Following on from the debate in Parliament last night, in which John McDonnell MP rightly raised concerns expressed on this blog about Granite and Northern Rock I have this morning written a note on this whole issue and the implications it has for the Northern Rock nationalisation. It reads as follows:
Northern Rock raised the finance it needed to issue its mortgages by issuing debt through a series of companies all sharing the name 'Granite'. More than £40 billion is involved. The mortgages in question are the highest quality debts that Northern Rock might have issued.
The Granite companies are legally not part of Northern Rock. They are owned by a charitable trust established by Northern Rock for the supposed (but not actual) benefit of a charity for the benefit of disabled children in the North East of England. This wholly artificial structure means that they can be considered completely legal distinct from Northern Rock and can be considered 'off balance sheet'.
The trust is in part administered through Jersey. Some tax savings may arise as a result.
Many advisers to Norther Rock have undoubtedly benefited from this arrangement.
In practice Northern Rock considered it controlled the Granite companies even though legally they were quite distinct. As such it has included them in its audited accounts. This was misleading. It claimed as its own assets which it did not own. In doing so it represented that some of its best mortgages were available for it to use to grant security when they did in fact already belong to a legally separate company, with the security on them already being wholly pledged to other people.
However, although that security had been granted to other people Northern Rock had not eliminated the risk on the Granite debt from its own affairs. This was because the money Granite borrowed was relatively short term (a few years at a time, with the whole debt being due for repayment over a relatively short number of years) whilst the mortgages Norther Rock offered using Granite money were granted over the long term (25 years or more). If when Granite becomes due to repay the sums it has borrowed to its financiers then if it is unable to do so Northern Rock has to step in to make good the deficit. This is exactly the scenario that plunged Northern Rock into its crisis last year.
This poses an enormous problem for the nationalisation programme. Northern Rock does not own Granite. It is however wholly responsible for it. It's officially 'on' its balance sheet in its accounts. But it is legally 'off' its balance sheet when it comes to getting hold of its assets as the basis for the security of the sums owed the Treasury: these assets are instead already beholden to others.
When the sums in question represent more than 40% of the assets of Northern Rock this is not an issue that can be left to be dealt with later: this issue is at the core of the nationalisation agenda for Northern Rock.
The government has called for greater transparency in finance. It has criticised the use of 'off balance sheet' structures and artificial financing mechanisms. Granite is all these things. It has to take a principled stand now. If the directors of Northern Rock could create this abusive structure then they must also now take the steps required to unravel it: to bring all the Granite entities into the ownership of Northern Rock and under its explicit control. Only then will the benefit of these assets be available to the taxpayer. Only then will the whole of the finances of Northern Rock be under state control for the benefit of the taxpayer. Only then can we be sure that 'off balance sheet' methods will not be used to secure benefit for some parties at further cost to the state from now on.
There are no grounds for ambiguity here. Action is needed.
For more information read:
http://www.taxresearch.org.uk/Blog/2007/09/17/northern-rock-the-questions-needing-answers/
http://www.taxresearch.org.uk/Blog/2007/09/21/northern-rock-those-in-the-queue-were-right/
http://www.taxresearch.org.uk/Blog/2007/11/05/northern-rock-the-real-questions-it-raises/
They've got to get this one right.
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I am by no means a tax expert so certainly bow to your superior knowledge on the tax affairs of Granite. I have, however, been a journalist specialising in securitisation since 2001 and was horrified to catch the tail end of the parliamentary debate last night. MPs on all sides of the chamber showed a remarkable lack of knowledge of what had happened to the loans, which ones they are, and the various triggers within Granite which address certain failings within the vehicle. The 5 year-or-so maturities which have been quoted are the ‘expected’ final maturity – there is a penalty to pay in terms of the amount of the reserve fund (the first loss piece owned by Northern Rock) and the rate of interest if the expected maturity is not adhered to, but there is no compulsion to redeem the notes until Legal Final Maturity. The LFM is set to allow for just this eventuality – the loans in the trust will all have amortised down to zero by that time (25-30 years from inception).
As for the MP who was going on about the LTVs ‘really’ being over 100%, this is clearly untrue (see Granite investor report at : http://companyinfo.northernrock.co.uk/downloads/securitisation/granite%20trust%20reports.pdf
The report also has (page 4 I think, luckily as its 1125 pages long!) a list of the non-asset and asset triggers and their required fixes. The current seller share (£5.85bn) and the minimum share (£3.83bn) are also quoted, as well as a breakdown of the loan book. The penalty for not topping up the seller share if it falls below the minimum is that the fund will begin to wind down, principal receipts from mortgages used to amortise the AAA-rated tranches starting with the shortest LFMs first, then to the AAs (pro rata) and so on.
I would recommend that anybody interested takes a look at a presale report on one of the rating agency websites – I find http://www.fitchratings.com helpful (though you will need to register for free).
Incidentally, Halifax (£45bn), Abbey (£40bn), BoS (£5bn), Standard Life (£5bn), Barclays, RBS and Britannia all have master trusts with similar structures.
Andy
You are quite right: John McDonnell was, for example wrong to call this a tax structure, it is not.
I do however think the ‘5 year’ maturities are realistic to quote. There are a lot of charades in this structure, and one of them is the final maturity date. No one expects them to be real, any more than anyone really believes that this is an independent company.
LTVs are also as you say though: this company has the best of the Northern Rock book, if not giving it a better credit rating than Northern Rock would have been just wrong.
Richard
“There are a lot of charades in this structure, and one of them is the final maturity date. No one expects them to be real”
That’s a weak response. If there is no legal obligation on NR (i.e. HMG) to redeem the bonds until the FMD, which there isn’t, then we won’t. That might not be what no-one expects, but it’s certainly what’s allowed.
Note also, the Granite prospectuses make clear that the loans securitised through Granite are based on *exactly the same* criteria as all NR’s loan advances. The “better credit rating than NR” is merely an artefact of the rating system.
(I’ve got a piece on why this is an utter red herring here, which goes over similar ground).
“As such it has included them in its audited accounts. This was misleading. It claimed as its own assets which it did not own”
It also might be worth pointing out to casual observers that this is the way in which, under IFRS, it is compulsory to account for these assets. Also that NR’s financial reporting, as mandated by IFRS, went into great detail about the breakdown between debt and assets held in SPVs versus debt and assets held within NR companies.
If this isn’t legally a fraud, it certainly should be! How could either the ordinary
depositor or small shareholder have reasonably known that their deposits &
investments were so much at risk?
john b
You write If there is no legal obligation on NR (i.e. HMG) to redeem the bonds until the FMD, which there isn?t, then we won?t.
Are you therefore employed by HMG?
JJ @ 5: by reading the annual report, perhaps?
Simon @ 6: no – HMG is us, remember…
John b
Re IFRS – it shows how useless this framework is if no one seems to understand the resultinf reports
Richard