Business Outlook: The crucial role of capital excesses

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The Independent Online
IT'S CALLED "excess capital" and apparently anyone who's anyone has oodles of it these days. The utilities had it in bucket fulls; banks seem to have it by the lorry load. Why, most companies worth the name have some degree of it. Companies that don't will find shareholders want to know why. Unless there's a good growth story to tell, the stock market is prone to think the lack of it indicative of management failure.

Let's not dwell too much on the reasons for this phenomenon, which are well rehearsed. Falling long-term borrowing costs, better management and more efficient use of capital are the chief factors. The question is less where it came from as what to do with it. Once upon a time managements used to be able to get away with pouring it into uneconomic investment and acquisitions. Very few can hope to do that now and survive.

So the easy course is simply to give it back to shareholders and let them make the hard choices on how to reinvest it. That's what most managements are doing. The corporate philosophy of our time is stick to your knitting, and if you cannot find an economic use for your money, let the capital markets do it for you.

Ambitious managements are still prone to stray, however. Indeed, they'd hardly be worth backing if occasionally they didn't come up with a good alternative. So what should the converted building societies be doing with their excess? Because until recently they've been locked into mutual ownership, unable either to spend or give away their accumulating capital, they've now got rivers of the stuff to dispose of.

A recent circular from Salomon Smith Barney estimated this surplus at more than pounds 6bn for the big three alone (Halifax, Alliance & Leicester, and Woolwich), a figure which seems to be broadly confirmed by Woolwich's own estimate of its excess announced with figures yesterday.

This is normally a highly dangerous position for managements to be in. The risk of profligate expenditure is obvious. As a consequence, the markets are demanding the money is returned as quickly as the converted societies' tax positions allow. With building societies there is a further factor that pushes them down this route; if they buy anything, they lose their five year protection under the law from hostile takeover and as a consequence immediately become a bid target themselves.

All the same, both John Stewart at the Woolwich and Mike Blackburn at the Halifax, talk merrily about finding other uses for the money, including acquisitions. With its special dividend and planned share buy-back, Woolwich is promising to deliver the maximum of its excess back to shareholders its tax position allows this year. Even so, that still leaves more than pounds 500m of surplus lying around in the Woolwich coffers without a use. If he can find the right acquisition, Mr Stewart would happily give up his protection to pursue it. The same is true of Mr Blackburn. The trouble is that with valuations at present levels, it's hard to see what either of them could buy that would deliver value to their shareholders.

For the time being, most of the converted societies seem to have reasonably plausible independent strategies. But looking beyond the five-year horizon, it is hard to see how all of them can hope to remain stand alone companies. Halifax is large enough to lead in the consolidation of retail financial services everyone is predicting. But what of Woolwich and Alliance & Leicester? The betting must be that they will find themselves part of a larger organisation. On what terms that happens depends crucially on how they perform in the meantime, including how they marshal all that surplus capital.

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