2.44 Before reaching a final decision, the Treasury considered a number of factors:
■ Protection for the taxpayer in a downside scenario - the private sector options offered a degree of risk transfer relative to public ownership by virtue of additional equity injections of £0.7 billion to £1.25 billion, which would provide an extra buffer for the taxpayers' exposure. This protection was, however, relatively small. Under the Virgin proposal the company could sustain a fall in the value of its assets of 12.4 per cent (equivalent to £7.7 billion) before the taxpayer incurred losses. By comparison under public ownership the company could sustain an asset value fall of 10.9 per cent (equivalent to £6.7 billion);
■ The reduction in the size and duration of public support - the Treasury had envisaged the guaranteed bond issuance being repaid in 3.5 years, but both of the private sector parties sought additional liquidity which would require financial support for up to five years. The size and duration of financial support under public ownership would depend on the business model to be developed by the new board, but it was not clear at the time that it would be substantially greater than under the private sector options. Private sector credit rating agencies had indicated to the Treasury that they might be more reassured by public ownership, and therefore more likely to maintain an A-rating for the company. The latter would have avoided Granite, the funding vehicle used by Northern Rock to raise money on the securitisation markets (see Appendix 4), being wound down (known as "pass-through") and the corresponding cashflow requirement that would entail;
■The share of any upside on a subsequent sale of the company - under the Northern Rock management team proposal, a sale of the company in 2011 might have yielded between £230 million and £360 million to the taxpayer on sale proceeds of over £2.5 billion. Under the Virgin proposal, the share of any sale proceeds was expected to be no more than £80 million.
2.45 The Treasury also considered that choosing one of the private sector proposals was not risk free, since the outcome would remain uncertain until final negotiations had been completed and any deal concluded. Moreover, if a private sector proposal failed it could result in a reactive, and potentially less orderly, move to public ownership at a later stage. Another consideration was certainty of execution. There were doubts about the extent to which a deal with Virgin could be successfully executed. Some major Northern Rock shareholders had made clear their opposition to the transaction and their preference for the management proposal. There was also another substantial concern. A major ratings agency had indicated it would downgrade Northern Rock on the completion of a transaction with Virgin. Such a ratings downgrade would trigger events which would raise the funding costs to Virgin and threaten the viability of its proposal. It was not clear to the Treasury whether such events would have been decisive for the viability of the Virgin proposal, but it raised concerns about deliverability. Such a problem was also likely to be an issue for the management team proposal.
2.46 Finally, the Treasury recognised that a private sector party would almost certainly reserve the right to walk away in the event that a satisfactory deal could not be concluded. It was unlikely that a deal could be cleared under State Aid rules and implemented before the end of 2008, resulting in a substantial period of uncertainty and vulnerability to future events.
2.47 On 17 February 2008, the Government announced that the private sector alternatives did not meet the test of protecting the taxpayer's interest and, taking wider considerations into account, concluded that the right approach was to take Northern Rock into a period of temporary public ownership. On 21 February 2008 the Banking (Special Provisions) Act 2008 became law and using the Northern Rock plc Transfer Order, on 22 February the Treasury transferred the ordinary and preference shares of Northern Rock into public ownership.
2.48 The Act required the Treasury to put in place a scheme for determining any compensation payable to former shareholders of a deposit taking institution taken into public ownership. The Act also contains provisions for determining how any compensation payable should be calculated, in particular, an assumption that financial support provided by the Bank of England and Treasury has been withdrawn.
2.49 On 8 September 2008, following an open competition, the Treasury appointed Andrew Caldwell, a partner at BDO Stoy Hayward LLP as the independent valuer for Northern Rock. With the support of a team of staff from BDO Stoy Hayward LLP and other professional firms, the independent valuer is assessing any compensation payable under the Northern Rock plc Compensation Scheme Order 2008. A fee of £4.5 million for the valuation work will be paid by the Treasury, with the intention that it will be reclaimed from Northern Rock when the company is returned to the private sector.
2.50 The assumptions applied to the valuation process were challenged by certain former shareholders. Two hedge funds, SRM and RAB Capital, as well as a Shareholder Action Group (the UK Shareholders Association), representing private shareholders, each applied for a Judicial Review of the Government's compensation guidelines. The former shareholders argued that the Treasury's compensation guidelines were in violation of Article 1 of the First Protocol of the European Convention on Human Rights. The High Court heard the application for judicial review in mid-January 2009 and rejected the shareholders' arguments on the grounds that they did not have any justifiable claim beyond their entitlement under the compensation scheme. The matter is now subject to appeal.