northern Shock

* "sell-off nets extra £538m for taxpayers" - I saw this headline in an article on the sale of Northern Rock and thought cool.  

It stems from Virgin buying a further £465m of Northern Rock's mortgage assets and agreeing to pay an extra £73m in cash for the bit it’d already bought for £747m. Which is lovely and straightforward; 465+73=538. That plus 747 gives £1,285m doesn’t it? Except “UKFI has estimated that the government could ultimately receive more than £1bn” vs the original £1.4bn invested in it by government on the taxpayer’s behalf. 

This left me confused, like where’s the extra £285m gone then? Best to head over to the National Audit Office (NAO) report on all this and see what its saying. 

Ahhhhh, I see. The main NAO focus was on whether the Virgin deal represented value for money for the taxpayer, what with Northern Rock having been split into a good bank and a bad bank (the good bank being the bit Virgin bought). And aye weren’t there suspicions (and chat) at the time that it got a bargain what with it getting “Customer accounts of £21 billion matched by £10 billion higher-quality mortgages and £11 billion cash” for £747m?

Well the NAO think the Virgin deal was good value because Virgin paid 80-90% of the good bank’s book value at a time when the market prices for major UK banks was around 50 per cent of book value. Crikey, that does sound good.

Its just, its just …… the Northern Rock bit that got sold was in no shape or form comparable to a major UK bank; its an apple and they’re all oranges give or take the odd lemon. Like (1) It has a “clean” mortgage book made up only of the good stuff i.e. it involves a lower risk of future losses than the mortgage portfolios of any other major bank (2) It’s a purely retail i.e. mortgage bank, so is and is likely to remain far safer  than any of the universal portfolios major UK banks actually have i.e. there’s none of the corporate, by which I mean the leveraged finance and commercial property, dreck that have been and remain the primary drivers of UK bank losses. And (3) its no exposure to the Eurozone with all the risks (and associated losses) that entails. So too bloomin’ right it should have been sold at a significant premium to other major UK banks.

The other thing is the reference to the sale transferring billions and billions of cash. I’m not sure what that actually means like did Virgin pay £747m for £11bn in cash? If so I’d like some of that sweet, sweet action. Alternatively, it means that when it was sold Northern Rock had an incredibly liquid i.e. strong, balance sheet. Hence, this alternative report on the sale states Virgin got a “£14bn mortgage book” and “a £16bn retail deposit book”, which is a loan to deposit ratio of 88%. Crikey! That's low and again emphasises how the sale involved assets in no way comparable to other major UK banks.

And remember Northern Rock failed because it was overly, like MAD overly reliant on wholesale funding and had a loan to deposit ratio of something like I don’t know 20p in customer deposits for every £1 lent as opposed to the good bank’s eventual 16p for every 14p lent. So Virgin need only make modest tweaks to its new bank’s funding profile, shifting assets from no/low return highly liquid things into some-return less liquid things and it’ll increase its profitability in an instant. Hmmmm............

Then there’s the bad bank we’re still left with and its £54bn of mortgages that are being gradually wound down. This bad bank is so bad it made total profits before tax of £1bn in 2010 and 2011! And the increase in the return on the sale of Northern Rock stems primarily from the additional £465m in (profitable) mortgages sold to Virgin i.e. its not really that what Virgin paid for the good bank has increased, rather its paid out more for additiona assets that appear to be rather profitable. It’d also be interesting to know if Virgin buying these assets affects its loan to deposit ratio. It’d also be interesting to know if the plan here is to sell off more of the bad bank to Virgin in due course.

All this makes me wonder given it sets a precedent for the handling of the taxpayer’s remaining and far larger bank investments. Like based on the Northern Rock experience:

1)       Government appears willing to sell early at a chunky loss
2)       NAO assessments involve some seriously spurious bollocks
3)       Sod it, why wasn’t it held on to for a good few years more until market conditions for a sale had improved with more money repaid in the meantime and the EU told, in a French accent, to stick their December 2013 deadline somewhere Greek
4)       The reporting of this is pants, being either inconsistent, incoherent or both; like where’s this extra £285m gone then and can a distinction between the sale price and any cash generated via subsequent (and additional) asset sales no be made?

* apologies for the obligatory Northern Rock bank run piccie

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