Arnold leads bidders looking to rival Virgin in battle for Northern Rock

Sir Richard Branson's proposed bid for Northern Rock faces a challenge from Luqman Arnold, the former boss of Abbey National, after the mortgage bank and the Government indicated they were open to other offers.

Sir Richard's Virgin Money consortium appeared to be in pole position to take over the stricken mortgage bank yesterday after Northern Rock said it would open its books to Virgin with a view to announcing an agreed offer by the end of the year.

But Mr Arnold and colleagues from his Olivant private equity firm were in discussions last night with the tripartite authorities – the Treasury, the Bank of England and the Financial Services Authority – pressing the case for his proposal, which is backed by some of the bank's biggest shareholders.

Olivant has been told that the bank financing that Virgin would use to repay £11bn to the Bank of England would also be made available if its proposal was accepted. Potential bidders insisted the race to buy Northern Rock had some way to go yet.

The American private equity company JC Flowers is not rushing to revise its proposal but is understood to believe it will remain part of the bidding process. Cerberus, the US hedge fund, also shows no intention of taking its proposal off the table.

Bryan Sanderson, Northern Rock's chairman, defended the Virgin deal, saying it gave something to all stakeholders. But he said the board was prepared to listen to other approaches.

"We are entering in good faith. We will give him [Sir Richard] priority in the next two or three weeks but if somebody comes in with a much better offer the board would consider it."

Mr Sanderson stressed that an offer would have to be substantial and workable and "not just a number". He said Virgin's proposal "covered all the angles" and that there was something in it for all concerned.

In a letter to the Treasury Select Committee, Alistair Darling, the Chancellor, said: "Until the transaction is formalised, the Government continues to keep all options open in relation to the future of Northern Rock."

The Virgin consortium proposes injecting £1.3bn of cash plus the Virgin Money business – which it values at £250m – into Northern Rock. Half the cash would be supplied by the consortium and half would come from a rights issue to existing investors at 25p per ordinary share.

The consortium would be left with up to 55 per cent of Northern Rock, which would keep its stock market listing. Critics say shareholders would pay to refinance the business and be left with only 45 per cent of the company. Virgin said the plan was designed so that shareholders could share in the bank's revival.

Virgin would charge Northern Rock for the use of the Virgin brand, as it does with other businesses in which it invests. Sir Richard will receive at least £255m over the next 30 years for licensing the Virgin brand name to NTL after selling Virgin Mob-ile to the company.

Northern Rock's second-biggest shareholder said the deal would short-change investors. Philip Richards, chief executive at RAB Capital, said: "We welcome today's developments as they are a step closer to securing the inherent long-term value in the business for current shareholders.

"However, we do not believe that this proposal reflects the true value of Northern Rock,and we would expect either that this proposal be improved or that alternative proposals be brought forward which would combine a similar repayment schedule for the Treasury together with improved terms for shareholders."

Jayne-Anne Gadhia, the chief executive of Virgin Money, admitted that the deal for shareholders was "the most contentious point" but said she believed the alternative was that they and other stakeholders would be left with nothing. "We are giving shareholders the opportunity to participate in the upside," she said.

Olivant proposes buying about 15 per cent of Northern Rock in a rights issue at a discount to the prevailing share price and installing Mr Arnold as chief executive. It believes Northern Rock needs a maximum of about £600m of extra equity and argues that its proposal would not dilute shareholders' interests to anything like the extent that the Virgin plan would.

Olivant says that it and shareholders would profit if Mr Arnold turned the business round. It also says its idea can be implemented more quickly than Virgin's and that speed is important to salvage Northern Rock.

Virgin would repay £11bn of Northern Rock's debt to the Bank of England upfront and the rest – about another £11bn today – by the end of 2010. Olivant proposes repaying between £10bn and £11bn straight away and settling up with the Bank and the Treasury within about two years.

Northern Rock's shares gyrated wildly yesterday before closing up 28 per cent at 110.1p, about three times the estimated value of Virgin's offer to shareholders.

Analysts put the fluctuations down to short sellers buying the shares to cover their positions. There was also speculation that hedge fund investors might be building positions that would give them more power to impose their will on the board.