RPT-UPDATE 3-Northern Rock Bidders Told to Improve Offers

(Writes through with details, N.Rock comment, updates shares)

By Sumeet Desai

LONDON (Reuters) - Britain has asked two suitors competing to rescue Northern Rock NRK.L to improve their offers or it will nationalise Britain's fifth-largest mortgage lender -- an option the government would rather avoid.

A consortium led by billionaire Richard Branson's Virgin group has been told it is a front-runner in the race, ahead of a rival "in-house" offer led by the bank's management team, Treasury officials said on Wednesday.

Both bidders, however, were asked to offer better terms because they did not offer a good enough deal for the taxpayer.

"We are in intensive discussions with Virgin but all options remain on the table," finance minister Alistair Darling told BBC radio. "Of course the option of a short period of nationalisation has to remain on the table."

The Northern Rock debacle has become a major headache for Prime Minister Gordon Brown, tarnishing his popularity and denting a 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.

However, a significant improvement of the bidders' terms could prove difficult, given difficult financial markets and an uncertain outlook for the UK mortgage sector and bad loans.

Britain has sought to avoid the political embarrassment of putting Northern Rock into public ownership, but Treasury officials warned on Wednesday that unless terms were improved, nationalisation was currently seen as a better option.

Several sources familiar with the negotiations, however, said the government had little appetite for an actual nationalisation, and was instead hoping to pressure the two suitors to sweeten their proposals.

One high profile bidder, investment group Olivant, has already quit the race, blaming the difficulty in satisfying all stakeholders in Northern Rock.

"They're using nationalisation as a stick," one source said.

A BETTER DEAL?

"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 Virgin said the group would continue to talk to the government about its proposal, but declined to comment further.

Northern Rock said the in-house team was also in ongoing talks with the government about its proposal.