Share Watch with Fergus Westwood

Nov 9 2009 by Fergus Westwood, The Journal

AFTER several weeks of speculation, investors finally got to see the next stage of the Government's plans to rehabilitate the banking sector whilst also introducing a greater level of competition to ensure consumers receive a fair deal. The nationalised and part nationalised banks were the main focus.

As anticipated, the boldest action came from Lloyds Banking Group. The Government approved the bank’s plans to operate outside the asset protection scheme. This will involve raising an eye-watering £21bn. £13.5bn will come from a rights issue. Crucially, the Government will be taking up its full allocation to avoid the dilution of its stake, and ensure the taxpayer enjoys the full benefits of any recovery. This will raise Lloyds Banking Group’s core tier 1 capital ratio up to 8.6% from 6.3%.

A further £7.5bn is to come from an exchange of debt securities into instruments that will convert to ordinary shares if the core capital ratio falls below 5.0%.

Lloyds will not be walking away from the asset protection scheme free of charge. A £2.5bn fee will be paid to cover the cost of the protection the bank has received through the credit crisis. The fee goes some way towards offsetting the Government’s subscription to the rights issue.

Concessions will also be made to satisfy the concerns of the European Competition Commission. This will entail the sale of a number of branches, Cheltenham & Gloucester and other brands such as Intelligent Finance. This still leaves the group with a formidable share of the UK retail banking and mortgage market.

Needless to say, shareholders’ hopes of finally enjoying the benefits of the HBOS acquisition are inextricably linked to the recovery of the UK economy.

Royal Bank of Scotland will also be the recipient of a large amount of capital, but this will not involve a lessening of any immediate participation in the asset protection scheme. To cover the cost of full participation, RBS will receive a capital injection of £25.5bn from the Government by issuing non voting “b” shares. The Government’s economic interest will rise to just short of 85%, whilst voting rights remain at 70%. In similar fashion to Lloyds there will also be an exchange of debt securities in order to serve as an additional capital buffer should the bank’s core tier 1 ratio fall below 5%.

The market was clearly disappointed, as optimism had started to build that RBS might be able to raise sufficient capital from investors to facilitate a reduced participation in the asset protection scheme. Although it must be remembered that chief executive Stephen Hester has previously spoken candidly about the scale and complexity of the reconstruction process.

Competition concerns will be addressed by the sale of branches, the insurance businesses Direct Line and Churchill and other assets such as Sempra, a commodities trading subsidiary.

Meanwhile, progress continues at Northern Rock. The bank reported an increase in mortgage lending and a slowdown in the rate of arrears. In addition, Chancellor Alistair Darling recently revealed plans to create a good bank comprising retail deposits and lower risk mortgages which will be sold when circumstances permit.

In summary, the reconstruction of the nationalised and part nationalised banks continues, but patience will be required, bearing in mind the scale of the task. Furthermore, a welcome by-product will be the reintroduction of some much needed competition, as significant capacity has disappeared as previously active banks from countries such Ireland and Iceland have withdrawn to attend to issues in their domestic economies.

Fergus Westwood is an analyst at Brewin Dolphin