Wednesday, October 8, 2008
Too Big fails - or just gallows humour?
The Times following up on a Telegraph story report that the Government is thought to be reluctant to consent to RBS’s participation in the bailout unless the chief executive relinquishes his role. Ministers are anxious that they are not seen to be forcing the hand of the RBS board. Asked about Sir Fred’s position, Alistair Darling, the Chancellor, said management changes at RBS were not the business of the Government. But ministers believe that it would be politically unacceptable for the man who led RBS to the brink of failure to continue running the bank with public money. Sir Fred has been blamed for RBS’s financial woes after he pushed through a €71 billion consortium bid for ABN Amro last year. This hit the bank’s Tier 1 capital, forcing the bank to raise £12 billion in a rights issue.
It is a tragedy or sorts for a great 300 year old bank (The Tories' bank, Margaret Thatcher's favourite), almost Shakespearean (MacBeth), as Chief executive Sir Fred Goodwin and chairman Sir Tom McKillop are today (as reported confidently in detail before breakfast) ousted, resigned and replaced (until this was denied abruptly with no detail by the bank) from what was one of the world's biggest banks, and proudly Scottish, its Saltire plastered all over Edinburgh airport, walking distance from its massive new HQ for 3,000 nestling in a woodland estate. They are to be replaced so the story went by Stephen Hester, formerly of the Abbey, and Sir Philip Hampton, currently chairman of Sainsbury's. It would be unusual for the story to be a malicious rumour with this level of detail. The departure of RBS's top management seems logical the day after its shares fell 39pc (£10bn) instantly over funding fears when S&P cut its correspondent banking ratings below AA-, and just when the PM and Chancellor (both Scottish) throw a £50bn lifeboat to UK banks. The fear is that there is more under the bonnet of RBS that smells toxic than is on balance sheet, but even so Fred the Shred as he was familiarly known after sacking 18,000 out of NatWest, is surely a victim of bad timing and circumstances (including overpaying for AAB) beyond even his big bank's powers to control? Maybe, but he should have listened to the economists and then asked himself whether it made sense to attempt an aggressive bid for another country's champion bank, to outcompete Barclays but only for the investment banking parts of AAB? RBS shares that had peaked at £5.97 closed yesterday at 90p. Until the 2Q 2008 the bank looked like it had a chance to be a winner from the crisis with its shares only down in line with the general market and holding up better than other major UK banks albeit falling to one half and then one third of the value of HSBC that only a year earlier it looked like rivalling. The bank looked relatively immune from the sub-prime credit crunch in 3&4Q 2007 but for no good reason except that it was in a bidding war for AAB, and therefore should be left alone, a bidding war that it won exactly a year ago to the day - but by then AAB was a shell of its former self; the competition had taken too long and victory tasted sour (the real winner being Santander who got AAB's Brazilian bank). Curiously, for a bank so proud of its history, its most recent history of buying AAB did not get added into the website:
Fred managed to keep amazingly silent for months about the financial crisis - maybe having little genuinely safe to say? - and RBS only really fell off its perch in the last few months. There were problems with its regulatory risk reporting, but then all banks have those. The bank's sub-prime exposures are in the USA, some of which was deemed non-material for regulatory reporting in the UK, that together with UK securitisations amounted to about $85bn before writedowns (excluding various legal risk liabilities carried by Citizens' hundreds of legal suits and RBS Greenwich Capital that had fee-based involvement in over half a $trillion of asset-backed securitisations, many of low quality, and from which the top managers quietly resigned in mid-2007). The bank in the last year lost over £80bn in equity, most of it in recent months, only in part because of buying AAB's wholesale banking divisions for something north of £20bn, at 70% premium despite the need for substantial capital raising including another £20bn or so to re-capitalise the banking operations of the new purchase. The few £bn in expected savings could not turn this into a short term coup, least of all when investment banking as a sector turned south. Commentators referred to 'Imperial ambition.' Fred had been under resignation pressure from shareholders for months and wanted a repeat of the NatWest glory - a bridge too far. Concerns over the group continued, compounded further when credit ratings agency S&P cut its rating over fears about future earnings and write-downs. The downgrade meant it would have problems with unsecured interbank borrowing. Sir Fred had earlier assured investors he remained the best man for the job after first half pre-tax losses of £691m. Concerns continued about writedowns and integration costs at ABN AMRO as well RBS's own toxic exposures.
The new team is Stephen Hester (ex-CEO British Land, which he joined in 2004 after 19 years under the charismatic and sometimes terrifying Hans-Jurg Rudloff at CSFB, in various Investment Banker roles before becoming CFO in 1996, then Global Head Fixed Income, and someone who knows all about M&A) and Sir Philip Hampton (FD of Lloyds TSB until 2004, which he left after falling out over strategy). The question that many will be asking is whether RBS will now follow HBOS in being taken over, or take fullest advantage of Government's capital infusion to bolster its book and share value (now only £14bn) to survive as a standalone bank (founded 1728) or take over or merge on a voluntary basis with another bank. Meanwhile, it has sizeable banking assets in the USA that may be sold however cheaply, and NATWEST (also Direct Line and Coutts) continues to be a large brand that could be sold, although disentangling the infrastructure would be a challenge.
Fred the Shred's last foray was to meet Chancellor Darling and regulators, along with the heads of Barclays, Lloyds TSB and HBOS, on Monday night, to discuss the crisis. Did he know or was he told it was time to go? Well, strange to tell, the bank boldly denies that Goodwin and Killip are going or gone. It was strange that successors were found so sonn if the reason for going was Monday's 39% share fall (nearly 50% in 2 days). Maybe Fred has second thoughts when he learned the outline of the Government's package (see blog below) and cancelled or postponed his departure - after all RBS is up 14% so far today!
Sir Fred Goodwin, 50, managed over £40bn of acquisitions since 2000 including £23.6bn for NatWest in 2000, $10.3bn in 2004 for Charter One Financial, about $19bn in 2007 for the investment banking and Asian units of ABN AMRO Holding. RBS raised £12.3bn by selling shares at 200 pence in June. Today the shares trade for half that much and the value of the whole bank (measured by the share price, not by book value) reached as little as £14-15bn! There would have to be a good reason not to resign in these circumstances! The share price is totally incredible when considered against the undoubted value of businesses in the RBS group, not least asset management and those earmarked for possible sale, Direct Line and Churchill insurance businesses. If RBS was not a bank it would be the ideal hugely profitable target for private equity asset stripping. A flurry of interested bidders would double or triple the share price and still leave room for break-up profit.
Before denying the resignation story (not rumour) RBS denied ``speculation'' yesterday that it asked the government for financial help to replenish their capital reserves.
RBS isn't alone in potential banking consolidation. There have been a record $232.5bn of financial services deals (all cheap and all without M&A advisory fees) in the past five weeks since Bank of America takeover of Merrill Lynch in September. I can only expect that UK banks' shares will rise now following the government's assurances and that no broker advice notes can fail to mark each of them as a strong 'buy', not 'hold' or 'sell.' Even when the dot com bubble burst and Tech stocks fell 90% this was mainly medium and small tech stocks; the biggest recovered rapidly. In the case of banks investors' fears are not really that the banks are worth so little - everyone agrees the banks are massively oversold - the fear is that they could go bankrupt or be taken over by other banks or by government and shareholders get nothing. The banks' share prices are therefore not measures of business value or measures of mark-to-market asset values; they now reflect entirely the extreme riskiness in turbulent panic-ridden markets of owning shares.
Equity is typically two thirds to half, sometimes three-quarters, of a bank's "own capital" that as a ratio to gross assets should be about 4%, to risk-weighted assets about 8% and 10-12% given today's once in a century extreme conditions. It is not hard to have predicted that over the course of a recession banks have to replenish up to 90% of their capital reserves. This becomes extremely hard to do when equity prices fall so far and so fast. Governments and central banks are concerned to restore banks' capital reserves (RBS and others are at levels of half to one third what they should be). But they neglected to appreciate that when they forced and supported mergers and break-ups of banks (N.Rock, Lehmans, Bear Stearns, Fortis) shareholders were entirely neglected despite the obvious fact that book value was worth more than the shares, and subsidiary businesses were worth more than the group price. Shareholders' confidence in the risk of share-owning has been fatally harmed - perhaps the greatest of all "moral hazards" in bail-outs of banks so-called. Can banks' capital be restructured without restoring shareholders' confidence in owning bank shares? When Ireland moved to protect business depositors and bondholders as well as retail depositors this was a big step forward. Governments now deciding to take equity in banks is the next step forward and deciding that there will be no more big bank failures adds weight to this. Governments too readily gave in to the idea that the real shareholders in banks are retail depositors only as if the banks were all mutual societies not publicly quoted! Shares are also owned by and on behalf of rich and poor households (pensions, life assurance, retail investment funds etc.). It is instructive that financial service firms that remained mutual or private have survived the current bloodbath much better - this was not what regulators thought should be the case when in recent years they put firms like Standard Life under pressure to de-mutualise on the basis of the idea that they would therefore be safer by being subject to equity market valuations! So, I conclude, that the next phase of the crisis has to be about restoring the value, role and security of shareholding!