Yesterday’s news of a £5.8 billion pound rights issue from Barclays, which it announced alongside its interim results, reminded UK investors that we are far from out of the woods where this crucial sector of the UK economy is concerned.
Barclays has decided to raise capital through a heavily discounted issue of new shares and an offering of so called Co Co or “Contingent Convertible “bonds. This action will allow it to meet tough new standards of capital adequacy introduced by our own Prudential Regulation Authority and the Bank for International Settlements or BIS in Basle. Barclays has decided to grasp the nettle now and perhaps gain a first mover advantage despite the fact that it could have waited for up to three years to meet the new capital ratios.
The decision by Barclays CEO Antony Jenkins to act sooner rather than later raises some interesting questions as far as its state owned competitors are concerned. Not least, because the UK Government is keen to offload some, if not all of its stakes in RBS and Lloyds Banking via share sales to institutional and private investors.
But given that RBS needs to raise some £13.6 billion of new capital itself and Lloyds Banking requires a further £8.6 billion of fresh cash, it’s not hard to imagine a situation where these Banks find themselves in a competition with their largest shareholders to raise funds via share sales. Even if these significant potential conflicts of interest can be managed successfully over the next 24 to 36 months, there are other challenges facing the state owned siblings. RBS may soon have to face up to a substantial fine and litigation costs over its historic activities in the US Mortgage Backed Securities markets.
Union Bank of Switzerland recently agreed an US$885 million settlement (a polite euphemism for a fine) with the US authorities over its actions in this area. Some commentators have suggested that RBS may have to pay up to US$ 2 billion if they are treated on a pro rata basis to the Swiss bank. A fine of that scale would effectively wipe out much, if not all of the profitability of the bank in 2013. Given that this may not be the total extent of RBS’s US liabilities, it will interesting to see what risk disclaimers are attached to any prospectus issued in conjunction with a Government share sale. However it is Lloyds Banking the owner of the other Edinburgh based bank, HBOS, that will lead the way as far as a sale of government owned stock is concerned.
Investors are thought likely to be tempted to subscribe to this sale through the return of Lloyds to the dividend list. Though it’s hard to imagine how even the most creative of investment bankers will be able to square the circle of the bank paying dividends to prospective new shareholders on the one hand whilst needing to raise almost £9 billion of fresh cash with the other. Once again the wording of any prospectus will make interesting reading…
I remain sceptical of the ability of the Government to sell significant stakes in either organisation without RBS and Lloyds being completely rehabilitated and have further philosophical issues with the idea of buying something we are told we already own as UK taxpayers.
As has often been the case with coalition policy, the government objectives here are confused and at odds with each other. For instance, the government, following on from the Vickers report, wishes to ring fence or even separate low margin retail banking from its higher margin investment banking cousins – a move that will ultimately reduce the profitability of the high street banks and in the process make the sector even less attractive to investors. Nor is it particularly helpful to continue to pursue the enforced sale of hundreds of Lloyds and RBS branches under the pretence of competition. After all, not one credible buyer has emerged for either of the branch networks, nor are they likely to do so, in our opinion, given the increasingly commoditized nature of the returns that are on offer in these businesses after the implementation of layer upon layer of new banking regulations.
In summary then, there will be plenty of calls on your cheque book in the coming months from the Banks themselves and their state shareholders. Whether you choose to open yours will be your decision, however the chart below may offer some guidance.
This chart shows the FTSE 350 banking sector performance on a monthly basis beginning in May 2008. As we can clearly see the index, which closed yesterday (29/07/13) at 5077.34, has historically rejected at and around the 5100 level despite testing up to 5300 and beyond on occasion.
Price action above 5100 in this period has been fleeting and unsustainable and we now find the index testing back towards and potentially through its 20 period EMA line found at 5049.
Given that Lloyds Banking is up by some 40% year to date it may well be time to consider locking in profits if you are long or indeed opening up a fresh short position if you are not.