Super Ron

Ron Sandler has the job of rescuing the stricken lender Northern Rock, but the City is divided on his chances of pulling off his biggest turnaround yet...

AS THE Banking (Special Provisions) Bill was clearing its final hurdle late on Thursday evening, Ron Sandler the troubleshooter brought in by Gordon Brown to oversee the rescue of Northern Rock, telephoned his new finance director Ann Godbehere.

By all accounts their conversation was brief, a mere courtesy call to confirm the Government had won the vote. Just five months after Northern Rock's then chief executive Adam Applegarth had gone cap in hand to the Bank of England, Britain's first major nationalisation since the 1970s was complete.

As Sandler rounded off his call with a brief conversation about his new-look board, analysts in the City were already beginning to ask what lay ahead for the stricken mortgage lender. As one City analyst said: "We are simply clueless. Sandler sat there at that press conference, and gave loads of platitudes about how he was going to run it (Northern Rock] within the confines of EU state aid law without detailing what exactly he was going to do. To be honest we are no further down the line."

Sandler, the former City executive who was born in Zimbabwe and is said to hold a German passport, will be paid £1m a year for turning the nationalised bank around. Judging by the scale of the task ahead of him, he is going to earn every penny.

"The feeling in the City is one of what's next?" said one industry insider. Certainly a brief look at the current business throws up a number of unanswered questions.

Can the taxpayer make money from the arrangement? Will the shareholders get any sort of return? Can the state recover a reasonable chunk of the £25bn in loans and £30bn in guarantees it has extended to the bank? Will the European Commission allow the Government to carry on supporting Northern Rock and if not can Northern Rock survive?

"With a Government guarantee it is a fantastic business," says Alex Potter, banking analyst at Collins Stewart, "and with massive Government funding at next to nothing it is a brilliant model."

Northern Rock's model is based on one product – mortgages – and one market – the UK. By focusing on one market it has been able to cut costs and gain market share by undercutting its rivals such as HBOS.

But its rapid growth meant that in the months preceding last summer Applegarth's board had been forced to tap into the money markets to fuel expansion. In short, the model they created relied on borrowing money from the wholesale lending markets, rather than customer deposits, and lending it to the public at a higher price, in some cases borrowing from the wholesale funds at 5% and lending it out at 6%, taking the 1% as profit.

But the model is bust. Although Northern Rock has little exposure to poorer-quality, or 'sub-prime' US mortgages, it has proved vulnerable to the liquidity squeeze triggered by the crisis in that market. Due to its small deposit base it has been forced to draw most of its funding from money markets. When the wholesale banks stopped lending it turned to the Bank of England.

"Northern Rock's main strength is that it is a low cost producer," says Potter. "That has not changed and the infrastructure is still there. Its weakness is its reliance on wholesale funding. The trouble with this model, as it stands, is that it is relying on explicit state aid. So there has to be some sort of counter-balance as to the way it is regulated. But, as ever, this administration seems unwilling to be either honest or decisive, so we have no clue as to what that really is."

Sandler has hired McKinsey to work on a business plan for the bank. For the record he indicated that he favours rapidly shrinking the Rock's mortgage operation by putting up the cost of mortgages. Some analysts say that to comply with European state aid rules he would have to shrink the mortgage book by up to £50bn over four years. Some say this would require shredding half of the Rock's 6,000 staff.

European rules governing state aid are not clear. They do not allow individual states to prop up businesses indefinitely. Yet some analysts say that if the Government's load was restructured as part of a takeover of Northern Rock, it would be classed as "restructuring aid", which is allowed.

Sandler's quandary is that he needs to attract billions more in retail deposits. As well as this he has to deal with Granite, the Jersey-based securitisation vehicle that turned about half of Northern Rock's mortgages into bonds. In an extremely fine balancing act Granite needs a steady supply of mortgage revenue to replenish its pool of collateral from the mortgages that have been redeemed early. Failure to do this could result in Granite being forced to close, shutting off Northern Rock's cheapest source of finance and tie-up the £4bn that the bank invested into it.

"Whichever way you look at it, it is a fine balancing act," said one analyst. "Can he pull it off? Your guess is as good as mine."

Snapping at his heels are the shareholders who are threatening to make his life legal hell. RAB and SRM Global, the two hedge funds which together held more than 20% of Northern Rock's shares between them, have already started legal action. The shares were trading at 90p before they were suspended on February 18, but the hedge-fund investors claim they are worth around £4.25. The Government is consulting its lawyer, Slaughter & May, about the process for establishing what compensation to pay Rock's shareholders. Once it has a legal framework in place it will appoint an arbitrator to come up with a figure.

"The problem is that an arbiter could conclude that without Government aid the shares are worth zero," said one source. "But the courts could decide the opposite." One thing is certain the shareholders will not give up without a fight.

"If the Government think they are going to get away without a legal challenge they can forget it," says Roger Lawson, of the UK shareholders association. "It's going to go the same route as Railtrack which means several years of interesting disclosures in court, ultimate embarrassment and probably the destruction of Mr Darling's career, just as it happened to Byers."

But Sandler is no stranger to the high-octane world of City troubleshooting. He first earned his spurs in the fall-out of the Lloyd's insurance market of the mid-1990s. Brought in as chief executive by chairman Sir David Rowland, his first job was to settle the acrimonious disputes that threatened to bring the world's most famous insurance market to its knees.

Observers say that despite his lack of experience he learned fast and proved up to the task of broking a settlement between Lloyd's and private individuals who had racked up heavy losses.

The official line from the Rock is that it will be in public hands until the mortgage markets improve. When that upside will occur is unclear but analysts say Sandler will be wise to keep in touch with Wilbur Ross, the US buyout specialist who helped mastermind the Virgin consortium. Last week he insisted he would be interested in a sale of the bank. The US private equity group JC Flowers and hedge fund Cerberus, which both did extensive due diligence on Rock, may also be interested in revisiting their interest in the bank.

The alternative is a break up with Sandler hiving off parts of the business to the highest bidder. Failure on both accounts would leave Sandler saddled with one of the UK's 10 biggest banks languishing in public ownership.

Former colleagues have attacked Sandler as having an "inflated opinion of his own abilities". Now is the time for him to prove them wrong.

Top troubleshooter

Ron Sandler, the man bought in by Gordon Brown to rescue Northern Rock, has been described as a quick learner, possessed with strong self belief who has the ability to rub people up the wrong way.

Sandler earned his spurs in the mid-1990s when he was tasked with troubleshooting the fall out from the Lloyd's insurance market. Brought in as chief executive by the then chairman Sir David Rowland he was charged with settling the acrimonious disputes between Lloyd's and the wealthy individuals who had lost fortunes underwriting the market.

During the takeover for Natwest Sandler was again parachuted in as director and chief operating officer. Although Royal Bank finally won, Sandler earned praise for the way he conducted the bank's defence strategy.

In June 2001 the then chancellor Gordon Brown asked Sandler to carry out a review of the savings industry, known as the Sandler Review. Sandler criticised the financial services industry for complicated products that had high charges and relatively poor returns.

This did not make him popular with the life and pensions industry but gained him respect elsewhere as a man prepared to stand up to them.

Recently Sandler has taken a series of low-profile positions, such as the chairmanship of pension buy-out firm Paternoster, which is headed by the former Prudential UK chief executive, Mark Wood.