Northern Rock again: why Granite isn’t that hard

If the Northern Rock debacle has done nothing else, it’s certainly given a lot of people a great opportunity to rant about things they don’t understand. The latest example is Granite, the name used for a collection of Special Purpose Vehicles [*] and associated companies [**] used by Northern Rock.

According to hard-left MP John McDonnell, Granite “holds approximately 40% of Northern Rock’s assets, around £40bn… where Northern Rock’s best assets sit outside the reach of taxpayers. So the bill to nationalise Northern Rock will, in fact, be nationalising only dodgy debt“.

The good folk of Commentisfree have gone even further to town, uniting socialist idiots and right-wing idiots alike in a chorus of “someone somewhere has carried out a rather large fraud and I would like that someone prosecuted“-type comments.

There’s only one tiny problem with this kind of commentary: it’s bollocks. The mortgages in Granite are exactly the same quality as the mortgages that stayed in NR, nothing untoward took place anywhere along the line (well, not involving SPVs), and NR isn’t liable for Granite’s debts.

We’ll buy, you’ll sell

At the beginning of 2007, the Granite companies owned £42 billion worth of mortgages managed by, and originally sold by, Northern Rock. Granite paid Northern Rock for these mortgages using £39 billion worth of bonds, which it sold to third-party investors for cash. This began in 1999 and was a deliberate strategy to allow Northern Rock to grow, not as some kind of sudden “quick, let’s hide the money!” racket.

The reason for selling mortgages to SPVs is that it means Northern Rock is no longer responsible for them. If the holders of mortgages that are owned by Granite can’t pay the loans back, then Northern Rock is under no obligation to compensate the investors in Granite bonds out of the rest of its assets. Therefore, the loans don’t count against NR’s capital for regulatory purposes (they do appear on its published financial statements, for reasons too dull to go into).

The assets that are purchased by the SPV are whole mortgages, not complex tranches of low-risk-ness versus high-risk-ness. Note also that the condition attached to the loans in the SPV – i.e. maximum 95% LTV, lower for higher-value loans, and can be varied at NR’s discretion – is exactly the same as for the mortgages that were kept in-house. In other words, concerns that the SPVs have cherry-picked NR’s finest mortgages and left it with the dross are complete nonsense [the linked document is just the most recent of NR’s securitisations – here’s more detail than anyone would ever need to know about the whole lot of them. If it transpires the conditions in any of these are materially different in a few of these from the random sample I’ve looked at, mine’s a hat sandwich…]


Using SPVs was a sensible way for a bank to protect its shareholders and depositors, at least as long as people were willing to invest in new SPVs (which they aren’t, any more, but that’s not a problem for the existing loans – Northern Rock isn’t financially liable for the Granite bonds, and they don’t fall due for another 20 years [***]).

The tax and charity issues are an utter red herring: barring exceptional circumstances, the SPV won’t incur any tax liability and won’t make a net return to be paid out to anyone. The charitable trust thing is simply because someone needs to be the legal beneficiary, even though it is structured so that no actual benefits will ensue, and if that beneficiary were the arranging bank rather than an arbitrary charity then there is a small chance it could make things (even) more complicated.

Northern Rock’s collapse had nothing to do with Granite – rather, the mortgages that it did still have in-house, and hence were still a risk to its shareholders and depositors, were funded by short-term commercial borrowing. When this source of funding dried up during the credit crunch, NR had no way of paying back its lenders.

Nothing to see here

While the use of SPVs means that you need to have some knowledge of finance to understand what’s happening in NR, the net result is not to defraud the taxpayer or to lose everyone money.

Everyone who bought NR shares or bonds knew the structure, as it was explained in some detail inthe annual report and in momentuous amounts of detail in the SPV prospectuses that NR also made available on its website. So did the BoE, FSA and regulators – in short, all the conspiracy theorists are simply talking gibberish.

The reason Northern Rock collapsed is because it borrowed too short and lent too long. That is all. The trappings associated with being a 21st-century financial services institution make the details harder to grasp, and create scope to see malice and fraud where there is none, but they don’t change the underlying story in the slightest.

Update: as might be expected, blogland’s biggest idiot has entered the fray with more cluelessness. HMG has guaranteed NR’s limited buyback obligations to Granite; it has not guaranteed Granite’s debt. This is simple stuff…

[*] Thanks to Andy in comments for pointing out that an SPV is not the same as an SIV. SIVs are the things which went bust in the US; SPVs are a general term for ‘off balance sheet’ (although literally, they tend to go on the balance sheet these days) financing

[**] Some of the companies were registered offshore, although most were registered in England and Wales

[***] Technically, there’s a five-year ‘expected maturity’. However, legal maturity isn’t for 25-30 years from loan tate (with the earliest 30-year loans from 1999 falling due in 22 years or so), and that’s the only point when Northern Rock is expected to bail out bondholders if things have gone terribly wrong – except that by then, all the mortgages will have been paid back or written off. The five year ‘expected maturity’ merely means that Northern Rock has to pay trivial (by comparison with asset size) penalties and annoy Granite bondholders a bit – it cannot be compelled to buy the bonds back. This FT blog explains exactly what NR’s residual liabilities to Granite are.

18 thoughts on “Northern Rock again: why Granite isn’t that hard

  1. So if I understand things correctly, Granite acts like Fanny Mae and Freddie Mac by buying mortgages from NR and thereby releasing capital back to NR to lend out again to homebuyers.
    btw rofl about your reply to Kay Tie on Tim Worstall's blog about her qualifications as a patronising arse!

  2. Spot on. Maybe it might be better to distinguish the Granite special purpose vehicle (SPV) from the disaster area that is the SIV (structured investment vehicle) market which leverages longer-dated assets and funds using short term ABCP?

  3. More to the point, it was never a secret – anyone who cares can see it in the annual reports. Richard was the first person to tell hysterical lies about its impact, true…

  4. Good work , JB. I suppose the embedded put in the SPV's, which I think forced the government to guarantee them, is just a technicality because of what you say about the legal maturity being beyond the term of the loans involved…

    The gov have made their position worse by pretending a profit will be realised from this. Given the fact that depositors will flee en masse immediately the guarantee is removed, I find it difficult to envisage what they will ever have to sell. Ironically, the exit route would appear to be to sell [give] the operation to the depositors – in effect a re-mutualisation. And whatever body replaces the entirely useless FSA needs to issue a tiered structure of guarantee levels to inform depositors of the risks run by what they perceive to be instiututions, but in the Rock case proved to be a reckless structure run by naive or/and greedy chancers.

  5. JB, clarification request: you said that "Granite paid NR with bonds which it issued for cash", do you mean

    a) third party gave cash to Granite in exchange for bonds, and Granite gave cash to NR – in which case NR is well out of it,


    b) Granite gave bonds to NR in exchange for mortgage assets. In which case, nothing has really happened – instead of borrower owing money to NR, the borrower owes money to Granite, which in turn owes money to NR?


  6. A, not B. I don't think NR owns any Granite bonds at all; if it does, then they're not a significant proportion of Granite's total debt / NR total assets. Have updated the piece to clarify. (update – see the FT piece for an exact calculation of what NR still owes Granite)

  7. Well, if it's option A, then from NR's and the taxpayer's point of view, this is excellent news!

    If NR could only flog off all its mortgage assets for cold hard cash for 93% of their face value, then that would be A Good Thing.

  8. John, there was a third Granite deal in 2007 (Granite Master Issuer 2007-3) which priced in September when the shit was already hitting the fan, both for NRK and the securitisation market as a whole. It was for £5bn, had maturities from 1 to 3 years and was retained by the bank to use as collateral at the BoE's emergency funding window.

  9. I may well be the biggest idiot in blogland, but where do I posit anything more than that the guarantee is of ".. all obligations of Northern Rock plc to make payments on the repurchase of mortgages under the documentation for the 'Granite' securitisation programme."

    Which isexactly what you confirml, what the Treasury said and what I understood.

  10. Granite's debt is not part of the taxpayer's exposure. The repurchase programme is. You're implying that there is some inconsistency in Yvette Cooper's position from saying the former. This is silly.

  11. OK, I get it, Granite just a tax efficient way for NR to get the cash now and slip the risk elsewhere. What I don't get at all is why HMG are buying us all a bank? What's wrong with letting it collapse? Its just a bank.

  12. "why HMG are buying us all a bank?" … its to hide the fact that Gordon Brown's 1997 restructuring of banking regulation was a crock of shit.

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