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The (un)charitable core of Northern Rock

Bore down into Northern Rock - deep, deep, deep…keep going - and you eventually come to this:

229.jpg
Granite, the immense, £50bn synthetic financial structure upon which the the stricken mortgage bank is perched, is itself balanced on a charity, the Down’s Syndrome Association North East (UK).

That will come as a surprise to many - and it certainly has to the Down’s Syndrome Association North East (UK), a family support group run by about 300 parent volunteers. The charity’s trustees have issued a statement:

In connection with the current problems of Northern Rock, we would like to assure our members and supporters that Down’s Syndrome North East (DSNE) has not been knowingly involved in any misuse of money. We are investigating why our charity appears to have been named as a beneficiary of a Trust without our consent. We have definitely not received any money from Northern Rock or affiliated companies, except for a one-off donation from a staff collection in 2001. Currently we have not received notification that any funds are being raised or collected by Northern Rock or affiliated companies on our behalf.

As is widely known, Northern Rock has been funding itself through a securitisation vehicle called Granite Finance Holdings, which has issued paper worth up to £50bn. Under a mind-boggingly complex scheme, Granite is not owned by Rock, but by a business services group called the Law Debenture Corporation, acting as trustee. Granite’s beneficial ownership is described as follows:

The entire issued share capital of Holdings is held on trust by a professional trust company under the terms of a discretionary trust for the benefit of one or more charities. The professional trust company is not affiliated with the seller.Any profits received by Holdings, after payment of the costs and expenses of Holdings, will be paid for the benefit of the Down’s Syndrome North East Association (UK) and for other charitable purposes selected at the discretion of the professional trust company. The payments on your notes will not be affected by this arrangement.

All this was dug up three weeks ago by Richard Murphy, a tax expert and forensic accountant, who runs his own blog.

While a piece on the matter subsequently appeared in Private Eye, he finds it staggering that no one in the mainstream media has seized on these details — and, reading through his detailed explanations of how Granite operates, we tend to see his point.

A charity’s name and status has been used without its consent to create an opaque financial monstrosity. Those doing the structuring presumably banked substantial fees - but not a penny of this has flowed through to the Down’s kids involved.

Murphy (no relation) declares the Granite structure to be a sham, where Northern Rock actually controls Granite, but pretends not to via a set of complex legal structures. He calls this three things:

a) An abuse of the charity involved, who (I stress) need not even have given their assent to be used in this way;

b) A contempt for those who take the real risk on financial markets, which is at the end of the day as this fiasco is showing, you and me and the government;

c) The construction of an arrival device to ensure that as few people as possible, almost certainly the Northern Rock directors included, know just how this deal works. I guarantee you it’s a tiny number that do.
And it’s this wholly artificial construction, seeking to shift liability and to avoid responsibility and abusing common sense decency with regard to the abuse of charity to achieve commercial aims that is pulling Northern Rock down.

Murphy’s full excavation work can be read here and the full Granite prospectus is available here.

Perhaps those who profited from Granite should reach into their pockets. Lead underwriters on the Granite programme were Lehman Brothers, Merrill Lynch, and UBS. Underwriters were Barclays Capital, Citigroup, JP Morgan and Morgan Stanley.

This entry was posted by Paul Murphy on Monday, October 8th, 2007 at 12:16 and is filed under Capital markets. Tagged with . You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. Oct 09   20:38 Posted by Credit Analyst [report]

    You’re missing the point. Massively.
    Securitization is about banks capturing excess spread, leveraging their capital and matching their assets and liabilities (yes; you read me right).
    The law requires “true sale” of assets [i.e. mortgages] for a number of reasons (tax being but one of them). Banks however want to continue to capture the entire benefits of express spread (i.e. the equity value) of the assets they sell to their securitization vehicle - they do this through holding the equity piece (i.e. most junior) of the securitization (sometimes this is a subordinated loan to a particular SPV). By virtue of holding the equity piece of the securitization, two important things happen: (1) Banks experience the full margnal benefit and full mrginal cost of loan performance (as the rewards of each default avoided go entirely to the equity piece; the reverse for each default ot avoided - provided defaults stay roughly within expecations [not true of US subprime!]) & (2) The equity value of the entire securitization, including the equity piece/Sub Loan, is nil - as all the benefits of excess spreads and the costs of excess defaults are expereinced not by the legal owner of the securitized assets, but by the holder of the equity piece.
    Hence: (1) the beneficiary of a the equity of a securitzation vehicle will earn nothing (and so can be anyone!) & (2) because Banks expereince the full economic gains and losses from the securitized portfolio (within reasonable tolerance of default expectations), IFRS allows them to consolidate the portfolio as they still bear the risk of the assets.

    NRK didn’t go under because they sold loans to Grampians: they went under because Grampians issued short term debt to finance the long dated assets which had been bought from NRK. This was NRK’s decision - but to blame the loan sale process rather than the inapproprite choice of liability maturity is wide of the mark.

    Caveat: I am *NOT* an ABS expert; just someone who looks at Bank balance sheets every now and again.

  2. Oct 09   13:33 Posted by Tax Research UK / Northern Rock - why it abused the charity [report]

    […] There are two real problems, but each is profound. The first is that I think, to put it bluntly but quite fairly, Down’s Syndrome North East was subject to identity theft by Northern Rock in pursuit of its own profit. Its name was used in documents that acted as inducement to subscribe for billions of dollars. But as the organisation has now made clear, they are now: investigating why our charity appears to have been named as a beneficiary of a Trust without our consent. We have definitely not received any money from Northern Rock or affiliated companies, except for a one-off donation from a staff collection in 2001. […]

  3. Oct 09   8:27 Posted by Presidential candidate Ron Paul warns of coming global economic depression « noworldsystem.com [report]

    […] The (un)charitable core of Northern Rock http://ftalphaville.ft.c….the-uncharitable-core-of-northern-rock/ […]

  4. Oct 08   17:23 Posted by Paul Murphy [report]

    Thanks Richard — aware it’s v v widespread — but it’s the link to a real charity that doesn’t know it is being used in this way that has pricked my interest. Any further examples on that front?
    Murphy/Alphaville

  5. Oct 08   16:57 Posted by Richard Murphy [report]

    Almost all banks use this type of dodgy structure.

    I have an article on an HBOS example, entirely off balance sheet and with £28 billion in it here http://www.taxresearch.org.uk/Blog/2007/09/14/where-is-the-liquidity-crisis/

    Most of this is offshore. That’s deliberate. It’s part of the race to the bottom on regulation that they facilitate.

    Richard Murphy

  6. Oct 08   14:46 Posted by hedgehog [report]

    for more of the same have a look at FT blog The Real Deal : beware the banks’ UFO’s - the financial markets are looking more and more like a pack of cards every day

  7. Oct 08   14:07 Posted by Charles Surface [report]

    Egads! I see your point!

  8. Oct 08   13:55 Posted by Tax Research UK / Northern Rock - rotten abuse of charity [report]

    […] The FT blog has a post on it that reproduces a statement from Down’s Syndrome North East, which says: […]

  9. Oct 08   13:18 Posted by bshopboy [report]

    btw this observer piece from a week ago (!!) is also very good

    http://observer.guardian.co.uk/business/story/0,,2179924,00.html

  10. Oct 08   12:53 Posted by bshopboy [report]

    So, this begs two questions:

    1. Why has it taken until after NRK’s collapse for this to be discovered - surely the relavant authorities should have been looking at it earlier? But I suppose they said that about Enron as well…

    2. Which other large organisations are using similar dodgy schemes, and shouldn’t the regulators be looking more closely into their SIVs and suchlike?

This post is closed to further comments.