Why administration may be Rock's best bet

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It's taken an age, but the Treasury has finally worked out that putting Northern Rock into administration could be the Government's least bad way out of this crisis. Lloyds TSB has declined to take on the business, even at nominal cost, and as I said here a fortnight ago, administration is the only legitimate way to take it from the shareholders without a fight. If the Government and the Bank of England are to avoid an outcome which will either enrich a rescuer or cost the taxpayer dearly, they may have to do it themselves.

The professional buyers of the Rock's shares calculate that as long as they are the legal owners of the business, they cannot be forced to accept any old takeover terms. They might like the idea of Luqman Arnold simply moving his team in and running the business back up to financial health, but the Treasury is understandably apprehensive.

When it comes to new capital, Arnold's proposals are even lighter than those of Sir Richard Branson. Both will saddle the taxpayer with a liability of over £10 billion, backed by worse security than the current £25 billion loan, and with the prospect of another crisis if things didn't go to plan. JC Flowers is proposing to repay more by running the bank down, but this could happen pretty fast if the remaining depositors take flight rather than leave their cash with a business they've never heard of, Government guarantee or no.

The shareholders are highly unlikely to agree to Branson's deeply-discounted rights issue. As so often when he rides to the rescue, someone else is bearing most of the risk.

We can only glimpse the true financial picture of his offshore-owned empire, and we have yet to see the small print dealing with the use of the Virgin name. Besides, no rescue rights issue can take place without an increase in the share capital, which the shareholders must approve.

As a group, they have a sort of financial suicide bomb; having lost so much in the fall of the share price, they could well decide to reject a derisory offer, even if the alternative is losing what little they have left should the Rock go into administration.

Administration is not a car crash, but it's by no means an easy way out, either. It would freeze the depositors' assets, and to unfreeze them the Government would have to stand ready to replace each pound withdrawn, to protect the position of the bank's other creditors.

This is cumbersome, awkward and unprecedented, but it looks a better outcome than hoping for some magic Virgin dust, or allowing private equity to grab the bank. Buyers of the shares believe the Government will not dare face the consequences of administration, but the wilting price suggests otherwise.

There may be more value in Rock's former permanent interest-bearing shares. Issued when it was a building society, these PIBS converted to £20 million of 12.625% perpetual subordinated notes when it became a bank, so they are no longer shares at all, but rather lowranking creditors. However, they are legal liabilities, and at 93p they yield 13.5%, payable until hell freezes over or Northern Rock goes bust, whichever occurs first.

The next interest payment is due on New Year's Eve, and if it's not made by 14 January, the holders of the PIBs can apply to have the bank wound up. Since the £1,262,500 it costs to make the semi-annual payment is small change in this multi-billion-pound affair, it's cheaper to pay up than to find yet more lawyers feeding off the Northern Rock carcase.