Jeremy Warner's Outlook: Bankers are desperate for more funding. So why are they paying bumper dividends?

Institutions must act on stock lending; Rentokil pays high price for dream team

Friday 21 March 2008 01:00 GMT

The media circus that surrounded the Governor of the Bank of England's meeting with senior bankers yesterday to discuss the turmoil in financial markets was in danger of feeding the very crisis the bankers are hoping to avoid, so at the close of the fireside chat, everyone agreed to say as little about it as possible.

Yet you didn't need to be a fly on the wall to know what would have been said. The bankers would have demanded that the Bank of England act like the Federal Reserve in the US, and through its statements and actions show that it is willing to do everything within its powers to solve the funding problems in credit markets.

More specifically, they would have urged the Governor to go beyond the £10.9bn of money market operations announced yesterday to provide almost unlimited term money secured against much wider collateral than has been allowed in the past.

Despite the high moral tone he adopted at the outset of the crisis, the Governor may no longer need much persuading. Already he's loosened the rules on collateral and provided quite a bit of term money. He appears more than willing to do more.

Yet he will also have given the bankers a severe ticking off. On two occasions now, he's publicly urged bankers to take steps to strengthen their balance sheets, so that capital ratios can be maintained and lending supported amid deteriorating credit quality. Far from listening, bankers seem deliberately to have contradicted him, both by saying they don't need any more capital and paying inflation-busting increases in dividends to demonstrate the point.

Like the markets, the Governor believes they are in a state of denial. There is also something faintly disturbing about the sight of bankers desperately crying out for funding from the lender of last resort on the one hand while simultaneously paying out record dividends and bonuses on the other. Obviously there is a difference between the two things. Liquidity is not the same thing as capital. It is quite possible for banks to have an absence of one while simultaneously having a surplus of the other. For bankers, there is no greater sin than cutting the dividend. Indeed, if you are going to raise more capital, it may help sugar the pill if shareholders at least know that the dividend is underwritten.

Even so, to most people, the difference between an absence of funding and capital looks technical and largely irrelevant. Logically, a bank which is desperately short of funding shouldn't be signing a £1bn dividend cheque.

Though bankers lecture their customers on the disciplines of the market, they don't expect to suffer its consequences themselves. Whenever there is a sickness in the system, even when it is one of their own making, they expect the authorities to come riding to the rescue.

Because of the central importance of banks to the economy – they are the plumbing that keeps the whole thing going – the authorities have little option but to oblige. Banks will require a lot more medicine before the fever goes away. Until the US housing market convincingly bottoms out, so that investors can be sure of the level of defaults and consequent losses, the credit markets will continue to look sick and bankers will also continue to hoard their cash against rising impairment charges.

The securitisation markets won't come back until debt has been convincingly repriced and the wrecks have been fully exposed by the receding tide. Though Bear Stearns may have marked the nadir of the crisis, the banking system is likely to remain on the critical list for months to come.

Institutions must act on stock lending

Time was when it was illegal to short banking shares, the idea being that confidence is so vital to the health of the banking system that anything that might undermine it should be strongly discouraged.

With today's global markets, I'm not sure it would ever be possible to reintroduce such a rule. Someone, somewhere would find a way of doing it. Yet the trouncing of Bear Stearns and the failed attempt to do the same thing to HBOS may call for extreme measures. Certainly, all institutions that provide the stock lending that makes shorting possible need urgently to re-examine their procedures and properly to model whether there is any advantage to their long-term investors in providing this service. It is hard to see how there can be.

The practice also self evidently opens the flood gates to scaremongering abuse when market conditions are as nervous as they are at the moment. There is a simple solution to the difficulty regulators have in pursuing the abuse: close down the mechanisms through which the miscreants practise it.

Every time there is a serious banking crisis, a mass of new regulation is introduced, which is then slowly dismantled as the lobbyists gets to work and the reasons for the rules are lost in the mists of time. Then there is another banking crisis and it all has to be reinvented.

Rightly or wrongly, there is going to be a pile of the stuff reimposed after the latest implosion. Lawmakers need to be careful they don't throw the baby out with the bath water, yet confidence in the banking system, now wide open to the abuse of scaremongers, plainly has to be bolstered somehow or other.

Rentokil pays high price for dream team

Brian McGowan spent so long agonising over who to appoint to run Rentokil Initial after engineering the dismissal of its founder, Sir Clive Thompson, that it was widely said he must have been trying to keep the job for himself. Yet though he no doubt enjoyed the trappings of the chairmanship, the reality was that he couldn't find anyone stupid enough to drink from such a self evidently poisoned chalice.

In the end he opted for Doug Flynn, a great guy but a wholly inappropriate choice. Mr Flynn's background was in newspapers and advertising, not rat catching and logistics. All in all, it was a quite exceptional result. Mr Twenty Per Cent was replaced with Mr Minus Twenty Per Cent. Worse, in fact, as the McGowan/Flynn partnership has since succeeded in halving the share price in a period when the rest of the stock market has risen 50 per cent.

So two and a half cheers for Peter Long, the senior independent director at Rentokil, who has moved with impressive speed since the last, calamitous profits warning in clearing out the old guard and bringing in the new. He was lucky, of course, in that the dream team of John McAdam and two of the other executives credited with turning around ICI had suddenly become available thanks to the Akzo Nobel takeover. He's also had to pay extravagantly to bag his talent. All three of them get free shares potentially worth £31.5m apiece on top of salary, assuming various share price targets are met. Unusually, these rewards are linked only to the share price, not wider measures of shareholder return and performance.

The remuneration package requires a little more effort, and the rewards are not quite so humungus, as those proposed by Sir Gerry Robinson during his management buy-in attempt a few years back, but the parallels are more striking than the differences. Back then, shareholders sent Sir Gerry packing, so outrageous did his demands seem. This time around investors are desperate, and although eyebrows will be raised, they will agree almost anything that promises the hope of salvation.

Sometimes it seemed Mr Flynn was more wedded to his passion for sailing, as well as returning to his antipodean roots down under, than running Rentokil, yet despite these distractions and the successive profit warnings that eventually sunk him, some of the right building blocks for recovery may already be in place.

Little more than a resumption of the bull market in shares may be required for Mr Mc-Adam and his colleagues to hit the jackpot. Timing is all in business, and Mr McAdam seems to have his spot on.

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