Hedge Funds’ Hopes For Bank Hit Rock Bottom

Feb 19 2008 | 12:00am ET

The big news across the pond is the British government’s decision to nationalize Northern Rock, the subprime-stricken bank, with hedge funds bracing to be the big losers.

Hedge funds poured millions into Northern Rock shares when the bank ran into trouble last year, expecting to profit handsomely in a sale of the bank. But the move by the British Treasury is likely to render their huge stakes all but worthless.

Northern Rock’s largest shareholders, hedge funds SRM Global and RAB Capital, with stakes of 11.5% and 8.1%, respectively, stand to lose in excess of £70 million (US$136.9 million) combined as a result of the government takeover.

The hedge funds are not expected to take the decision lying down. The Financial Times reports that SRM is preparing a legal case against the government, while RAB met with lawyers yesterday to consider its options. RAB CEO Philip Richards blasted the nationalization as “immoral.”

“It is extraordinary that the government, presented with a very credible package led by new management and backed by shareholders to the tune of £700 million (US$1.4 billion), has chosen to try to expropriate the bank for next to nothing,” he told the FT.

The government rejected a pair of rescue plans for Northern Rock because neither could guarantee the full repayment of the taxpayer pounds needed to prop up the bank. Under the terms of the nationalization, an independent arbitrator will assess how much the government must pay shareholders. Analysts are predicting a valuation of about £0.05 per share.

According to the FT, none of the aggrieved shareholders hold out much hope of stopping the nationalization, but instead expect to push for a higher valuation and to set a precedent preventing future such moves.

“I work on the front line in places like Kazakhstan and even there I haven’t experience expropriation of shares by the government,” hedge fund QVT Financial’s Angelo Moskov, whose firm owns about 1% of Northern Rock, said. “The importance of legal action is enormous, to remove the ability of the government ever to do this ever again.”

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