Taxpayer-owned banks still look a bad bet
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Associate Editor
David Stevenson Nov 02, 2009
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'Our' banks – the ones in which we taxpayers hold large stakes – are back on the front pages. But this time, the stories are about them being split up and sold, rather than bailed out of bankruptcy.
It seems the authorities now reckon the world is financially safe enough for the likes of Royal Bank of Scotland, Lloyds and even Northern Rock to stand on their own feet again.
That sounds like good news – but what does it mean for bank shareholders?
Why banks ended up in state hands
Just over a year ago, you'll probably recall, US investment bank Lehman Brothers bit the dust in the world's biggest-ever bankruptcy.
This wasn't just a huge hit for the markets. In trying to make a fast buck, the planet's largest financial players had been doing ever larger and riskier deals with each other. When Lehman, one of the key counterparties, couldn't settle its trades, all the other punters in the game were clobbered with vast losses, too. The collateral damage went global, further hammering banks that were already in trouble after making too many loans that had gone wrong.
Indeed, we've since been told that Britain was "within hours" of a banking shutdown. As both RBS and HBOS were tottering on the brink of financial oblivion, even the cash points could have been closed. But thanks to the round-the-clock efforts of Treasury mandarins and the Bank of England, claim the regulators, the crisis was averted. Phew!
The trouble was that this all came at a massive cost. The British taxpayer ended up owning 70% of RBS, while HBOS was forced into a shotgun wedding with Lloyds – we now own 43% of that combo. And both Bradford & Bingley and Northern Rock had already been nationalized. Last month, Bank of England boss Mervyn King pointed out that the total cost of all Britain's bank bailouts had been a "breathtaking" £1 trillion.
But what a difference a year makes. There's been plenty of chat for a while about state-backed banks being broken up and sold off, but at last it seems to be actually happening.
The European Commission has been reviewing bank bailouts across its 27 countries to see who's been given an unfair advantage from getting taxpayers' cash.
Within the last week, Northern Rock has received the green light from the EU to hive off its toxic mortgages into a 'bad bank', which will run down its remaining assets and eventually be liquidated – with taxpayers left to pick up the tab for any losses. The 'good bank' bit, which is free of dodgy debt, can now become a major high street lender again, although only with the help of a further £8bn loan from taxpayers. The government will also be able to sell it off, with rumoured buyers including Tesco and Virgin.
Now the EU is getting tough on state-owned banks
But what about those state-backed banks which are still listed on the stock market, Lloyds and RBS? The bad news for these two is that the Eurocrats have been talking tough. Dutch financial services group ING for example, has been forced to flog off its insurance side to repay emergency government funding.
Lloyds and RBS look set to face something similar. RBS is in a particularly weak position. It is going to have to take part in the government's 'asset protection scheme'. This gives it some insurance against all those dodgy loans it bought when it snapped up ABN Amro, but it will also be costly. So the government looks set to end up owning more than 80% of the bank.
That in turn means that the EU's disposal requirements will be more stringent. Its insurance arm (which includes Churchill and Direct Line) plus more than 300 branches will have to be sold off. The decision is likely to be announced later this week, but we'd certainly avoid the shares with such uncertainty hanging over them.
Lloyds is in a better position. The group is planning to raise £20bn in capital so that it can avoid joining the asset protection scheme. This protects lenders if their old assets go toxic, but is pricey – the premium is £15.6bn, says the FT - so it's quite understandable that Lloyds wants out. And it also means that while it will have to sell off more peripheral businesses, such as mortgage provider Cheltenham & Gloucester, the bank remains largely intact.
Lloyds shareholders should sell up
So what's the bottom line for Lloyds' shareholders? Well, the trouble is, this capital raising exercise look set to include a rights issue to bring in £13bn, i.e. more than half the group's current market cap. And the issue is likely to be at a huge discount, maybe up to two-thirds, to the current 86p share price.
Of course, that discount wouldn't mean shareholders get something for nothing. The price of the existing shares is automatically adjusted down (to see how rights issues work, see: Investment strategy: Avoid recent rights issues If you're not already a subscriber to MoneyWeek magazine, get your first three issues free here.) On the contrary, with so many new shares about to hit the market, the chances are the overall value of their holding will drop, whether they take up their rights or not.
So if you still hold shares in Lloyds, we'd suggest selling now. Apart from all the old loans that have gone bad, quite a lot more could go sour. Moody's warned a few weeks ago that Britain's high street banks could yet incur another £130bn of losses in the next 18 months.
But we'd be wary of 'short selling' Lloyds' shares (selling stock you don't own with the aim of buying back later at a lower price). Hedge funds have been heavily shorting the stock, and The Telegraph reported last week that more of the same is being planned for the rights issue announcement.
When everyone expects a share to move in one direction, it has a nasty habit of doing the opposite. In a nutshell, selling Lloyds seems to makes sense, but shorting it right now could just catch you out.
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