Tell Sid we might need him to buy our banks

Nationalisation is hard enough, but it's reprivatisation that the Treasury is most worried about.

By Richard Northedge
Sunday 25 January 2009 01:00

One of the reasons the Treasury is resisting growing calls to nationalise Royal Bank of Scotland and the new Lloyds Banking Group is that officials are worried about re-privatisation. Treasury officials admit privately that if the Government did nationalise the banks, selling the state's holdings later would be a bigger and even more difficult task than any of the privatisations of the 1980s.

Ironically, perhaps, some of the City's top bankers argue that if the banks were taken into full public ownership then privatisation would be more staightforward, as well as making the interim management easier. Jon Moulton, venture capitalist and founder of Alchemy Partners, has added his voice to the calls, arguing that nationalisation is the only way to remove the uncertainty hanging over the banks.

Even the Government's move at Royal Bank of Scotland last week did not do much to bolster confidence, as the shares collapsed. But after agreeing to raise its stake in RBS from 58 to 70 per cent, buying out the minority shareholders at the current stock market price would cost a mere £2bn. As taxpayers have already invested £20bn on a stake that is now worth less than £5bn, purchasing the rest of the equity could be a cheap way of simplifying the Treasury's holding.

Buying the outstanding 57 per cent of Lloyds Banking Group, the business created by last week's merger of Lloyds TSB and HBOS, would cost another £2bn following the rout in its shares. Although Lloyds is opposed to the Government increasing its stake, the bank, like RBS, must pay a fee to join the bad-debt insurance scheme announced by the Treasury last week. And unless it can find the cash, that payment could mean issuing more ordinary equity or preference shares.

One problem the Treasury faces in running two major quoted banks is the conflict of interest. At the start of the credit crunch in mid-2007, there were eight retail banks in the FTSE 100; now the state is the largest shareholder in five of them – RBS, Lloyds TSB, HBOS and the fully nationalised Northern Rock and Bradford & Bingley loans business. With Alliance & Leicester bought by Santander of Spain, only HSBC and Barclays remain independent, and the latter is largely owned by Qatar and Abu Dhabi investors following its own recapitalisation.

The Office of Fair Trading's investigation into the competition effects of merging HBOS and Lloyds was curtailed last year when the Government used legislation to expedite the deal. But any concerns over the two major banks uniting are multiplied now the state controls so much of the sector, especially after last week's decision to expand Northern Rock again.

Alistair Darling has established a company, UK Financial Investments, to hold the nationalised bank stakes and prepare them for privatisation. But while the Chancellor insists that UKFI operates at arm's length from the Government and that a majority of its directors are independent, he has already dictated conditions on matters such as boardroom pay, dividends and lending policies.

Vince Cable, the Liberal Democrat economics spokesman, is among those who think full nationalisation could remove the need for arm's-length management and allow ministers to force the banks to start lending again. "With RBS now 70 per cent publicly owned, there can be no more excuses for it not to start lending at reasonable levels to viable businesses and individuals," he says.

Sainsbury's chairman, Sir Philip Hampton, was named last month as chairman of UKFI, with Treasury civil servant John Kingman as its chief executive. Sir Philip insisted his job was to manage taxpayers' investments rather than to manage the banks, but this month he was plucked away to chair RBS instead, with Glen Moreno, chairman of the Pearson publishing group, taking his place temporarily.

John Crompton, a former Merrill Lynch and Morgan Stanley banker, has been recruited to UKFI to deal with Lloyds and RBS and is currently drawing up an exit strategy.

The conflicts in owning so many banks that are meant to compete with each other makes a speedy realisation sensible, but few expect this to happen. Ministers will be unwilling to sell until they can recoup the huge losses incurred on the quoted investments, and with bank shares still falling, no sale this side of an election is expected. Many believe the state will be a bank shareholder for the next decade.

The Treasury invested £15bn in RBS at 65.5p a share last November and last week converted its additional £5bn of preference stock at 31.25p a share, but the shares closed the week at just 12p . Lloyds shares bought this month for 173.3p are now worth only 49.3p. With both banks, the Government suffered by agreeing to buy shares at a fixed price in a falling market, and there are fears it could lose again when it sells the shares if the banks remain listed.

The privatisations of the 1980s and 1990s involved monopoly businesses that were 100 per cent owned by the state, such as water, rail, steel, telecoms and airlines.

If RBS and Lloyds remain quoted, Mr Crompton will face trying to sell huge stakes in the company while the stock market price moves, possibly down because of the huge overhang of equity about to be sold. He will have to decide which bank to sell first but not let that sale damage the market and make it harder to sell the other.

Even at today's depleted prices, the two banks are valued by the stock market at about £10bn. But in order to sell at a profit, the Government needs them to be valued at more than £35bn, which would make this by far the largest UK privatisation.

City bankers are comparing Mr Crompton's task with the disposal of the Government's final stake in BP in 1987. Although that was a minority holding, it was worth £7.3bn. After a marketing campaign aimed at small investors, the Government announced a fixed offer price, but then, between pricing and closure, came the "Black Monday" stock market collapse and underwriters pleaded to cancel the sale. Ministers refused but the Bank of England had to provide a buyback facility. The Kuwaiti Investment Authority used the low price to snap up a 22 per cent stake in the oil company and the Monopolies Commission had to force it to resell, causing a diplomatic tiff.

The only recent privatisation of a listed firm was this month's acceptance of EDF's takeover of British Energy. Mr Crompton can't rely on a similar bid for Lloyds or RBS, however, and he can't afford another BP.

Because UKFI is outright owner of Northern Rock and Bradford & Bingley, it can seek a trade sale. Taking RBS or Lloyds into full ownership would allow those banks to be sold more easily too.

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