Northern Rock: politics, investors, customers collide

Take a government under fire and a deepening global credit crisis, add in Britain's best known businessman, fears that a major bank could collapse and the battle for Northern Rock becomes a complex cocktail.

LONDON (Reuters) - Take a government under fire and a deepening global credit crisis, add in Britain's best known businessman, fears that a major bank could collapse and the battle for Northern Rock becomes a complex cocktail.

It's two months since Northern Rock NRK.L, Britain's fifth biggest mortgage provider, was forced to get emergency loans from the Bank of England, and billionaire entrepreneur Richard Branson is leading a consortium picked to rescue it.

Branson's Virgin Group is backed by some heavy hitters, including insurance giant AIG (AIG.N) and restructuring expert Wilbur Ross.

It wants to seal a deal as quickly as possible to limit further damage to Northern Rock. It's conducting due diligence and aims to formally make its offer by Christmas.

Virgin is now viewed as the strong favourite to land the deal, but that's not assured. Northern Rock and its advisers are still in contact with other potential suitors, but they are seen as fallback options.

A person close to one other suitor said: "They still take our calls but it has been made clear to us that Virgin are on an accelerated process."

Virgin's edge is its popular brand -- important to reassure retail savers -- and a well advanced proposal offering a chunk of cash for the government, safeguarding most jobs and something for shareholders.

But some disgruntled investors, a real funding challenge and lingering political issues could still unravel the proposal.

FINANCING CHALLENGE

Rival bidders are waiting in the wings, not all patiently. Some, as they mull their options, are considering revamping their proposals in the hope of breaking back into the auction.

U.S. buyout firm J.C. Flowers was regarded as the frontrunner to land a deal, and remains interested.

Investment firm Olivant is playing catch-up after entering the race late. It feels it hasn't had access to the same information as rivals, but is confident that doubts about its financing are misplaced.

The firm, which would parachute in new management led by former Abbey National boss Luqman Arnold, held talks with the Bank of England, Treasury and regulators on Monday, hours after Virgin had been unveiled as preferred bidder.

Olivant also appears to have support from Northern Rock's two biggest shareholders, who have said the bank can be saved as a going concern and investors should get a say in the outcome.

Hedge funds SRM Global and RAB Capital have lifted their combined stake over 15 percent this week. Virgin's proposed rights issue would substantially dilute their shareholdings.

But they have been told that without a deal Northern Rock could go into administration and investors lose everything.

The government's main priority is to shield taxpayers from any losses, after bruising criticism of its handing of the crisis since it erupted on September 14.

Virgin will immediately repay 11 billion pounds to the central bank and pay back the rest within three years. The BoE is estimated to have lent Northern Rock about 25 billion pounds.

Virgin says it has liquidity financing lined up for 15 billion pounds, believed to be from Citigroup (C.N), Royal Bank of Scotland (RBS.L) and Deutsche Bank (DBKGn.DE).

Bankers warn raising so much will still be a big task and expensive in current markets, as interbank lending rates have continued to ratchet higher in recent weeks.

The gloom in financial markets also appears to be deepening and with banks appearing to hoard cash before the end of the year a quick fix seems unlikely.

Against an uncertain political, investor, financing and customer backdrop Northern Rock shares have bounced between 70p and 135p this week, and by midday on Thursday were holding around 118p, valuing the bank at 500 million pounds.