14 November 2007

Northern Rock will have to face EC's state aid inquisition

The European Commission has to date kept a low profile in its oversight of the UK government's bailout of Northern Rock, but the beleaguered bank and its current and potential backers will sooner or later have to face repaying billions of pounds in aid or a massive enforced restructuring of the bank's assets. 

The commission has already taken an interest but has judged it prudent not to push its case right now. For the moment, it has limited its concerns regarding the Northern Rock bailout (and others, including German bank IKB) to “making enquiries” and “maintaining a dialogue.” 

The prudence is apparently driven by a desire not to rock the boat unnecessarily and allowing an environment where the UK government can ensure its actions have stopped the rot spreading further through the banking system. 

The fact will remain though that the aid will need to be reviewed and it is likely to test the limits of what might or might not be allowed. Certainly the granting of an unconditional government guarantee to a bank in trouble is unprecedented, at least in the time-frame encompassed by the application of European state aid rules, and the sheer scale of the bailout has still not been determined (Figures of 20 billion pounds-plus are being bandied about but it is unclear, and presumably still unassessed, what the economic value of the total aid package is and will be). 

Neither has the duration. All indications are that the future operations of the bank will be tied together with ongoing state support, regardless of the outcome of a strategic review being undertaken which is expected to come to a conclusion in February.

Olivant, the independent investment group, private equity groups JC Flowers and Cerberus, as well as Virgin Money have all expressed interest in, or been linked to Northern Rock. But any plans for what they or anyone else would or could do with the bank after the aid has been ratified – indeed, if it is ratified, remain unclear.

If the aid is to be judged as rescue aid, then under the rules it will have to be paid back within six months or the company forced out of business. If it is judged restructuring aid – which it will be if it lasts more than six months – then it will need to be accompanied by a plan which ensures the bank and its new owners don't unfairly benefit from the UK government's largesse. 

The European Commission has been strict in the past with state aid to banks, particularly where the aid is required to cover corporate missteps. The commission's vetting and ultimate approval of the multi-billion euro French government rescue of Credit Lyonnais – at the time one of the world's biggest banks – eventually saw the operation reduced to a rump domestic, largely retail group eventually swallowed up by Credit Agricole. 

More relevant – and possibly more ominous for Northern Rock – is the precedent set in the Bankgesellschaft Berlin restructuring aid case concluded by the commission in 2004. Being more recent, the case was considered under the same rules and guidelines currently in force and the disposals required, unlike the discretionary way in which they were applied in the Credit Lyonnais case, now have much more precision. 

In exchange for obtaining the commission's approval under the state aid rules, Germany and the government of Berlin submitted a variety of divestiture commitments including undertakings to divest Berliner Bank, one of BGB's two retail brands, to hive-off the real estate services subsidiaries which were the main cause for the crisis and, finally, to sell Bankgesellschaft Berlin by the end of 2007. The restructuring plan also provided for a series of other measures such as the divestment of Berlin-based Weberbank and the sale or closure of national and foreign branches and subsidiaries. 

In that case the bank was judged to have received aid with an economic value of 9.7 billion euros and in the banking sector the commission has clear rules linking the size of the business that has to be disposed of to the amount of aid being granted. As a rule of thumb, banks can be expected to have to give up the equivalent of about four or five times the amount of aid in terms of their balance sheet. 

Northern Rock's strategic review, and that of its suitors, will clearly need to keep tabs on the more critical review that may be taking place in Brussels between the UK government and the commission. 

By Robert McLeod

© Graham Bishop