Potential bidders for Northern Rock are scrambling to revise their proposals after the Government unveiled a string of conditions for it to guarantee a massive bond sale to fund a private sector deal.
As well as having first priority over the assets used to back the bonds, the Treasury would insist on an extra buffer of about £5bn of Northern Rock assets that would be ringfenced to absorb losses if bad debts were to rise on the loans.
The Treasury's plan, devised by Goldman Sachs, would see Northern Rock repay its £24bn debt to the Bank of England by selling loans – or assets in banking speak – to a financing vehicle which would issue bonds backed by the assets. The vehicle would pay Northern Rock the proceeds from the bond issue and Northern Rock would use that money to repay the Bank of England.
To make the bonds attractive to investors, they would have a Government guarantee, ranking them alongside Government sec-urities in terms of safety. Virgin, Olivant and Northern Rock's board remain the three main options for the Treasury, which has taken control of the bidding process. With a deadline of 4 February, the chances of additional suitors coming in look slim.
JC Flowers has turned its attention to Friends Provident and had balked at giving shareholders more than a cursory payment for their stock. Lloyds TSB, which considered buying Northern Rock in September, has indicated a number of times that it believes the bank is in a far worse state than when it weighed up a bid.
Sir Richard Branson's Virgin Money consortium remains the front-runner but he faces opposition from Luqman Arnold's Olivant investment firm and a proposal being put together by Northern Rock's board. The board is said to be increasingly confident it can put together a proposal to ret-ain control of the bank with the Government's backing.
Northern Rock shares leapt 46 per cent to 94.25p yesterday on hopes that investors could gain from a revival of the stricken bank.
Virgin has the advantage of proposing the biggest equity injection into the business through a £1.3bn issue of shares. Sir Richard's proposal proved unpopular with Northern Rock's shareholders because, for Virgin to get its desired 54 per cent stake, it would have diluted their holdings.
Shareholder approval will still be needed for a deal to go through and Virgin was reported to be considering reducing its intended stake to 45 per cent. But that now looks too hopeful after the Government demanded that the taxpayer should also gain from a revival of the bank. The Treasury's stake in a recovery could be through a straight share in the equity or warrants that act like share options.
Sir Richard said he would look at building a Government stake in the bank into his plans but said there was "not much room" for sweetening his bid. However, the cheaper borrowing allowed by the Government's guarantee could give bidders scope to improve their offers.
Olivant proposes a smaller £800m equity injection and has already offered the Government a 5 per cent interest in a revived Northern Rock. Shareholders such as RAB Capital and SRM Global have favoured Olivant so far.