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Northern Rock Takeover
Marks Risky Bet for U.K.
Surprise Move Reveals
Global Crisis' Depth;
Holders Decry Action
By ALISTAIR MACDONALD and CARRICK MOLLENKAMP
February 18, 2008
LONDON -- The U.K. government has decided to take full control of troubled mortgage lender Northern Rock PLC, in a surprise move that reflects the depth of the global credit crisis and represents an embarrassment for Prime Minister Gordon Brown.

After a tense weekend of last-minute negotiations with two bidders -- a consortium led by entrepreneur Richard Branson's Virgin Group Ltd. and Northern Rock's own board -- the government decided that it could best serve the interests of taxpayers and consumers by "temporarily" nationalizing the bank, Chancellor of the Exchequer Alistair Darling told a hastily called news conference yesterday. He said the government would introduce the necessary legislation this morning, and that a new management team led by former Lloyd's insurance market Chief Executive Ron Sandler would assume operational control of the bank immediately.

"I wanted to see a private-sector solution, but it had to be on the right terms," said Mr. Darling. "Governments have to see these things through." He said the bank would continue to operate as usual, making loans and taking deposits, but that its shares would be delisted before trading opened today on the London Stock Exchange.

Taking full responsibility for one of the country's largest mortgage lenders is a politically treacherous move for the government, which has faced strident criticism for its role in the affair since September, when its announcement of an emergency bailout package triggered the U.K.'s first bank run in more than a century. The decision amounts to a bet that it can manage the lender -- which owes the government some £25 billion ($49 billion) -- and then sell it at a better price sometime later, when financial markets improve. Mr. Darling said he still hopes to find a private owner for Northern Rock as soon as possible, though he declined to set any target dates.

"The government took credit for the economy's strength and now its reputation has been damaged by hasty decisions made on the hoof," said Stuart Thomson, a fixed-income fund manager and economist at Resolution Asset Management in Glasgow. Opposition leaders and analysts said the decision to nationalize could be a prelude to a slow winding down of Northern Rock's business, as loans and depositors are gradually paid off.

Mr. Sandler, speaking at the news conference, suggested that some downsizing -- including job cuts -- will be necessary.

The government's inability to find a private-sector buyer for Northern Rock highlights the severity of the global financial crisis, which has slammed banks and made funding for all kinds of private deals difficult to obtain. While Northern Rock is the first bank to be nationalized in the current crisis, many others have had to turn to governments and outside investors for emergency support. The German government, for example, has pledged more than €1 billion ($1.47 billion) to prop up IKB Deutsche Industriebank, which became the first notable European victim of the U.S. subprime-mortgage crisis last summer. Some of the world's largest banks -- including UBS AG, Citigroup Inc. and Merrill Lynch & Co. -- have turned to Asian and Middle Eastern investors for billions of dollars in capital infusions after suffering heavy losses on mortgage investments.

The government's move immediately drew harsh criticism from Northern Rock's shareholders, who had been supporting the bid from the bank's board in the hopes that it would put a better value on their shares. Mr. Darling said the bank's shares will be valued by an independent arbiter, on the basis that the company doesn't have government support. That could leave shareholders with next to nothing.

"It's appalling and very disappointing, and I think the government is in for a load of trouble," said Roger Lawson, communications director at the U.K. Shareholders Association, which represents the interests of about 100,000 individual Northern Rock shareholders. "There will almost certainly be shareholder litigation." Two hedge funds that collectively control nearly 20% of the shares -- SRM Global Fund, a fund of Monaco-based SRM Advisers, and RAB Special Situations, operated by London's RAB Capital PLC -- also had thrown their support behind the management bid. An RAB spokesman declined to comment, while officials at SRM weren't available for comment.

Mr. Branson, the Virgin Group chairman, said he was "very disappointed" by the government's decision to nationalize the bank.

The recent history of nationalizations in the U.K. suggests the experience could be painful for the government. In October 2001, then-Transport Minister Stephen Byers put the operator of the country's rail infrastructure, Railtrack Group PLC, into receivership after years of providing it with state subsidies. Eight months later, Mr. Byers quit his post amid criticism of his management style and shareholder lawsuits demanding compensation. London's High Court rejected the shareholders' demands in October 2005, but the case forced the government to endure years of negative attention.

The main opposition Conservative party immediately denounced the move. "Now the taxpayer will bear the full risk of lending £100 billion of mortgages in an uncertain housing market," said the party's "shadow" chancellor, George Osborne.

Northern Rock first ran into trouble in August of last year, when the short-term lending markets on which it depended for financing froze up amid broader turmoil in credit markets. An attempt to engineer a takeover by U.K. bank Lloyd's TSB failed after the Bank of England refused to provide financing for the deal at a preferential rate. To calm a run on the bank that broke out after the bailout package was announced, the government took the unusual step of guaranteeing all deposits.

The government had been in negotiations with various bidders since last fall, but as the global financial crisis deepened and funding became a problem, the list of viable suitors dwindled to two. A consortium led by Virgin Group and Northern Rock's board had each been in talks with the government about making offers, although discussions had stalled owing to uncertainty over financing.

The government had threatened to nationalize Northern Rock if a private-sector bid failed to meet its requirements, stressing that it would put the interests of taxpayers and consumers over those of the bank's shareholders. It agreed to guarantee new bonds that would be issued by the revamped Northern Rock in order to pay off the government loans, and said it wanted an "appropriate share" of any potential upside equity returns.

Both bidders made last-minute efforts to sweeten their offers late last week, but as of yesterday those offers were still very far from what the government wanted, said people familiar with the situation. Under the Virgin bid, for instance, Northern Rock's total value would need to rise to at least £2.7 billion -- several times its current level -- before the government would reap any financial benefit. The government also felt the management proposal wouldn't raise enough new cash to protect taxpayers -- the bank's largest creditors -- from the risk of losses.

"When we looked at the two proposals that we had from Virgin and from Northern Rock as compared to the option of a temporary period of public ownership, simply, the numbers didn't stack up," Mr. Darling said. "The better deal was for a temporary period of public ownership."

People familiar with the matter said Mr. Darling made his final decision after 2 p.m. local time yesterday, after consulting with Mr. Brown and his advisers at Goldman Sachs. Mr. Branson learned of the decision at 3 p.m., according to a person familiar with the matter.

To oversee Northern Rock, the government has turned to Mr. Sandler, a veteran of London's financial community with experience in putting out financial fires. The former consultant -- he got his start in 1976 with Boston Consulting Group and later worked with Booz, Allen & Hamilton -- helped restructure the Lloyd's of London insurance market in the 1990s after investors were hit with billions of pounds in losses, the result of natural disasters and asbestos and pollution liabilities. In 1999, banking company National Westminster PLC hired him to lead a defense against a hostile takeover bid from Bank of Scotland PLC. Royal Bank of Scotland Group PLC ultimately ended up buying the bank.

At yesterday's news conference, Mr. Sandler said he planned to arrive at Northern Rock's office in Newcastle today. He surfaced as a potential head of a nationalized Northern Rock in mid-January, an early signal that the government saw the institutional takeover as a possibility.

--Margot Patrick, Anousha Sakoui, Rod Stone and Laurence Norman in London and Joellen Perry in Frankfurt contributed to this article.

Write to Alistair MacDonald at alistair.macdonald@wsj.com and Carrick Mollenkamp at carrick.mollenkamp@wsj.com

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