Jeremy Warner's Outlook: Problems aplenty emerge in the great bank bailout
There's a problem Houston – the Lloyds dividend; Don't bank on bounce back in bank shares; Sir Philip Green to capitalise on decade of debt
Wednesday 15 October 2008
The United States authorit-ies are adopting a rather gentler approach to recapitalisation of the banks than their British counterparts. On the face of it, virtually all the $250bn (£143bn) earmarked in the US for recapitalisation will be injected via preference stock. There are warrants, but equity holders in US banks are left largely undiluted, unlike some of those participating in the British plan.
What's more, the capital is being offered on amazingly generous terms. Even in a bull market, banks would struggle to raise new capital on the 5 per cent coupon being offered by the US Treasury. Bankers can hardly believe their luck. They are being required to accept a number of quite undemanding curbs on pay, but otherwise the capital seems to be almost condition free. I know it's unfashionable to raise the issue of moral hazard in these enlightened times when bailing out bankers is seen as part of our national duty, but this is ridiculous.
Directors of Goldman Sachs, which is taking $10bn of the new preference stock, must be thinking how wise they were to get their own man in at the US Treasury. Before becoming Treasury Secretary, Hank Paulson was chairman of Goldman Sachs.
There's a problem Houston – the Lloyds dividend
The dividend curbs being demanded by the Government as a condition of its bailout package are becoming a major issue at Lloyds TSB. Unless the Government relents, it could yet prove a deal breaker in the mooted merger with HBOS. Several big-income investors in Lloyds TSB have begun openly to question the wisdom of the merger, which has locked Lloyds into curbs on dividends similar to those agreed by Royal Bank of Scotland (RBS). They thought they had bought into a high-yield income stream, but instead find their board is taking a three-year punt on HBOS.
If it hadn't been merging with HBOS, Lloyds TSB would have gone the same route as Barclays in attempting to raise the new capital from private investors, and could thereby have had a freer hand with dividend payments. Lloyds TSB thought it was being helpful to the Government in agreeing to be part of the solution for HBOS. Instead it finds itself penalised, unfairly in the view of its investors. It has already won some concessions. Unlike RBS and HBOS, it is still allowed to pay cash bonuses to executives. There are two ways out of the dividend problem. Either the Government could relent, and let Lloyds resume dividends at pre-announced levels. Politically, that would be difficult, as it would look like the Government paying in capital only to see it paid out again to private investors. The better way might be to let Lloyds try to place the preference part of the capital itself, as Barclays is attempting to do. This might free the bank from dividend curbs on the ordinary shares.
Banks used to account for getting on for a third of the entire dividend income of the FTSE 100. That's about to be severely curtailed by the terms of the Government's bailout. Investors might have adopted a different view on subscribing to the ordinaries if they were packaged with the preference stock, which will carry a mouth-watering 12 per cent coupon. Yet under the terms agreed, the prefs are not on offer. They are wholly reserved for the Government as part of its pound of flesh for all the support it is being obliged to give the banking system. In any case, the Lloyds TSB/HBOS merger, trumpeted as a brilliant piece of opportunism by Lloyds' chairman, Sir Victor Blank, is not looking nearly so clever now, even on the reduced terms.
Certainly, it is proving very damaging to the Lloyds TSB share price, which has been heading south ever since plans for the "superbank" were announced and was again trounced yesterday. As with all Government intervention, the law of unintended consequences is fast setting in. The dividend is not the only problem. As long as there is no lock-in on the Government's shareholding, the shares will remain depressed by the overhang of what ministers insist will be a "temporary" investment.
Don't bank on bounce back in bank shares
Hope springs eternal when it comes to investment, but the idea that with a following wind from stock markets, RBS might avoid public control, with its own shareholders putting up all or a major part of the £20bn being raised instead, strikes me as fanciful.
For a start, the size of the fund-raising is just too big for the City to digest in one gulp. No one is going to invest if the price is below the 65p a share the Government has agreed to subscribe at, but even if the price settles a good way above this level, there will still be only limited interest.
One of the reasons for this is that for the next couple of years at least, and possibly a great deal longer, there are going to be no dividend payments on the ordinary stock. Banks used to be in huge demand from income investors, but that attraction has now been vapourised.
The other big deterrent to taking up any rights is that whatever happens, the bank is highly likely to end up controlled by the Government. Despite what Sir Tom McKillop, RBS's discredited chairman, says about operating at arms length on a fully commercial basis, this is plainly not going to be the case. Agreement to hold small- and medium-sized business lending at last year's levels is a politically dictated, non-commercial undertaking that will undoubtedly lead to sub-optimal risk-reward judgements as the economy heads into recession. The Government also gets a say in the appointment of "independent" directors.
Finally, there is the issue of what RBS and other banks are going to become. At this stage, no one knows. The only thing that seems certain is that Sir Fred Goodwin's dash to build a substantial capital markets business will be put sharply into reverse. In any case, RBS and other banks are going to remain highly uncertain investments for several years to come.
There is a good reason RBS trades at little more than 20 per cent of book value and that's because the asset quality is thought, rightly or wrongly, to be exceptionally poor. This may be the buying opportunity of a lifetime but major investors are going to remain wary until they know just how poor.
RBS and HBOS are not so much lessons in corporate governance failure as in the fact that banks are dangerous and complicated animals that need people at the top who know what they are doing. Both banks ticked all the right boxes for corporate governance practice, but crucially, both had non-bankers as chairman, and HBOS even had a non-banker as chief executive.
As Sir Tom McKillop has insisted in the past, he's no patsy, but nor, self evidently, did he know much about the risks of banking. His main qualification for the job seemed to be simply that he was Scottish and available. Despite all the warnings, he allowed an overly powerful chief executive to run rings round him.
Sir Philip Green to capitalise on decade of debt
With characteristic chutzpah, the retail financier Sir Philip Green has seized the moment to try to gain control of Baugur's string of UK retailing assets. Good luck to him. Sir Philip had the foresight to make himself personally debt free going into the downturn. Those without debt now have the opportunity of a lifetime to reap rich rewards at the expense of those still geared up to the gills.
But please spare us the sanctimonious lecturing on the credit-fuelled excess of recent years. Sir Philip built his empire on leverage, and I'm not talking here about the credit card spending of the young women who go to Topshop every weekend. Sir Philip's genius was largely in persuading bankers – including the now beleaguered HBOS – to lend him the money to buy his businesses.
Others who came after him took the leverage buyout trend to extremes, but Sir Philip was one of its original pioneers, a creation if you like of the easy credit of the past 10 years. To pay it back, Sir Philip thrashed his suppliers and mortgaged his properties.
You have to wonder what would have happened to Marks & Spencer had Sir Philip's mooted bid, again financed largely by debt, succeeded. If still geared at anything like the level implied by the bid, it would be deep in the do-do. Sir Philip rode the wave, but had the good luck or sense to duck out of it before it broke. Now with the cycle turning dramatically down, he's sitting pretty and preaching the virtues of thrift. You have to laugh.
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