Bank Nationalization DayOld HQ pictured. Following failure of shareholders to buy more than 0.24% (only £36m for 56m shares) of the Royal Bank of Scotland Group's £20bn share issue, RBS (1) (including Citizens Bank, USA, and NatWest Bank, England) today became the third to be formally nationalised (nearly 58%). The small take-up of the issue by existing shareholders had been expected as the offer price of 65.5p was 10p higher than the price at which the shares were trading, so those who did buy on paper lost £5m doing so. The share issue by RBS was part of the government's plan to recapitalise banks. The government will pay £15bn for the majority stake in the bank plus £5bn of preference shares in the bank. Taxpayers too have an immediate paper loss of £2.4bn based on Thursday's closing share price. The bank's Chief Executive Stephen Hester said, "We regret that existing shareholders did not take up their pre-emptive rights but understand that market sentiment toward the banking sector made this uneconomic in the short term." That is the least of it. What is remarkable is that there is not more confidence in a regulated, government backed, major public company whose accounts are as transparent as the best standards demand, and whose market price is far below 'book value'? What has happened to investing in fundamentals for slightly longer than the immediate short term? Hester says,"There remain substantial uncertainties and challenges outside our control but for our part the job is underway." There are always uncertainties, but they should not any longer be called 'substantial' when a bank is covered with guarantees and writedowns and paperf losses are far ahead of any actual losses yet experienced in the underlying assets. The bank now needs its major shareholder's approval for executive pay and dividend, and has to agree to return to "normal" lending levels and more sensitive customer relations practices. Last week it said it is guaranteeing overdraft rates & contracts for business customers for a year at least. The UK government's shares of banks are held by a company called UK Financial Investments Ltd, which is to maximise value for taxpayers and prevent politicians making business decisions about banks something that the Opposition Conservatives are keen to monitor to ensure this is true. The new RBS HQ (pictured) opened just as RBS-led consortium's deal to buy ABN-AMRO 'successully' closed, a deal paying 71bn euros ($91bn; £61bn) for the Dutch bank, that was the last great deal for a sold bank's shareholders, which lost RBS its creditworthiness, and also contributed to Fortis Bank's collapse after it agreed to buy ABN-AMRO's Benelux banks, while the third partner, Banco Santander, which got ABN-AMRO's Brazilian bank remained strongly priced (thanks to severe risk contols by Spain's Central Bank) and next bought Alliance & Leicester (A&L) cheap, albeit that Santander now too has to make a rights issue and has cold-shouldered its many UK shareholders in an over-hasty process. Mortgage exposure proved to be the made risk to share value for UK banks as panic spread from the USA, however, even though the UK market has been a full 2 years or more behind the USA in mortgage defaults (currently 2% in UK and over 9% in USA), confidence fell mainly because of Northern Rock's bank run - a special calamity for all UK banks. Previously nationalised UK banks are Northern Rock and Bradford & Bingley. I took my secretary to the House of Commons Treasury Committee: Nationalised Banks meeting on the 18th to find out how Government is managing its banks? Others to follow into Nationalisation soon include Halifax Bank of Scotland and Lloyds TSB, or possibly the combined Lloyds Bank Group, even though HboS Directors warn that Nationalisation is a ‘risk’ strenuously to be avoided (even if it means selling HBoS for a fraction of its book value by voting for the takeover by Lloyds TSB). The new combined Lloyds Bank Group could still be 43% Government-owned. To avoid this 'calamity', which would, of course, restrict the bankers’ bonus pay, though their first anxiety is to restore dividend payments to the much-abused shareholders. Hence, why Lloyds is in talks with sovereign wealth funds and UK insurance groups about selling stakes in a merged Lloyds-HBoS group, with a preliminary deal expected by January (subject to HboS shareholders voting for the takeover on 12 December). Lloyds want cash to redeem £4 bn of the ‘restrictive’ government-owned preference shares in Lloyds and HBOS at the earliest opportunity (as soon as HboS shares are delisted). But, what is there to fear about a commanding Government stake when this would guarantee the solvency of the bank and when major global banks such as Citigroup are finding that Government ownership is highly profitable? Reading from my secretary’s typed notes, from HoC Treasury Committee questioning of NR and B&B banks, what do I find?
1. HM Government (HM Treasury) are in daily contact by telephone with NR and B&B, but do not steer the banks' commercial decisions.
2. They face a potential conundrum, which is that while they have ‘frameworks’ in place whereby they must reduce the size of their balance sheets so as to be in better shape return to private ownership as soon as practical, Government also wants banks to maintain their lending levels, except this latter requirement is not being overtly applied to NR and B&B. 3. B&B has a £40bn mortgage loanbook of which £24bn is buy-to-let (B2L) mortgages (20% of UK total) and £8bn is self-certified mortgages (mainly for the self-employed). Government provides a £14bn guarantee. B&B’s current defaults are 1.8% but 3% among B2L. Moody’s stress tested the loanbook and estimate through-the-cycle loss will be 3% in total or £1.3bn against £1.7bn capital reserve (76% capital wipeout). The Execs did not repeat anything about weakness in the bank’s accounting system that had been originally blamed for failure because the board simply did not know how bad its position was?
4. The HoC Treasury Cmte was anxious to know if bonus culture (where execs get many times the % ratio to salary in bonus compared to all staff) was the cause of excessive book-building such as contracting to buy £6.5bn of buy-to-let mortgages from GMAC (owned by General Motors)? B&B execs explained half of these were UK mortgages and seemed to fit with the bank’s speciality. 90% of all its book came to it via intermediaries anyway (and 2.5% fees were added into the mortgage loans while the GMAC arrears are just over 3% and the long term contract proved embarrassingly inflexible as credit conditions changed). 5. NR was quizzed about bonuses too at 5 times ratio to salary as all staff (which by the way are subject to Government Approval), and about why its mortgage foreclosures seemed so much larger than the industry average. The execs countered that bonuses are linked to progress in redeeming the Government’s equity, while foreclosures only produce 1% of that revenue and its 4,200 stock of homes for sale were gathered over 18 months, not 1 year, hence it is not so draconian as the media speculated. (NR’s deposits business was sold to Abbey- Santander)
6. NR has a ‘Together’ mortgage book for high loan to value borrowers (typically 115% of home purchase price, higher now that house prices have fallen) but these only show a 3.1% default against a general arrears of 1.87% when the industry is 1.33%. Only 10% of arrears result in repossessions and one third of these are voluntary.
7. NR is designing MORTGAGE RESCUE PRODUCTS that will build on payment holidays and interest deductions 9currently negotiated case by case depending on individual circumstances). At the same time NR is writing little new business (and not trying to out-compete the market on price) and encouraging borrowers to re-mortgage elsewhere, except elsewhere doesn’t want to do so for any loan-to-value ratio of more than 80% (at present depressed and falling house prices), hence Government will probably continue to own the bank for about 3 years more.
8. The Committee asked about the cost of Government support. B&B said it was at full commercial rates (measured across a number of funding and guarantee types). NR said it was charged to them at above commercial market rates, something that may be currently reviewes. This is important to the European Commission's enquiry to ensure that Government support does not distort competition unfairly - report not expected until the Spring of next year.
9. A risk consultants report into NR found that risk management was not independent of business operations, risk culture not imbedded, and need for induction training; all matters being fixed by a new Risk Head’s new structure, and new risk policies manual. The Treasury Cmte Chairman ended the meeting with reference to NR’s “shambolic organisation” and he was not being humorous about that. (1) Note: The Royal Bank of Scotland was founded with Government support in 1728 to create a rival to the Bank of Scotland that was suspected of being Jacobite (anti-Hanoverian, supporter of the Stuarts). In 1728, the Royal Bank of Scotland became the first bank in the world to offer an overdraft facility when merchant William Hogg was allowed to take out £1000 unsecured (£65,000 today) more than he had in his account! "I warn you, Sir! The discourtesy of this bank is beyond all limits. One word more and I — I withdraw my overdraft!"
The Committee members were all knowledgeable and asking intelligent questions intelligently, just as banking professionals might do if they have that much common sense about banking. I conclude that oversight by Government seems neither draconian (unless bankers are most anxious about their bonus levels) nor is it a shadow management, but more like an anxious major shareholder that is keen to sell out when the balance sheet is made safe and prospects are stable or positively improving. Why should Lloyds, HboS or Barclays (facing shareholder anger over the bank’s choice of expensive sovereign fund investors instead of Government backing) believe ‘nationalization’, which NR and B&B execs always describe as ‘temporary’, is such a bad risk to be avoided even at substantially higher cost? Are the objections ideological, or driven by shareholders anxious to restart cash dividends, or by bankers afraid for their bonuses, or are they afraid of Government making them behave more sensitively and empathetically to customers? Or maybe the banks worry too that they might be restrained from making major foreign investments such as buying foreign banks or such as RBS’s recent participation in a gigantic $35bn loan to support Ontario Teachers Pension fund buyout of Telcom Company BCI for 52bn, that looks like failing to proceed at the last minute?!
Contributed by Robert Mcdowell