Government plans to split and sell state-owned Northern Rock have met with mixed reaction.

The plan is to create a new savings and mortgage bank, called Northern Rock Plc, which will take deposits and offer savings and home loans.

The second part will become Northern Rock Asset Management, holding existing mortgages and unsecured loans, and closed to new lending.

The Chief Secretary to the Treasury Stephen Timms, speaking on Wednesday after European regulators gave clearance for Northern Rock to be broken up, said it was still the government's intention to sell both arms of Northern Rock, saying it would maximise taxpayers' gains.

The bank received billions of pounds in state aid and deposit guarantees.

One camp believes that rather than being sold, the bank should be turned into a mutual owned by its customers, while another camp thinks it's fine to sell it off as a publicly listed company.

What would be best for taxpayers?

That's the provocative question posed by Willem Buiter. His latest, characteristically lengthy, blog post tackles the regulatory vogue for forcing banks to hold much greater reserves of liquid assets - in practice, government bonds.

Buiter's missive follows new rules from Britain's Financial Services Authority, which will force banks to increase their reserves of government bonds by more than a third. The rules have been met with predictable bleating from the industry, which accuses the regulator of undermining Britain's competitiveness and promoting the fragmentation of the global financial system. Another concern is the FSA's handling of the transition.

Buiter's objections are more fundamental. He's not convinced banks should be preparing to deal with a seizure in the markets. That, he argues, is the job of central banks:

It may be possible for private banks to hold enough liquid assets (government debt, effectively) on their balance sheets to survive even a major liquidity crunch without recourse to the central bank.  But that would be socially inefficient.  Banks are meant to intermediate short liabilities into long-term assets, and frequently into long-term illiquid assets.  It’s what their raison d’être is.

By contrast, Buiter says: "Providing liquidity is what God made central banks for."

It's an argument which deserves to be explored further, though it does raise some practical concerns.

The first is whether central banks are able to prop up individual lenders without making matters worse. After all, the run on Northern Rock started after  the Bank of England announced it was providing support to the mortgage bank. The Bank of England has since installed a permanent discount window similar to the one used by the Federal Reserve. But it remains to be seen whether banks will dare use it once markets have returned to normal.

Then there is the question of collateral. The crisis has forced central banks to lend against a much wider range of assets than they previously accepted. Buiter appears to be suggesting that in future central banks should be willing to accept all kinds of illiquid assets, almost regardless of quality, as long as they apply an appropriate haircut.

Britain's embattled banks may welcome Buiter rallying to their cause. But they shouldn't get too carried away. The LSE professor prefaces his argument with a lengthy call for a global regime to shut down failing banks and seize their assets.

Only this, he claims, can "turn our financial sector back into something that belongs in and sustains a market economy instead of a form of communism for the rich and well-connected."

Shares in Lloyds Banking Group are worth 150 pence apiece, according to the analysts from Royal Bank of Scotland, who think the shares offer "a compelling restructuring opportunity" around today's 95 pence.

Lloyds, say the brokers, is going to recover sufficiently to pay a nominal dividend next year, and something quite substantial in 2011, thanks to margin expansion, cost control and normalising bad debts.

Well, maybe. Over in the distressed debt market, they are a lot less sure. Mind you, they are not very sure of anything, and anomalies abound. Brokers Collins Stewart, who have specialised in the backwaters of preference shares and PIBs, have one this very day. They are offering the snappily-titled HBOS Capital Funding 9.54 percent fixed-to-floating perpetual preferred securities at 65 pence.

The buyer gets a 14.68 percent return until 2018, when he either gets 100 pence, or the coupon is reset at Libor plus 6.75 percent, a rate deliberately designed to be punitive for the borrower, which is of course, HBOS' parent, Lloyds.

That, at any rate, is the theory. Existing holders of these obscure instruments have little idea how to value them. As Collins Stewart point out,  similarly-ranked paper from Lloyds itself yields 11.28 percent. There's the additional risk of Lloyds following Northern Rock's example and electing not to pay the interest, since it's clear that the bank is still short of capital.

The point, though, is that Lloyds cannot pay a dividend if interest on these higher-ranking securities is not up to date. If the RBS analysts are right, then the mouthful of HBOS stock above is cheap; it looks better value than the shares, at any rate.

- Bob McDowall is research director, Europe, at TowerGroup, a research and advisory services firm focused exclusively on the global financial services industry. The opinions expressed are his own. -

The banking results being published this week are inseparable from the catastrophic financial events of the last two years. It is time to glance back to where we have been and determine where we are now.

Almost two years ago, the slow-burning fuse to a financial services bomb was lit with the run on Northern Rock. The UK Government and its financial regulatory agencies defused that bomb “minutes” before it could devastate the UK banking and financial system in October 2008.

Official records will not be available for public scrutiny for 30 years or more, but anecdotal evidence indicates that at least one bank was within days of literally running out of cash. It has also been speculated that moves were planned by some businesses to prevent the customers of ailing banks from withdrawing cash from joint and third-party ATMs, although this has been denied.

Against this state of financial tension, the UK Government and the Bank of England had no choice but to save the UK domestic banks and stabilise the financial system. If they hadn’t, the loss of confidence in the financial system would have spread to the wider economy and would have weakened the sterling, perhaps irreparably.

It is unlikely that the Government or the Bank of England could have taken steps other than recapitalisation. Surviving businesses could not have been persuaded to acquire the ailing banks when significant financial assets had no market or known realisable value.

The lack of knowledge of the depth and materiality of the ‘bad assets’ held by banks made it near impossible for the UK Government to make a judgement call on how significantly damaging these assets were and how to manage them in any other way.

Recapitalisation was therefore an essential move by the UK Government and Bank of England, but it should have included a legal precedent that was missed.

We are currently in a situation in which the taxpayer’s money is funding the assets the UK Government has deployed and invested in the banking system. But the banks are still reluctant to lend. This power balance is not in the best interest of the taxpayer.

The UK Government appointed the UK Financial Investments plc (UKFI) as an arm’s-length agency to hold investments in the impaired banks and manage those investments for the beneficial interest of the UK taxpayer. However, the UKFI is also faced with the demands of the European Union competition interests and the other shareholders of the banks, including their employees and management.

If in its professional judgment, the UKFI believes that the taxpayer will make a capital gain, in the guise of a tax rebate, by retaining the taxpayers’ investments long term, then this is a course of action they should follow.

The danger in this strategy is that the UK domestic banking system could suffer from a lack of innovation and competition. It is the Government’s responsibility to ensure that this conflict of interests is managed for the best of the taxpayer and the economy.

- Margaret Doyle is a Reuters columnist. The opinions expressed are her own. -

The crisis at Northern Rock marked the beginning of Britain’s slide into large-scale state ownership of the banking system. Returning the mortgage lender to the private sector would be a sign that normal service is being resumed. But rumours that the British government is poised to sell Northern Rock, are premature. Suggestions the government could do so at a profit are even more far-fetched.

Prime Minister Gordon Brown is apparently keen to offload the Rock, ideally “at a substantial profit” before the general election, which must be held before next summer. According to the Times, the prime minister “wants desperately to avoid a Conservative government taking the credit”.

It would be lovely to think the government’s main worry is who might benefit from the “profits” from the banking bail-out, rather than the substantial losses it has underwritten at the state-owned banks. There are plenty of thorny matters to be settled before the Rock is sold.

The government itself has two conflicting objectives. As a shareholder, it wishes to sell its stakes as soon as it can, and to be able to dress up the sale as a profitable exit. However, as the guardian of the economy, it wants to moderate the rate at which the banks shrink their balance sheets, because that denies credit to viable businesses and would-be homeowners. Indeed, the government recently instructed the Rock to stop shrinking its balance sheet and to start lending again.

This is why the European Commission, which has to approve the bailout under its state aid rules, has demanded more information from the Rock. Given the tough stance Neelie Kroes took with Germany’s Commerzbank <CBKG.DE>, the EU competition commissioner is also likely to look closely at a Rock that is growing again thanks to its government backing.

Even if the Rock can negotiate this hurdle, the idea that the government could turn a quick profit on the bank is fantasy. The current plan is to split the Rock into two companies: a BankCo, which would hold the branches, deposits and new loans and AssetCo, which would hold the bulk of the legacy mortgage book. It is hard to see rivals falling over themselves to buy the Rock’s low-quality mortgage book. While there may be interest in the Rock’s branches and deposits, the price is likely to be minimal.

Santander paid just 150 million pounds for Bradford & Bingley’s 197 branches and 21 billion pounds of deposits. (The government took on the bank’s 50 billion pound loan book). The Rock has just 75 branches and though it has a similar deposit base, some of these savers would be likely to rethink their allegiance if the bank was returned to the private sector.

Any proceeds would have to be set against the money the Rock owes the government. This stood at 9.8 billion pounds as of March, and the government is expected to inject at least another 3 billion pounds to boost the Rock’s capital ratios, which are now below the minimum required by regulators. Gordon Brown can rest assured. No one is going to be turning a quick buck on the Rock any time soon.

(Edited by David Evans)

-- Alexander Smith is a Reuters columnist. The opinions expressed are his own --

People are up in arms about bankers receiving bonuses when the banks they worked for have gone down the pan. But isn't it just as shocking that so many state-backed financial firms still subsidize the eye-popping wages of sporting superstars through rich sponsorship deals?

It's the same story on both sides of the Atlantic. Citigroup, which received $45 billion from the U.S. government, is sticking with a $400 million marketing deal from 2006 which includes the naming rights for the new home of the New York Mets baseball team, which will be called Citi Field.

Meanwhile Royal Bank of Scotland announced it had renewed its sponsorship of the 6 Nations rugby competition last month, only 10 days after reporting the biggest loss in British corporate history. And it continues to sponsor the Williams Formula 1 team, a sport known for eating up tens of millions a year.

There is indeed a strange correlation between failed companies and sporting sponsorships.
Manchester United sponsor American International Group (AIG), Newcastle United supporter Northern Rock and failed British bank Bradford & Bingley, which sponsored not one but two soccer clubs, Bradford City FC and Barnet FC, have all crashed spectacularly since during the credit crisis.

And it isn't just financial firms which have run into trouble and seen their names stripped from team shirts and hoardings. English premier league club West Ham United lost their sponsor when tour operator XL Leisure Group folded.

But this shouldn't really be a big surprise. Some have even made a direct link between sporting sponsorship and corporate underperformance. A recent report by U.S. fund advisory firm Advisor Perspectives crunched the numbers for U.S. companies that entered into so-called "naming rights agreements" and believes it has established a statistical connection.

Its study of 69 U.S. naming deals shows the performance of companies that purchase such rights trails the S&P 500 index by 4.7 percent over the course of the deal. If you invested in a company the day it announced a naming agreement and sold when the agreement was done (or still held onto it for current name holders), your portfolio would be down 9.1 percent, versus a fall of 4.5 percent for the S&P 500.

Advisor Perspectives argues that poor corporate governance, leading to risky or bad decisions on capital allocation, is to blame for this underperformance and points out that three of the top five largest bankruptcies in history, Worldcom, Enron and Conseco all sponsored major U.S. sports venues.

They also point the finger at executives who benefit from the luxury boxes, hospitality packages and privileged access to sporting celebrities, all at the expense of shareholders.

So when Royal Bank of Scotland struck its Formula 1 deal with the Williams team, Citigroup signed its Mets deal or AIG paid to have its name on the shirt of the world's most successful soccer team

Manchester United, investors should have read these as clear sell signals for the stock.

Given the financial wall some of the banks have hit it is puzzling why they haven't pulled the plug on these embarrassing deals. After all the CEOs of RBS, Northern Rock and Bradford & Bingley have all been jettisoned, as have the bosses of Citigroup and AIG.

But with some lengthy sports sponsorship deals, ending them would in most cases be counterproductive, wiping out any value left. And where banks have been nationalized, political factors come into play. In the case of Newcastle United, any damage caused by ending the sponsorship agreement with Northern Rock and alienating a fiercely loyal soccer fan base would have far outweighed the cost savings of scrapping the deal.

So for an early warning signal of a company with a vain or out-of-control CEO, a poor record of capital allocation, a likely share price underperformance and in the worst case scenario an above average chance of going bust, look no further than the big sports signings, not of players but of sponsors.

-- At the time of publication Alexander Smith did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. --