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News arrived this week of one last shot at a private sector solution for Northern Rock. But whatever happens, private deal or nationalisation, the Rock’s investors will recoup something. Simon Keane listens in as shareholders find their voice

Michael Doherty, former Northern Rock (NRK) employee and shareholder, is clear in his own mind who is responsible for the Newcastle-based bank’s current situation: ‘The failure has got to be pointed directly at the Bank of England,’ he claims.

The 71-year-old, who holds a modest 1,000 shares, does not buy the argument Northern Rock’s troubles were its own making. Its collapse was not the result of a fundamental weakness in the business model, but the fault of Bank of England governor Mervyn King for sparking a run.

It may seem like wishful thinking that, had King decided not to publicise its emergency loan to Northern Rock, the mortgage lender wouldn’t be where it is today. But Michael was expressing a growing opinion. It seemed the debate as to whether Northern Rock shareholders had any rights had reached an breaking point.

The former development manager from Northumberland was speaking outside Newcastle’s Metro Radio Arena where he had just attended an emergency meeting of the stricken bank. Last week’s gathering was called by hedge fund groups RAB Capital and SRM in an attempt to get extra shareholder protections written into the bank’s articles of association which govern how the board acts.

Addressing the 600-strong audience of private shareholders, RAB chief executive Philip Richards (above) explained why investors had a ‘moral case’ for their interests be taken into account. The attempt to chance the articles – which as it happens failed – was driven by RAB and SRM’s fear that the board wouldn’t properly defend their interests against competing stakeholders, most notably the British taxpayer, with whose financial support Northern Rock is currently being kept afloat.

Named and shamed

In the run up to the meeting, shareholders had been given short shrift by national newspaper commentators – they had no right to expect anything, the press screamed. Shareholders took a risk, they lost. The Northern Rock business model was a flawed one (lending too aggressively by borrowing short on the money markets) and had it not been for taxpayers’ support, in the form of £26 billion in emergency loans from the Bank of England and, we are told, another £25 billion in Treasury guarantees to Northern Rock’s lenders, the interests of investors would have been completely wiped out.

There are of course elements of truth in this argument from which the logical conclusion, in many peoples’ minds, is to immediately nationalise Northern Rock in order to secure taxpayers’ money. This view is most notably advocated by Liberal Democrat shadow chancellor Vince Cable. But it is being argued, correctly or not, that Northern Rock’s collapse was not purely the fault of the clearly aggressive business model. Amid all the noise, this argument was not being heard, that was until last week. Since then, of course, the ground has shifted again. On Monday (21 January) the government announced it wanted the private bidders to reformulate their proposals by 4 February in light of a funding package devised by its financial adviser Goldman Sachs. This gives new hope to the Virgin and Olivant bids, a stand-alone solution, whereby the current board would continue to run the bank, and reportedly re-opens the door to US private equity company JC Flowers. But what is clear is that, as this process takes on a new tack, the interests of shareholders are being given greater weight.

Both Richards and Jon Wood, the former UBS trader and founder of SRM, say the Bank of England has to take the blame for the mess Northern Rock finds itself in.

‘A number of commentators say there is a moral case [for nationalisation] we disagree with that,’ said Richards. ‘It is the role of central banks to be a lender of last resort, we believe the Bank of England did it badly. Some banks have gone to the European Central Bank secretly. We believe that, because Northern Rock was publicly named and shamed, this crisis happened. The funding gap [was initially] £2 billion-£3 billion. That naming and shaming led to the crisis, which was exacerbated by the press and hedge funds and depositors withdrawing money.’

Battle lines

Immediately after last week’s meeting there was a change of mood in the financial pages of national newspapers, for the first time the idea was being entertained that shareholders would need to be compensated in the event of nationalisation. In Monday’s announcement the government, which is still considering public ownership, confirmed: ‘The legislation [for nationalisation] being brought forward would provide for the assessment by an independent valuer of compensation payable to any holder of securities transferred to HM Treasury.’

We learned on Monday that the original plans for funding a private bid (Royal Bank of Scotland, Citigroup and Deutsche Bank had reportedly been working on a deal) had failed. But it was confirmed an alternative financing arrangement from Goldman Sachs was on the table. Here Goldman would repackage up Northern Rock’s mortgages into bonds and sell them to outside investors in order to repay the £25 billion Bank of England loan. The government would back the funding package by guaranteeing the bonds.

Because of the ongoing financial support of the guarantee, the Bank of England and Treasury have the ‘right, at their complete discretion,’ to decide on which private bid to support. Monday’s announcement also confirmed nationalisation remained an option. Shareholders may be forced to choose between a bidder such as Virgin – which is likely to cause them much more dilution than, say, Olivant – or nationalisation.  Either way, whatever the outcome they will no longer be totally wiped out.

The Northern Rock EGM

It didn’t quite look right. You would have thought he’d be surrounded by an army of black clad advisers carrying important looking wallets stuffed with briefing papers. But no, there was Philip Richards, chief executive of hedge fund RAB Capital, milling about, alone in the huge foyer of Newcastle’s Metro Radio Arena, all his possessions seemingly in a small blue textile bag.

Here was one half of the reason this emergency meeting of Northern Rock ever took place and yet Richards could have been part of the crowd, a private investor with 1,000 shares rather than 33 million. I imagined this was the intended effect. Addressing shareholders as a ‘West Country man’ who only moved to London aged 25, Richards ‘had a better appreciation of how Northern Rock up in the north east is something to be proud of.’

Richards stressed ‘we are full taxpayers’ and that his hedge fund group was different using its influence ‘creatively’ and ‘to build things up’. Next was Jon ‘we speak from the heart’ Wood’s turn to take to podium. On chairman Bryan Sanderson’s earlier comments that some ‘hedge funds’ had suggested the board play bluff with the Treasury, came: ‘I hope Bryan you were not talking about us. I have never played poker in my life and I don’t bluff.’

It is not the usual job of hedge fund managers to appeal to the public, but they clearly did a sparkling job. Of the 104 million-odd shares that voted in favour of their resolutions, it looks like 20 million-odd came from small private investors. That is around a fifth of all shares belonging to the 120,000-plus small shareholders believed to be on the register. But it was probably a case of how Richards and Wood put their point – attracting many ‘here, heres’ and much clapping – rather than the logic of their argument that won them the support. These were not the Rock’s sophisticated private investors.

Most in the audience seemed bewildered. As a whole, the 600-strong group looked out of its depth, not only with the subject matter but also in the surroundings too. The 11,000 seating capacity Metro Arena stadium and the giant plasma TV screen through which the board addressed them all seemed too big for the Rock’s smallest members. Sylvia Murphy probably summed up the feelings of most around her: ‘We are confused, we don’t know what is happening, nothing is clear cut.’

When their questions weren’t off the wall – why doesn’t Northern Rock go on the attack’ and take over Virgin – they were mainly about remuneration. Only a few seemed to grasp Richards’ and Wood’s central proposition of Bank of England culpability. Most wanted to vent their anger about director bonuses and former chief executive Adam Applegarth’s decision to sell shares near the top. As the crowd piled out in to the rain to be greeted by the national media its 15 minutes was over, and for most of the people in it, the whole day would soon be forgotten.

What would shareholders get on nationalisation?

Some press reports have made parallels between Railtrack and Northern Rock, but the two situations are completely different. The government put the former into administration before later nationalising it. Usually when a company is put into administration shareholders will only get a pay out if, once all creditors are paid (bondholders, trade suppliers, etc) there is something left over from the process.

As it happens, Labour did compensate Railtrack shareholders. But that was a pay off ahead of a threatened legal claim (institutions took the money but private investors rejected the settlement, although subsequently lost in the High Court) surrounding the legality of putting Railtrack into administration.

The rules would be totally different in Northern Rock’s case. The government has to buy out the owners of nationalised property as this is not a third world state where property is expropriated. But David Greene, partner at law firm Edwin Coe, which represented the private investors in the Railtrack case, explains their would be an argument as to the ‘fair value to pay on nationalisation’. Some say zero as Northern Rock would be bust if not for the taxpayer but RAB and SRM seemed to have effectively countered this last week.

In Monday’s announcement the government confirmed shareholders would be compensated. Meanwhile, SRM reportedly wrote to the Treasury saying it has legal advice to the effect that any payment of less than 400p on nationalisation would be in breach of human rights laws. Reports in the press talk of 100p.

WHAT THE INVESTORS THINK

Michael Doherty, 71, retired Northern Rock development manager from Northumberland voted in favour of the hedge funds

‘It was a very quick explanation of what happened. He (Richards) is quite right that the failure has got to be pointed directly at the Bank of England. I hope that the shares will recover one day, if they do it will probably be the grandchildren who reap the benefits. Luckily I’ve also made some money out of Northern Rock since I run a small share investment club with my golfing partners and in the past we have done quite well.’

David Killens, 70, retired sales manager from Newcastle voted against the the hedge funds

‘At the end of the day I went with the board, there is so much to take on. It was a good meeting but I thought there would be more confrontation. The whole thing is incredibly sad. I am from the south of England but have lived here for 30 years, when you see an institution like this with serious problems it is just sad.’