On bank capital mismanagement
Why should investors – nevermind the government – give the banks new capital when they were so inept at looking after the capital they had?
Nevermind the capital written off when loans and investments proved bad, what about the capital they deliberately gave away? Right up until the end (or until their nationalisation) big banks thought they had such a surplus of reserves they could hand them out share buy-backs.
The problem with banks like Halifax and Bradford & Bingley is that they started as overcapitalised building societies and when they converted into banks they decided high reserves were not a useful safety cushion but a drag on their capital efficiency ratios. To boost their return on capital they either needed more profit or less capital: they chose the easy way out.
Not only did they not need to raise any capital when they floated, they immediately got rid of what they had. Within a year of Halifax’s 1997 flotation it announced a £1bn share buy-back.
That set the pattern for future years, even after the Bank of Scotland merger. HBoS bought back another £1bn of its own shares in 2005 and another £1bn the following year. Even after the credit crunch struck it kept buying, spending £500m in 2007 including purchases last December, just months before it realised it was so short of capital it asked shareholders to return £4bn and do without their dividend.
Now it is being forced to raise another £11.5bn of capital.
The smaller Bradford & Bingley was little better. It announced its first £150m buy-back just after its 2000 flotation and its last £250m programme just as the credit crunch struck in July 2007. This year it had a £400m rights issue – and still had to be nationalised.
So even in their final days these banks thought they were so overcapitalised they could buy their own shares. And as their shares fell the banks seemed pleased they were buying more for their money rather than asking why they were falling. HBoS was buying in at 770p last December: in April it re-issued shares at 275p in its rights issue; now it is raising capital at 113p price and the market price is under 70p.
That not only proves the directors are bad bankers, they are bad investment managers – buying at the top and selling at the bottom.
And while dividends were money in-hand for investors who have seen their share prices decimated; most saw no benefit from the buy-backs because small shareholders were never invited to sell.
There is no inquiry into what went wrong with the banks, but if there was it should look not only at the mistakes on the asset side of their balance sheets but their capital management.
Earlier this year, when he was blind to the future, HBoS’s chief executive, Andy Hornby, boasted about the need to shed capital saying: “Capital is owned by our shareholders, who expect us to treat it as a scarce resource.” In the months since then it has proved so scarce HBoS has had to raise more than £15bn or new capital – three times the value of the bank – and it will become a subsidiary of the Treasury if the Lloyds TSB rescue does not go ahead. Mr Hornby is now former CEO.
