Thursday, October 9, 2008
It's all about share values, stupid!
Last night, some bank shareholders were cheering at the prospect of Government taking shares in the clearing banks. Others, who now see that the risk of bankruptcy of banks has been removed, were totally angry at the idea, even of convertible loans that could become shareholdings any time in the future, but not now. This latter group are now cheering as the equity stake aspect of the £50bn capital restructuring funding from government appears to have been quietly dropped, so quietly that most media this morning have not noticed. My neighbour, Keith Skeoch, the chief executive of Standard Life Investments, which even now owns £billions of bank shares, was pleased that ordinary shareholders are not having to worry about any dilutive arrangements, telling The Times, “We welcome particularly the fact that the announced package shows a willingness by the authorities to work with market mechanisms in a manner that appears to respect the capital structure.”
The Government will not now receive warrants (see note below) – options giving it the right to buy bank shares at a low, pre-agreed price – as part of the plan, a measure that would have diluted ordinary shareholdings and/or been instrumental in restoring shareholder conifidence - take your pick. Warrants or other kinds of “equity kicker” were on the table in secret talks (by the way began ten days ago, not 6 weeks ago as some believe). However, that aspect disappeared by Tuesday night when the deal was watered down so that banks were obliged to sell the Government only plain-vanilla preference shares or permanent interest-bearing shares. Last night, Treasury friends insisted that the preference shares could be convertible into common stock, allowing the Government to share in any recovery - but only in some cases (i.e. T&Cs on a case by case basis). One bank CEO says no such feature was discussed and another that it was still not clear (Times report). Now, if the bailout succeeds, the banks will be obliged to pay only a fixed rate of interest of perhaps 10 per cent on the preference shares, according to one senior banker.
There can be no doubt that not only large institutional investors, but also those banks that are winners from the wreckage of the banking sector, could be very alarmed at the idea of government holding "golden shares" in RBS, Barclays, LTSB/HBOS, and others thereby hampering M&A opportunities and so on. The idea that government taking shares in the banks would dilute shareholder capital is somewhat bizarre or archaic in present circumstances, circumstances where the banks are oversold precisely because there is risk of banks failing and the risk of holding shares is 100%. It is only the action of governments and central banks that is savings the banks and therefore they have every right to take shareholdings. This view is not accepted by all, ideologically, commercially or technically. They think if some banks survive then it is because some banks deserve to survive while those that are fatally weakened deserve to fail - dog eat dog world and to hell with the systemic issues. Hubris among bankers has not died out. What banks like HSBC and other "good banks" have to appreciate is that the bigbad bear markets could come for them next simply because loss of capacity in banking affects all; not a zero sum game in which banks only compete with other banks. The risk over the whole sector is that government will dictate more comprehensively and rule that banks must stoick to narrow traditional banking only in the future. Some banks may believe they are so global that they are beyond the reach of political risk - maybe, but I doubt it? Henry Paulson, the US Treasury Secretary, last night said US companies will continue to collapse in the near future while reassuring investors that Washington is moving swiftly to implement TARP. “Patience is needed because the turmoil will not end quickly and significant challenges remain ahead. Neither passage of this new law nor the implementation of these initiatives will bring an end to immediate difficulties.”
Note: Preference or preferred shares normally entitle a holder to a prior claim on any dividend paid by the company before payment is made on ordinary shares. They do not normally come with voting rights but carry more rights in the event of a liquidation. Permanent interest-bearing shares are shares that pay a fixed rate of interest. Warrant, a security entitling holders to a common share or shares at a fixed price, known as the strike price, in the future. The strike price is normally higher than the level of the current common share price. (source: The Times)