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Treasury Rock Losses

• Robert Peston
• 11 Jan 08, 09:14 AM

At last a bit of good news for Northern Rock and the taxpayer.

It has sold a chunk of assets – some equity release mortgages – and will repay a bit more than £2bn of the £26bn lent by all of us to the troubled bank.

So our overall exposure to the Rock, including guarantees for other lenders, comes down from £57bn to £55bn.

Which may not be huge progress, but at least the trend is in the right direction.

And, what is perhaps more important in a symbolic sense, the Rock does not appear to have received a fire-sale price. It is receiving a 2.25% premium to book value from Tony Blair’s new employer, JP Morgan.

What of the chancellor’s hopes – which he reiterated yesterday to the Treasury Select Committee – that we as taxpayers will ultimately get all our £55bn back?

Well, I can reveal that the Treasury has already incurred a notional loss on one element of its exposure.

You may remember that back on November 19, I pointed out that the so-called “premium” on the interest payable to taxpayers by the Rock is being rolled up into subordinated term debt rather than being paid in cash.

John Kingman, the Treasury official in charge of steering the government through the Rock crisis, told the Treasury Select Committee yesterday that the Treasury’s holding of this subordinated debt is less than £100m so far – though the holding is increasing all the time at a rate of about £6m every week.

Here’s the thing.

The Rock had already issued about £750m of this subordinated debt to investors. And the current market price of that “lower tier 2 subordinated debt” is 65p in the pound.

Which implies that the Treasury is incurring a 35p loss on every pound of subordinated debt it receives from the Rock.

If the Treasury’s holding is around £100m, which is what Kingman implies, the loss to date would be £35m – hardly calamitous, but the price of a school or two.

By the way, with this subordinated debt trading at substantially less than par, the Rock’s shares should in theory be worth zilch – since shareholders are last in the queue in any wind-up of a business.

But what strikes me about the pricing of the subordinated debt is that if the government were to nationalise this bank, there would be a most compelling punch-up between the hedge funds who hold the bank’s shares and those who hold its debt – with each claiming the moral high ground and first right to any spoils.

Other gloomy news this morning is the disclosure of a £100m deficit in the Northern Rock pension scheme – which is a worry for current and future Rock pensioners and is one more liability for any potential rescuer of the troubled bank.

I also have a bit more detail to add to what I wrote yesterday on Goldman’s scheme to convert between £12bn and £15bn of the taxpayer Rock loans into triple-A rated bonds for sale to international investors.

In an attempt to reduce what would be colossal fees of £250m payable to the underwriters and arrangers, the Bank of England’s own name would go on the deal as one of the lead managers – along with Goldman, Citigroup and Merrill Lynch.

And to achieve that all-important triple-A rating which would make the bonds sellable, Goldman has been talking to AIG – the huge US insurer – as well Buffett (whom I mentioned yesterday).

Goldman’s hope has been that one or both of them would share the liability of guaranteeing or “wrapping” the bonds, to reduce the exposure of the government and all of us as taxpayers.

The deal hinges on two considerations. Will Brussels allow it, or will the Eurocrats rule that the deal falls foul of rules prohibiting state aid to the private sector? And would it be prohibitively expensive for the Rock?

Those are substantial hurdles to surmount.

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