The process was completed in May 2016 and represents the UK government’s largest ever financial asset sale. The Committee finds UKAR “took advantage of good market conditions and strong investor demand” to sell loans to the value of £13.3 billion; the transaction was completed within a tight timeframe, and competitive tension between bidders was achieved.
However, the Committee is concerned by the lack of formal business case for the sale and that alternative sale options were not valued “until very late in the sale process”. It urges the Treasury to ensure formal business cases are produced for every asset sale, to include a timely valuation of all potential sale options, and that business cases be updated throughout the sale process.
Among its other conclusions, the Committee finds the valuations of the assets sold “erred on the side of caution and the assumptions on which they were based were not well evidenced”. This, says the Committee, created a risk that UKAR could have sold the asset for less than its inherent worth.
The Committee also highlights that the Treasury “did not consider the tax domicile and its impact on expected tax payments of bidders during the sale”, even though these could affect the overall taxpayer value of a transaction.
The winning bidder Cerberus has a complicated company structure with companies based in the Netherlands and the Cayman Islands. The Committee is concerned the Treasury’s approach in relation to tax put UK domiciled companies at a disadvantage and recommends that when an asset is sold, the Treasury “should require departments as far as possible to discount gains from tax avoidance that may be factored into bids.
“HM Treasury should also produce unambiguous guidance, for both selling departments and potential bidders on if, and how, tax will be taken into consideration as part of a sale or a contract award.”
Meg Hillier MP, Chair of the PAC, said “Achieving value for money for taxpayers must be the driving ambition of all public asset sales. There are valuable lessons the whole of government can take from the strengths and weaknesses of the sale process examined in our Report and the Treasury must ensure these are shared.
“In particular, government must put more work into establishing and maintaining solid foundations for asset sales. We would also like to see far greater clarity around the tax implications of proposed sales and how government will address the potential impact of these on the public purse.
“There were also consequences for individuals from this sale. Former Northern Rock customers whose mortgages were sold to Cerberus are paying more for these than those whose mortgages are still with UKAR. In future sales I would like to see stronger steps taken to protect affected mortgage-holders from the impact of subsequent changes to the Bank of England base rate – in whatever direction these may be.”
PAC REPORT SUMMARY
UK Asset Resolution (UKAR) took advantage of good market conditions and strong investor demand to sell £13.3 billion of former Northern Rock loans in the UK government’s largest ever financial asset sale.
The transaction was executed successfully within a tight timeframe. Competitive tension between bidders was achieved resulting in a final price that was slightly more that the outstanding value of the loans sold.
While there are many positives from the sale there are also areas for improvement particularly during the preparation phase: there was no formal business case for the sale bringing together in one document all the information needed to make critical decisions; the potential value of alternative sale options was not quantified before the transaction began; and the financial adviser was selected without an open competition.
HM Treasury should also have done more to consider the wider implications of the sale by scrutinising the impact on customers and tax revenues more thoroughly.
CONCLUSIONS AND RECOMMENDATIONS
There are lessons to be learned from this successful sale. This sale was over four times larger than any UKAR has previously conducted and involved a financing structure which increased the complexity of the transaction. UKAR and its advisers overcame these difficulties and managed the sale well. The assets, most of which were mortgages yielding over 4.5% interest, were attractive to investors. As a result, bidders competed against each other for the assets which resulted in a sale price above the par value of the loans. The Government is planning to sell more financial assets, including student loans and other UKAR mortgages. These loans may be less attractive to investors which may make achieving a good price more challenging. Ensuring competitive tension in these future sales will be a key part in achieving value for the taxpayer.
Recommendation: HM Treasury should conduct a post-sale review for this, and all other major sales, setting out lessons learned and ensure these are shared across government to increase corporate finance knowledge and skills.
There was no formal business case for the sale and alternative sale options were not valued until very late in the sale process. While numerous documents were produced by UKAR, UKFI and HM Treasury regarding different aspects of the sale, information was not brought together in a single document, or business case, to provide a comprehensive overview of all aspects of the sale. Alternative sale options were considered prior to the sale launch (in November 2014), but these options were only valued near the end of sale process (in September 2015) after bids had been received. Documents produced by HM Treasury and UKFI noted that holding the assets to maturity would have been positive for the public finances in the long term, but a hold valuation was not produced. We consider that the production of a rigorous business case for the sale would have made the omission of a timely valuation of alternative sale options (including the hold valuation) less likely.
Recommendation: HM Treasury should ensure that formal business cases are produced for every asset sale. These should include a timely valuation of all potential sale options, and be updated throughout the sale process. HM Treasury should develop business case guidance and a template specifically for asset disposals.
The valuations of the assets sold erred on the side of caution and the assumptions on which they were based were not well evidenced, creating a risk that UKAR could have sold the asset for less than its inherent worth. Valuations are important as they set a reserve price which has to be bettered for the asset to be sold – if the bar is set too low and there is insufficient competitive tension or there are poor market conditions, there is a risk of accepting an offer which does not reflect the true worth of the asset. In this case a well-run sale meant that this risk did not materialise. Nevertheless we are still concerned that some of UKAR’s assumptions had a conservative bias – for example, the assumed cost of equity that bidders would require was higher than in previous transactions. In addition, the documentation of the evidence used to inform and support UKAR and UKFI’s judgement in selecting the valuation assumptions was not transparent.
Recommendation: HM Treasury should ensure that hold and sell valuations are produced for all asset sales. The sell valuation should be from the perspective of a potential buyer, informed by market data on the cost and mix of finance that a buyer would use – if there are different buyer types it may be appropriate to produce more than one sell valuation. HM Treasury should consider setting up an independent panel of valuation experts for all major sales to review and challenge valuations in advance of all significant asset sales.
The process used by UKAR to appoint Credit Suisse as its financial adviser for the sale did not follow good practice. Credit Suisse’s fee more than doubled and there was a potential conflict of interest. Credit Suisse, which had previously advised UKAR on another sale, was selected to be UKAR’s financial adviser after a limited competition with two other firms. After Credit Suisse was appointed, when it became clear that the sale size would be larger than had been originally anticipated, UKAR agreed to increase the transaction fee from £2 million to £4.5 million without any competition. UKAR told us that it would not appoint an adviser in this way again, but considered that retendering would have delayed the transaction by at least six weeks which would have risked value for money. The large size of the sale meant that some of the bidders would need to borrow significant sums from banks to finance their bids. In order to maximise the pool of banks able to lend to bidders, UKAR allowed Credit Suisse to provide financing for potential bidders despite prohibiting this in an earlier sale due to the potential conflict of interest. Credit Suisse Asset Management, a separate legal entity within Credit Suisse, was also part of a bidding consortia which made the highest bid in the first round but subsequently pulled out due to a perceived conflict of interest.
Recommendation: HM Treasury should ensure that departments and arm’s-length bodies have an open competition to select a financial adviser. Sale advisers must be independent and not conflicted through involvement in other roles on the sale (such as financing or bidding). However, if there are exceptional circumstances where conflicts are unavoidable, there must be a clear rationale and plan in place to mitigate risks.
Ex-Northern Rock customers whose mortgages were sold to Cerberus are paying more for their mortgages than those whose mortgages remain with UKAR. The 0.25% Bank of England base rate cut in August 2016 was passed on in full from 1 September 2016 by UKAR to its ex-Northern Rock customers with Standard Variable Rate (SVR) mortgages. However, customers whose SVR mortgages were sold to Cerberus only received a reduction of 0.15%, from 1 October 2016. Cerberus told us that its funding model meant that it did not benefit from the base rate cut to the same extent as banks did and that as a result it could not pass on the rate cut in full to its customers. UKAR and UKFI structured the sale to give some protection to customers whose mortgages were included in the sale in the short term from interest rate rises, but they had not contemplated a rate cut so did not require purchasers to pass this on. Customers are able to switch mortgage provider, but some customers, particular those with an imperfect payment record, may find this difficult.
Recommendation: UKAR and UKFI should consider what measures should be put in place to protect customers from being disadvantaged by such sales. They should attempt to quantify the potential impact on the sales price of placing more comprehensive restrictions on future interest rate movements. The FCA should consider whether consumers would benefit from understanding how different types of mortgage lender set interest rates, and what this could mean for borrowers should the owner of their mortgage change.
HM Treasury did not consider the tax domicile and its impact on expected tax payments of bidders during the sale even though these could have an effect on the overall taxpayer value of a transaction. The winning bidder Cerberus has a complicated company structure with companies based in the Netherlands and the Cayman Islands. Cerberus said that if it had bid using a UK domiciled company it was likely that it would have paid more in tax but also less upfront for the assets. HM Treasury told us that it does not consider the tax domicile of potential bidders primarily because it would be open to legal challenge. Therefore no information was requested or calculated by HM Treasury on the expected UK tax impact of the sale. We are concerned that this put UK domiciled companies at a disadvantage. We note that in response to a previous report of this Committee, HM Treasury formally agreed that it was legitimate to prevent off-shore arrangements used in a transaction.
Recommendation: When an asset is sold HM Treasury should require departments as far as possible to discount gains from tax avoidance that may be factored into bids. HM Treasury should also produce unambiguous guidance, for both selling departments and potential bidders on if, and how, tax will be taken into consideration as part of a sale or a contract award.