Predicting what bank shares will do next has proved extremely tricky over recent weeks – since , UK banking shares have displayed a usually reserved for penny dreadfuls. On many traditional valuation metrics, bank shares have wildly fluctuated between cheap and ridiculously cheap.
But traditional valuation metrics don't hold much water at present. And certainly, it would be wishful thinking that, after the great bail-out, the worst is over. The threat of recession still looms large, and, with further massive write-downs still to come, there are worries that the government's £50bn capital injection – or its debt guarantees - will not be enough to see the banks through. Banking shares could continue to display volatility for some time to come. Banking analyst Sandy Chen at broker Panmure Gordon paints a bleak picture: "We still expect that in the longer term, macro environments will continue to deteriorate, house prices will continue to fall, unemployment will continue to rise etc – meaning that there will be further defaults, further write-downs, and further pressure on capital ratios."
An alternative, more palatable, view is that the intervention has, as the Treasury boasts, been decisive enough to save the system, and that the short term pain bank shareholders suffer will soon be forgotten as bank shares stage a rapid recovery in the coming years. The bailout is not unprecedented - the Swedish government was similarly forced to bail out its banks back in 1992, and as our online editor Jonathan Eley , bank shares there recovered by 520 per cent in the 12 months after intervention.
Certainly, the Treasury has said that it has no intention of becoming a permanent investor in UK banks, and intends "over time to dispose of all the investments it is making as part of this scheme in an orderly way". Shareholders should welcome this approach, and the news that the government fully expects to make a return on its investment - after all, a return for the government means a return for shareholders, too. The government was criticised heavily over its handling of Northern Rock for ‘privatising profits and nationalising losses'. Now it can nationalise the profits too – although with bank shares trading well below the rights issue prices, the government currently sits on a hefty loss.
But the runaway profits that have so often plastered the front pages of newspapers will become a thing of the past. Banking looks like it could revert to a bygone era of caution and restraint – or, as RBS describes it, “profitable growth opportunities within a disciplined risk framework” - and with that banks would once again become the safe but relatively pedestrian haven they once were.
The Capitulators: Royal Bank of Scotland
The Scottish banking giant's fall from grace has been spectacular to say the least. Just a year ago it was splashing out £56bn on the takeover of the Netherlands's ABN AMRO. Now it's scrambling for government handouts. And its famously unassailable chief executive, Sir Fred “the Shred” Goodwin has been, well, shredded, to be replaced by ex-Abbey chief operating officer and current British Land chief Stephen Hester.
Shares have slumped 87 per cent in the last 12 months to 60p, and the massive £20bn recapitalisation is likely to see them further diluted. RBS will issue £15bn of new ordinary voting shares at 65.5p a share – with the equity fundraising underwritten by the taxpayer – as well as £5bn from the government in the form of preference shares.
If, as is likely, shareholders do not take up their entitlement, the government will own a majority stake in RBS, over 60 per cent of the group. Shareholders will also see dividend payments disappear, with the government stipulating that no dividends on ordinary shares will be paid until preference shares have been repaid (at a dividend of 12 per cent).
But RBS has been left with little choice. It admitted that it will see further write-downs in the fourth quarter after £5.9bn worth in the first half, and the level of financing it has required indicate that it was by far the most exposed of the UK's clearing banks. It would take a brave investor to bet against RBS over the long-term, though. This is a bank with 17 per cent of the UK retail banking market with deposits of £1,200bn, and the injection will see its tier one capital ratio “substantially exceed” its 7.5-8.5 per cent target, which will allow it to accelerate its de-leveraging. That said, shareholders should leave the rights on the table if shares trade at a discount to the offer price - and given the massive uncertainty that still remains, we think there may be safer buying opportunties ahead. Fairly priced at 70p.
The Capitulators: HBOS
As annoying as its advertising mascot Howard may be, the last thing the world wanted to see was the collapse of the UK's biggest mortgage lender, HBOS. Rumours of the company's imminent demise proved the flashpoint that sent the UK banking system into outright collapse. No amount of official guarantees could convince the market that the bank wasn't in serious financial trouble, and shares plummeted. Only a highly controversial eleventh hour deal in which HBOS would be bought by rival Lloyds TSB fended off outright collapse.
And questions over the deal rumble on. Is it on? Is it off? Rumours at the weekend suggested the deal could have collapsed – on Monday, Lloyds said that it will lower its offer for the company to reflect the significant dilution HBOS will face as it raises new capital. Lloyds' new offer is for 0.605 of its shares for each HBOS shares – at the current (albeit volatile price) that's worth 92p a share, valuing the entire equity capital of the company at a little under £5bn.
Which means the proposed £11.5bn equity raising will annihilate existing shareholders, should they choose not to take up their rights. The government will underwrite an £8.5bn rights issue at 113.6p a share (already a 38 per cent premium to the current price of 82.5p) and receive £3bn in preference shares, which will convert to Lloyds shares once the merger is completed. But the capital injection will boost its tier one capital ratio from 8.6 per cent to a healthy-looking 12 per cent. Shares will track Lloyds' shares now, so are fairly priced at 89p.
The Capitulators: Lloyds TSB
Lloyds TSB has always has the reputation as one of the more conservative pillars of the UK banking system, and its shareholders must be wondering how it's managed to find itself caught up in the credit crisis. Its innate conservatism has left it in a far more secure position than rivals HBOS and RBS – the company is expected to ‘only' raise £5.5bn, of which £1bn will be preference shares sold to the government, with the remainder coming from a rights issue at 173.3p a share.
But the risk of a deep recession in the UK affects the group more than most, because unlike most of its rivals, it does not have interests in emerging economies to offset home market weakness. And the decision to bid for HBOS has had a devastating impact on the shares, which have slumped from 290p a month ago to just 162p today, a fall of 44 per cent.
That doesn't mean HBOS isn't a great opportunity. Competition issues appear to have been brushed aside in favour of the stability of the financial system, and, for a knockdown price, Lloyds will become the market leader in mortgages, with 28 per cent of the market, and extend its lead in current accounts, adding HBOS's 14 per cent share to its own 19 per cent. And although the combined Lloyds HBS will be 43.5 per cent owned by the government, Lloyds' shareholders won't bear the brunt of that dilution – while existing HBOS shareholders will own just 20 per cent of the enlarged group, Lloyds holders will own 36.5 per cent. With the market price below the rights issue price, shareholders should avoid the rights issue for now, and await news on the HBOS takeover before buying shares in the market. At 156p shares are fairly priced.
The Fighter: Barclays
The prospect of someone appointed by the government sitting on the main board of Barclays no doubt had some influence on the bank's decision to ask for more time to raise funds to boost its capital reserves. Rather than going cap in hand to the taxpayer, issuing new shares and suffering the ignominy of part nationalisation, Barclays has set out plans to raise £6.5bn of Tier 1 capital through the private sector. If successful, the move would boost ratios to around 11 per cent, well in excess of the 9 per cent minimum recommended by the Financial Services Authority.
The risk is that if Barclays fails to raise the capital, then the bank would have to return to the government, and may be offered terms less favourable than those on offer at the moment. For now, the plan is to raise £3bn through the issue of new preference shares by the end of the year and £3.5bn through the issue of ordinary shares before the end of March next year. What's more, the final dividend payment has been suspended, which could save around £2bn, but dividend payments are expected to resume in the second half of next year. The rights issue price will be announced at a later date, and shareholders will need to see how this compares to the current trading price before deciding whether to take it up.
Shares in Barclay's rose on the plan to shun government help, and the bank added a note of cheer with news that profits in September were significantly ahead of the monthly run-rate seen in the first half of the year.
Barclays is clearly much better placed than its rival HBOS, Lloyds TSB and Royal Bank of Scotland, and is likely to attract what little confidence there remains in bank shares. The danger is that it might fail to raise the capital, and until this is out of the way, at 222p the shares remains fairly priced.
The Survivors: HSBC
HSBC has steered a quiet path through the latest banking crisis to emerge as one of the strongest capitalised and most liquid banks in the world. Not that it hasn't had its difficulties. In fact HSBC was one of the first major banks to concede a problem with US sub-prime lending but was quick to stabilise its operations in the US and restructure management. And with three quarters of profits coming from emerging markets, where growth has been strong, the bank is sufficiently well capitalised not to require any extra funding from the UK government. In fact, its UK operation recently received an injection of £750m from elsewhere in the group, and this was all that was needed to meet capital base requirement laid down by the UK authorities.
What's more, the bank has been busy oiling the cogs of the interbank market, lending around £4bn in three and six-month money to other banks in the three days leading up to the announcement of the government's latest measures. Nor does the bank have any plans to buy up distressed assets, and given the strength of its finances looks set to win business from other high street banks, particularly on the mortgage side.
HSBC has emerged from the banking crisis with fewer scars than most. The main worry is how well its Far East operations will stand up to the global recession. However, given its diversity of earnings, strong global presence and solid balance sheet, our worries valuation nhave eased somewhat and shares are now high enough at 851p.
The Survivors: Standard Chartered
Standard Chartered is not a UK clearing bank and over 90 per cent of group profits come from operations in Asia, Africa and the Middle East. True, there have been provisions in the first half of this year of £316m but this is small change when compared with the multi-billion pound write-down that many other banks have suffered.
So it came as no surprise to learn that the bank would not be taking part in the UK government's latest rescue plan, having already met the capital requirements laid down. “Standard Chartered… meets the capital requirements under the UK Government's banking sector scheme announced last week, and we will ensure it continues to do so,” it said in a statement.
The biggest worry for Standard is its reliance on Far East markets, notably Hong Kong, where operating profits in the first half of the year jumped by 30 per cent year-on-year – like HSBC, it may find it tough to sustain the growth levels seen in the Far East as the financial contagion spreads. So, even though it is better placed that most of its peers, the shares at 1,109p look high enough.
