Sandler faces Northern Rock funding quandary

The nationalisation of Northern Rock will not include the £50bn off-balance sheet vehicle called Granite which funds half of the Newcastle-based lender's mortgages.

The latest news and analysis from the banking and financial services sectorIf Granite were to go under, the state-owned Northern Rock would be at the bottom of the queue of creditors, meaning taxpayers could face a £5.5bn loss. The Government yesterday confirmed that Granite, which is a Jersey-based trust, would not be covered by the nationalisation legislation.

Mr Sandler could decide to liquidate Granite, which funds half of Northern Rock's mortgages
The Conservatives warned the revelation meant the move was risky for the taxpayer.
Northern Rock set up Granite to fund about half its mortgage book. It owns an 11.5pc stake worth about £5.5bn.

As the bank is set to pass into public hands as early as Friday, that liability will pass to the taxpayer, the Conservatives pointed out.

Granite is unlikely to collapse but its existence puts Northern Rock's incoming executive chairman, Ron Sandler, in a difficult position. He has to strike a balance between shrinking the bank fast so assets can be freed up to repay the Government's £25bn loan, and keeping Granite funded.

Investors in Granite have bought bonds which mature at certain points and are invested in mortgage assets.

Mortgages which get paid off or moved to a rival company have to be replaced in a process known as "feeding the beast". Granite's bonds range in quality from triple A through to below B, but most of the vehicle is invested in high quality mortgages.

Therefore, as mortgages in Granite are paid off, Northern Rock must either replace them with the good mortgages from the rest of its portfolio, or go out into the market to win new customers with a low risk profile.

Alternatively, Mr Sandler could decide to liquidate Granite. Sandy Chen, an analyst at Panmure, said the move might make sense. "It would shrink the size of the book and if you are bearish about the UK mortgage market, it might make sense to sell now rather than later." Liquidation would only work if Northern Rock thought it could make enough money to repay all the bondholders and cover its own shareholding.

Separately, Northern Rock will scrap its Together mortgage, the 125pc loan it used to ramp-up its new lending in 2006 and the first half of 2007.

Meanwhile, Northern Rock has yet to publish its 2007 results.
The bank had said they would be published by the end of March, but it is now unclear whether, as a nationalised entity, it will have to unveil its performance during the crisis period of the past six months.

By Katherine Griffiths, Financial Services EditorLast Updated: 1:05am GMT 21/02/2008Telegraph telegraph.co.uk

The Jersey Enron!