Darling’s bail-out looks like capital but is a loan
The state bank bail-out is not nationalisation after all. The £50bn of preference shares the government is offering to buy looks like capital but, as any finance director knows, is really a loan. It protects the taxpayers’ money but there will be no windfall if banks’ fortunes soar again.
Eight big lenders have been told to raise £25bn of capital by Christmas and if they can’t raise it elsewhere, the government will subscribe. Another £25bn is there if banks want it.
But it will be in the form of preference shares (or, for Nationwide building society, Pibs – permanent interest-bearing shares). The government will “assist in the raising of ordinary capital if requested” – which sounds like underwriting – but when prefs count as capital for Basel’s Tier-1 ratios, expect the banks to go for the fixed-coupon paper or to offer new shares elsewhere.
The bail-out is in danger of creating Tier-1 banks like HSBC that need no government help, Tier-2 lenders that accept the Treasury prefs and Tier-3 institutions so desperate they give the state an equity stake. Unfortunately, if they’re that desperate the equity stake is potentially worthless.
Raising £25bn or £50bn of equity capital would be a tall order. HBoS had a £4bn rights issue at a 40 per cent discount to the prevailing share price only three months ago but it fell flat and the bank was worth just £5bn (including that £4bn) when chancellor Alistair Darling revealed his rescue.
The combined market value of Barclays, HBoS, Lloyds and Royal Bank of Scotland was just £57bn when Darling’s announcement was made. His £50bn would have bought control of the lot.
But some banks have yet to tap existing investors and sovereign wealth funds still have money to invest at bargain prices.
In theory, each £1bn of capital the banks raise lets them to lend about £8bn. In practice it will allow them to write-off £1bn of bad loans leaving no scope for extra lending.
Any bank that accepts Darling’s money will not only be admitting to problems but must accept restrictions on dividends and directors’ pay as well as make promises on small-business and personal lending.
Darling will hardly want equity then tell the bank to cut its dividends. Preference shares will receive a full and fixed dividend, of course – but no upside when bank shares recover.
The strongest banks will reject his offer entirely. The strong banks will sell him prefs and cancel them as soon as they can afford it. If your bank sells him equity, change bank.
