(This article appears courtesy of International Financial Law Review, sign up for a free trial on their site)
by Rachel Evans
Granite – Northern Rock's master trust – has been mislabelled a tax dodge, an asset stripper and a threat to taxpayers. Such statements are inaccurate, naïve and dangerous.
In a late Commons reading of the Banking (Special Provisions) Bill – the government's emergency legislation to nationalise UK mortgage lender Northern Rock – on Wednesday February 20, Members of Parliament expressed concern about the bank's master trust securitisations, but failed to ask the right questions.
"The best mortgages of the bank are wrapped up in the Granite vehicle... an asset-stripping operation," said Vince Cable MP, deputy leader of the Liberal Democrats, clearly unaware that the FSA forbids firms from cherry-picking assets to put into a securitisation.
Northern Rock has set up a prime-mortgage master trust, so sub-prime mortgages cannot enter the pool, and it must have a weighted LTV (loan-to-value) ratio across the portfolio. Such eligibility criteria apply to all securitisations and certainly do not entail asset stripping or mean that Granite has better mortgages than Northern Rock.
Philip Dunne MP expressed concerns that Granite "will have the ability to take what other good assets remain in Northern Rock." Wrong again.
Master trust structures do require that new mortgages be fed into the trust in order to replace those mortgages which have been repaid in full. But Granite will not "suck assets out of Northern Rock". If Northern Rock does not contribute new mortgages, the deal will simply amortise and bondholders and Northern Rock will get their share back.
And John McDonnell MP worryingly argued that Granite was set up "to avoid tax" and so benefit the salaries of Northern Rock's directors, leaving taxpayers with the liability.
No. At a trust level, Granite is tax neutral. Like any securitisation, the purpose of the master trust is to allow a company to tap the capital markets by securitising a pool of assets. It is not to avoid tax.
As for liabilities rising out of Granite, master trusts – like other special-purpose vehicles used in securitisation – are bankruptcy remote. Even if all the mortgages in the Granite pool defaulted, Northern Rock would still not be liable for bondholder losses.
Northern Rock's only risk in relation to Granite is the risk it holds in relation to its share as the seller. Under the master trust structure, Northern Rock is required to maintain a minimum seller share on which it bears the risk. This risk would be the same if the assets backing the seller's share remained on Northern Rock's balance sheet.
Granite is in fact a means by which Northern Rock can obtain cheap financing in a bear market. "Potentially, investors would like to see this deal go into rapid amortisation. With current pricing they might well prefer to have their principal back and reinvested in higher yielding securities. This is financing for Northern Rock achieved when the market was at its tightest and I would suspect it won't be able to securitise further at this rate for some time," said Christopher Walsh, a master trust specialist at Clifford Chance.
Instead of picking on sensationalist (and inaccurate) aspects of securitisation, Parliament should have asked about the intentions of a nationalised Northern Rock towards Granite. Will the government allow Northern Rock to contribute to Granite's mortgage pool? Or will the securitisation wind-up?
The fallout from this debate on master trusts is unlikely to spill beyond Northern Rock. Basel II, which came into force in January, has made it less profitable to use a master trust structure. Many banks are instead using covered bonds which are more regulatory capital efficient for RMBS.
But securitisation more generally could be harmed. "The danger with commentators and politicians attacking structured debt and securitisation mechanics is that it taints them with a bad, unjust and wrong image. If this leads to banks being unwilling to tap the capital markets for cheap finance the person to ultimately lose will be the consumer as the banks will, I suspect, be forced to pass their higher internal financing costs onto borrowers," said Walsh.
"Securitisation is one of the reasons why we have such a competitive mortgage environment in the UK; it allows banks and other originators to offload risk into the capital markets and achieve much more efficient refinancing rates." RE
Shareholders set to sue
| Commons quotes |
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"We were right to save the bank and do everything to find a private sector buyer... we are now right to take over the bank on a temporary basis" |
Alistair Darling, Chancellor of the Exchequer
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"[The government was] right to decide that temporary nationalisation is a better option than a bad private sale. I am tempted to say, "I could have told you so"" |
Vince Cable, Liberal Democrat deputy leader
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"The Chancellor ... is actually introducing unprecedented, sweeping, draconian powers that will let him nationalise any other bank... by ministerial fiat" |
| George Osborne, shadow chancellor of the exchequer |
The UK government faces a wave of litigation after announcing emergency legislation to nationalise Northern Rock and leave shareholders with nothing.
Under the Banking (Special Provisions) Bill, shareholders will receive minimal, if any, damages.
Compensation will be calculated on the basis that "all financial assistance provided by the Bank of England or the Treasury to the deposit-taker in question has been withdrawn... and that no financial assistance would in future be provided". The value of shares in Northern Rock would resemble shares in an insolvent bank.
Legal action from shareholders looks inevitable. "[The government] is now going to face endless litigation from what looks like a group of very aggressive hedge funds that are latecomers to this party," said John Maples MP at last month's Commons statement.
An "independent valuer" – most likely one of the large accounting firms – will determine compensation, which can then be challenged at the Financial Services and Market Tribunal. But the tribunal cannot alter judgements. It can only refer a case back to the independent valuer for review.