Why the bank takeover is bad news for shareholders
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Associate Editor
David Stevenson Oct 14, 2008
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Selling your shares looks the best option
Day One into the Brave New World of the big bank bailouts, and how's it looking?
Most UK shares rallied strongly after the weekend's news of Gordon Brown's £37bn 'investment' in British banks. And short-term interest rates dropped too, with the Bank of England keen to splash plenty more cash around in the money markets.
So, everyone's happy… except for shareholders in the banks about to enter public ownership. Because as the details emerged, their shares kept crashing…
We're into a new era. The state takeover of the UK financial system has started. How far it will extend, only time will tell, but the opening shot's a £37bn dose of government - i.e. taxpayers' - money being 'invested' into three of the country's biggest banks.
Now Gordon Brown's government could end up owning a majority stake in Royal Bank of Scotland (RBS) and more than 40% of the soon-to-be-combined Lloyds TSB and HBOS.
The cash boost will "result in these UK banks being some of the best capitalised – i.e. with the most capital relative to assets held - in Europe", says the FT. What's more, Mr Brown has been congratulating himself on the bank stake-buying plan, calling it a "rock of stability on which the British people can depend" in "an uncertain and unstable world".
Meanwhile the Bank of England was celebrating the deal by joining forces with the European Central Bank and the Swiss National Bank in auctioning unlimited amounts of dollars to free up the money markets and send short-term interest rates down.
Isn't it amazing how a bit of extra money can oil the wheels? Suddenly, everything the garden is rosy again.
Nationalisation means no dividend payments
Er… not quite for everybody. Despite an 8% bounce in the FTSE 100 index yesterday, shares in HBOS dropped another 27%, while Lloyds TSB tumbled 14% and RBS slid 8%. Meanwhile, just to rub it in, Barclays and HSBC, the two banks which made it quite clear that they don't need our money, went up by 4% and 7% respectively.
What's the problem? In a word: nationalisation. It's bad news for shareholders. The banks have been told by the Treasury that they won't be able to pay dividends on their ordinary shares until they've repaid the £9bn-worth of preference shares they're issuing to the government. And in the meantime, they have to shell out a painful 12% a year on those preference shares.
There's another unpleasant side effect too. Part of the overall deal involves a large chunk of new ordinary shares also being issued by RBS, Lloyds TSB and HBOS. These will be offered to current shareholders, but without the incentive of receiving dividends it's unlikely the existing owners will be very keen on snapping them up.
So these new ordinary shares are also likely to end up with the government, leaving them with a 60% controlling stake in RBS and as much as 43% of the Lloyds TSB/HBOS double act.
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Politics may start to influence commercial decisions
The government really will hold the whip hand then, not that it isn't already wielding a big stick. Gordon may protest that ministers won't be involved in running these banks, but that hardly sits with his insistence that tough conditions have been attached to the deal. For example, heaving out some of the current board and adding a raft of Government-appointed directors.
And don't take too much notice of Mr Brown's claim that nationalisation is intended to be merely "temporary". As the great monetarist Milton Friedman once said, there's nothing so permanent as a 'temporary' government programme.
Indeed, just about the only good bit of news is a state-enforced restriction on executive pay, with none of the banks' directors due to receive cash bonuses this year.
But what's really scary for RBS and Lloyds TSB/HBOS shareholders is that these banks will now be "forced to raise their mortgage and small-business lending to 2007 levels - far higher than they currently stand", says the Telegraph. So lending decisions could soon be made on political, not commercial, grounds.
Mr Brown told the BBC yesterday that the UK property market is likely to bounce back before those in other countries because "we failed" to build enough houses, and Britain has a "pent-up demand". As MoneyWeek editor Merryn Somerset Webb recently pointed out, this is complete drivel.
But the danger is, with banks' loan books already looking increasingly dodgy, that even larger bad debts will pile up at the nationalised banks as more people get suckered into buying houses at prices that are too high.
Alistair Darling is trying to get us to believe that taxpayers will, one day, get their money back from the new deal. Shareholders in the state takeover candidates are unlikely to be so lucky. Selling out of these now, particularly if the shares do manage to rally, looks by far the best option…
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