Britain's government has asked two suitors competing to rescue Northern Rock to improve their offers in order to avoid the alternative solution of nationalizing Britain's fifth-largest mortgage lender.
The Virgin consortium has been told it is a front-runner, ahead of a rival "in-house" offer led by the bank's management team, Treasury officials said on Wednesday.
Both, however, have been asked to offer better terms, as the government would prefer a private deal but currently sees public ownership as a better option for taxpayers.
"Negotiations are continuing and all options remain open, including public ownership," a Treasury spokesman said, adding the government remained in "active discussions" with Virgin.
The Northern Rock debacle has become a major headache for Prime Minister Gordon Brown, tarnishing his popularity and denting the government's reputation for financial stability. The bank already owes taxpayers 25 billion pounds ($49 billion) and has been put on the government's books as some 90 billion pounds of debt.
Since the crisis broke in September, the government has said it would prefer a private solution, but both the Virgin and the "in-house" alternative are now public-private partnerships, as both depend on government guarantees.
"Virgin are ahead at the moment but they would need to improve their offer before the government is ready to do a deal," one source close to the talks said.
A spokesman for entrepreneur Richard Branson's Virgin said the group would continue to talk to the government about its proposal, but declined to comment further.
News that Virgin is ahead, though, will be a blow to the bank's larger shareholders who have said that proposal would significantly dilute existing investors' stakes.
The bank's volatile stock closed lower by 9.1 percent Wednesday at £95.50 a share.
A Better Deal?
The Daily Telegraph said the improved terms the Treasury hoped to extract included a larger share in any future upside, for example a larger warranty over the shares, and an improved fee for the government's deposit guarantee.
Both Virgin and the bank's management have already indicated they would give the government a share in future profits.
A significant improvement to the terms could prove difficult, though, given broader market conditions, including an uncertain outlook for the UK mortgage sector, bad loans and for
capital markets which, if they recover, could fuel faster growth.
Virgin, whose bid is led by former Lloyds TSB boss Brian Pitman and Virgin Money head Jayne-Anne Gadhia, plans to inject more capital and to rebrand the bank as Virgin Money.
The management-led alternative, led by former investment banker Paul Thompson, would keep the brand but would pull back from aggressive lending, halve the asset base and boost retail
deposits to bring the bank back to its healthy levels of 2003.
Virgin and the bank's management team submitted rescue plans for Northern Rock, Britain's biggest casualty of the global credit squeeze, last week. The government is expected to make a decision by the end of this month.