JC Flowers, Cerberus eyeing Northern Rock: sources

Northern Rock's advisers are in talks with U.S. buyout firm JC Flowers over a rescue bid for the stricken UK mortgage bank, as U.S. firm Cerberus also considers a move, sources familiar with the matter said.

News that at least two potential bidders remain interested lifted Northern Rock's battered shares by over 14 percent in early trade on Wednesday.

JC Flowers, founded by former Goldman Sachs banker Chris Flowers, has secured more than 15 billion pounds ($30.6 billion) in funding that could be used in a takeover of the UK lender, one of the sources said, largely to refinance loans.

Flowers is currently doing due diligence work, a process set to take weeks as pressure increases from all sides for a quick solution to stem losses and damage at the bank, the source said, adding funding arrangements were contingent on that work.

The objective here is not break-up, more to keep the thing together and make it work, the source said.

Breaking up a bank like this would be a three, four-year operation... You would have to have a very cogent plan for how you would do that.

Another of the sources said private equity firm Cerberus was also still interested, though it could aim to break up Britain's fifth-largest mortgage lender.

Northern Rock shares, down almost 90 percent from the start of the year, were up 10.6 percent at 150.4 pence at 1140 GMT, recovering from a record low of 112p on Tuesday. The shares earlier hit 154.9p, valuing the bank at 630 million pounds.

The business is almost certainly going to be taken out or split into parts, so ultimately the question is what price is it worth, said James Hamilton, analyst at brokerage Numis.

The best price for equity shareholders will arrive if there are multiple people interested in acquiring it. I suspect that as the general quality of the assets is pretty good there will be competing bids for various parts of the group, if not for all of it, he added.

NEW ROCK ADVISER

Northern Rock said it had appointed U.S. investment bank Citigroup to work alongside Merrill Lynch to advise it. It said it continued to consider a range of options, but declined to comment on specific details.

JC Flowers and Cerberus also declined to comment.

Several bidders expressed an interest in Northern Rock after its troubles in the wholesale funding market escalated last month, forcing the Bank of England to extend an emergency loan facility. But most suitors have since pulled out.

A trade sale of the bank in its current form to a UK rival is now seen as increasingly unlikely.

Analysts say refinancing the mortgage book remains the key issue for any buyer, with the bank's funding running off at 1.5 billion to 2 billion pounds a month. The book is also running down as maturing products are not being re-marketed.

We continue to struggle to see how JC Flowers creates value from such a transaction, Royal Bank of Scotland analysts said in a note. The key problem for any bidder remains the current cost of funding versus the pretty much locked in yield on the mortgage portfolio which creates a negative spread.

A potential buyer would also need to persuade credit rating agencies not to cut ratings further in the event of a sale, in order to stave off further funding problems.

But it is unclear whether a suitor would be able to count on a guarantee of financial support from the government -- keen to avoid more political damage from the crisis -- beyond the promise by the Bank of England to grant a buyer access to Northern Rock's existing emergency loan facility.

Bondholders are also watching the situation closely, with as many as 100 investors taking part in a conference call on Tuesday organized by investment bank Houlihan Lokey, which is advising holders of Northern Rock's tier-2 debt.

The call was a first step towards forming a committee by Thursday, one of the sources said. Tier-2 debt, which legally comes ahead of tier-1 in the queue to receive money in times of trouble, is worth about 2 billion pounds.

News of private equity suitors for Northern Rock pushed up the cost of insuring the bank's debt against default.

Five-year credit swaps widened by 25 basis points to 210 basis points, meaning it costs 210,000 euros a year to insure 10 million euros of the bank's debt against default.

(Additional reporting by Steve Slater, Elena Moya, Natalie Harrison, Mathieu Robbins and Tim Pearce)