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Rock undermined by markets

• Robert Peston
• 4 Dec 07, 07:32 AM

There could not be a worse moment to sell and refinance its balance sheet.

The interest rates charged by banks and financial institutions for lending to each other – the now-famous – are soaring.

So bin the idea that the taxpayer-backed loan provided by the to the Rock is at some premium or penalty rate.

In current market conditions, the 7 per cent interest on it represents a remarkable bargain.

And don’t forget that, as I disclosed last month, only 5.75 percentage points of that is payable in cash.

The rest is rolled up and converted into subordinated debt, held by the .

Now the cash interest rate for strong banks that want to borrow from other banks for just a month soared yesterday to more than 6.7 per cent.

And the three-month bank-to-bank rate (as calculated by the ) increased to 6.62 per cent.

Those are the rates available to top-notch institutions: the Rock would have to pay more.

So what is the market price for a jumbo loan backed by the kind of mortgage-collateral which the Rock can provide?

Well , the medium size mortgage bank, has just borrowed £4bn for just two years from banks led by .

I am told that A&L is paying materially more than 7 per cent per annum in interest, if upfront fees are included in that rate (though bankers are refusing to confirm the rate, citing commercial confidentiality).

This matters, because all the possible rescue deals mooted for Northern Rock involve borrowing from banks to pay back a portion of the £25bn which taxpayers have lent to the Rock.

The , for example, says if it owned the Rock, it would raise £11bn; JC Flowers, the private equity house, would borrow £15bn if it owned the Rock.

If debt on that scale can be obtained in current tight market conditions – and that is by no means a certainty – they would kill the Rock’s profit margin.

There are four other possible rescuers: , , the Tyne Consortium (led by ) and (which would take only a minority stake in the business).

However none of them are in any better position than Virgin or Flowers to find a loan for the Rock at anything other than crippling interest rates.

In theory that should not bother the Treasury, so long as it gets some taxpayers’ money back now and all of it in a few years.

But here’s the thing: market mayhem is wreaking havoc with an element of any rescue package that is essential for the Treasury.

Under EU rules on state aid, the Bank of England’s loans to the Northern Rock can only be continued after February if they can be deemed to be on commercial terms.

And the easiest way to prove that they are on commercial terms would be for the Rock – if controlled by Virgin – to borrow its £11bn from banks, and reconstruct the residual £14bn or £15bn of taxpayer loans so that they are on identical terms to the bank loans.

This means that the collateral underpinning the bank loans and the taxpayer loans would have to be identical: the banks lending to the Rock could not cherry pick the best and soundest Rock mortgages as their security.

That seemed achievable only ten days ago.

Not any more, I am told.

Banks lending to the Rock want its best assets as collateral – which would leave the taxpayer in a weakened position in respect of its remaining loans.

Here’s the big problem for the Chancellor, Alistair Darling, and the Treasury.

A deal that handed all the best assets to the lending banks might not just be illegal under EU rules, it might also undermine Darling’s determination to ensure taxpayers don’t suffer any losses on their loans to the Rock.

On any scenario, the taxpayer will continue to have massive exposure to the Rock for two to three years.

And plainly the risk of losses on a residual £14bn or £15bn would be higher, if that loan were backed by less attractive assets.

All of which is to explain why the Treasury has retained the option of nationalising the Rock.

Nationalisation is not the Treasury’s preferred option.

No Chancellor in his right mind would choose to become the de facto chief executive of a commercial mortgage bank.

But the commercial solutions on offer may not work.

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