December 19, 2007 | posted by Michael Baxter in Northern Rock |

Here is a good tip for a share. You know that banks are not doing all that well at the moment. Well, here is a bank which is trading normally, has access to funding and is currently a net provider of liquidity to the inter-bank market. So that sounds good so far. But there’s more. “If we were to consider (this company) as a closed book in run-off with a half-life of three years on its mortgage book/asset portfolio, this would suggest a fair present value of 872p on the stock, a 27 per cent premium to the current share price.” In other words even if this bank was closed down and assets sold off, it would have a value greater than the current market valuation. And finally one more piece of exciting news: “unlike US mortgage players where there remain doubts as to the book value from… revaluation of the sub-prime portfolios, (the bank) is a prime lender with negligible intangible assets.” We don’t normally do tips, but this particular tip is so good we thought we would make you aware of it. The tip comes from a good source too: Merrill Lynch.

Here’s an apology. We have just spotted the tip above relates to a document published on August 16. Sorry about that. Still, it may be worth taking a look at the share price then and see how it compares with the price today. Back then shares were trading at 687.5p, and the share price today is, that’s strange, this can’t be right, 86.90p. This sounds too good to be true, this must be an obvious buy.

No doubt you have guessed the snag with this tip by now. The company concerned is Northern Rock.

Once again the bank is in the news. Now the Treasury is not only guaranteeing your money if you are what’s known as a retail customer of the bank, but if you are a commercial lender, a bank perhaps, or a hedge fund, and you provide funding via the wholesale market, your money is safe too. That doesn’t mean the bank has all its liabilities 100 per cent guaranteed. Northern Rock has this scheme called the Granite programme. This is a horrendously complex scheme designed to facilitate the sale of Northern Rock loans over the money markets. This scheme has around £50 billion tied up, and if that was to fold, then the Treasury would not be required to stump up any money.

But the point is that the failure of the Granite programme is highly unlikely. Even so, total government exposure to Northern Rock is now running at around £57 billion. Across the land, newspapers have been busy with their calculators and it’s been worked out that each and every taxpayer now has £1,800 worth of exposure to the bank.

It makes a good headline of course and last night’s TV news bulletins were full of talk about our exposure. But it’s a completely misleading figure. If Northern Rock were to go bust, and the government lost all its money (not something which is likely this side of Armageddon), we would NOT all have to suddenly cough up the money, with, say, a one-off tax bill.

Some have looked at what the money could be spent on if it were used elsewhere, but these calculations show a complete ignorance of how the economy works. The money being used to bail out Northern Rock does not come from our taxes, it is not spent at the expense of beds in hospitals. Central banks have the ability to create credit. Left unencumbered, this will lead to inflation, but in a situation in which a crisis is caused by lack of credit, the creation of credit (which, by the way, has to be repaid) is not necessarily inflationary at all.

It would seem that Northern Rock’s assets are still worth more, far more than the amount of money the UK government is exposed to. Over time, the entire mortgage book of Northern Rock could be converted to cash. Remember, mortgages are repaid eventually and these days, more often than not, borrowers change their mortgages more than once. If Northern Rock was to stop trading, and just wait for the mortgages on its books to be repaid, it seems likely the government would not only get its money back, but there would be some dosh left over too.

Governments don’t tend to make good managers of banks. What Northern Rock needs is a good management team, they say, and that way shareholders’ interests will be best served, and jobs saved.

But, surely even a government can run a bank which is just, simply, gradually selling off its assets over time.

It is time the government put the needs of its shareholders first: that’s us. We have all bailed out the bank, and yet shareholders in the bank have been objecting to some of the plans put forward to buy it. How dare they do this! By any normal consideration, shareholders in Northern Rock lost their rights to have a say over the matter when the bank was saved from bankruptcy by the government. By any normal consideration, Northern Rock now belongs to us.

Yesterday, even Mervyn King seemed to side with that view when he said, “Reaching a reorganisation of Northern Rock is made much more difficult by the fact that the shareholders can block a sensible discussion.”

Nationalising Northern Rock and then running it down will be unpopular in the North East, where jobs are at stake and where many shareholders who acquired their stake when the bank was formed, live. More to the point, the North East is where the current government can count upon lots of votes.

But the original shareholders are on a hiding to nothing as it is. Both the deals currently on the table involve rights issues and the requirement of existing shareholders to stump up money, or see their stake heavily diluted.