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April 5, 2013 6:59 pm
Stephen Hester and António Horta-Osório find themselves in early 2013 with two things in common.
As the helmsmen of Britain’s two state-backed banks, both chief executives and their institutions continue to come under an unenviable degree of scrutiny as they steer a course through tougher regulatory waters and navigate the charged issues of banking culture and pay.
But more happily, both also now share a sense of quiet optimism about the odds of taxpayers getting their money back several years after Royal Bank of Scotland and Lloyds Banking Group received bailouts at the height of the financial crisis. They are both looking towards the day when the government divests its shareholdings.
The question of how best to return those stakes – of 82 per cent and 39 per cent for RBS and Lloyds respectively – has shot up the political agenda in recent weeks.
There have been three triggers.
The first is that the share prices of both lenders have risen dramatically over the past year, even allowing for a recent dip on the back of the Cyprus troubles.
Shares in RBS have risen around 10 per cent to 274p while those of Lloyds, which closed at 48p, have approximately doubled since spring 2012.
Both have benefited from a rally in European bank shares generally, spurred in part by an expansion of the European Central Bank’s bond-buying programme last year to help troubled economies such as Spain and Italy.
Secondly, both Hester and Horta-Osório have used decidedly optimistic language in recent weeks.
“The time when it can be privatised . . . is coming much closer,” a visibly upbeat Hester told investors when presenting annual results last month.
His counterpart at Lloyds was less willing to discuss a timetable, but stated firmly: “I am very confident we will get taxpayers’ money back.”
In the case of Lloyds there was also an indication of the minimum share price deemed necessary for the government to begin a divestment – it’s 61p, the average price at which the equity support is booked in the government’s accounts.
That number was revealed as part of the pay disclosure for Horta-Osório, being the price at which the government must sell its shares in the bank before he can claim a bonus for 2012 under one set of conditions. Another trigger would be the shares reaching 73.6p, the price at which the government actually invested, for 30 consecutive days.
How to do it
Broadly speaking, there are three scenarios for returning shares to the private sector.
With the privatisation of Royal Bank of Scotland and Lloyds now on the horizon, can UKFI gain any useful tips from overseas?
Sweden and South Korea are both countries that took banks into state ownership following financial crises. But while Sweden’s experience in returning them to the private sector is instructive, South Korea provides a case study in how not to do it, writes Brian Caplen.
Sweden’s advantage was in having a bank to sell that already had the bad assets removed, Northern Rock style. In the Swedish financial crisis of the early 1990s, only two banks were nationalised – privately-owned Gota Bank and Nordbanken (which was already partly state-owned, and which changed its name to Nordea in 2001). The other troubled banks were recapitalised by their own shareholders, like Barclays in the UK.
The good parts of Gota and Nordbanken were merged in 1993 and an IPO for 30 per cent of the combined group was completed as early as 1995, just four years after the crisis. Since then, the government has sold down further in stages (the most recent being a 6 per cent disposal in early 2011) and now retains just 13.5 per cent. Getting started early but then taking the long view has enabled the government to take advantage of market peaks and recover taxpayer funds.
By contrast South Korea has allowed its privatisation efforts to be marred by a combination of prejudice against foreigners, a distrust of private equity and hostility from labour unions. After the 1997-98 Asian financial crisis, a number of troubled banks there were consolidated into Woori Financial Group, but three attempts to dispose of a 57 per cent majority stake have failed due to lack of bids.
Foreign bidders have been scared off by the experiences of US private equity firm Lone Star, which acquired a stake in Korea Exchange Bank in 2003 but ran into a political backlash when it tried to sell out at a profit. The stake was finally sold to Korea’s Hana Bank in 2010 but delays in the process proved costly. Standard Chartered bought Korea First Bank in 2005 and suffered a lengthy strike in 2011 when it wanted to introduce performance-based pay.
Given the general hostility towards banks in the UK, the government can also expect political fallout if a strategic buyer benefits from any upside in a part-nationalised bank. For that reason a widely-distributed disposal in stages, Swedish style, would seem the preferable exit.
Brian Caplen is editor of The Banker, an FT-owned magazine for the global banking industry
The most eye-catching option would be gifting the public so-called “free” shares. The thinking behind this is that since taxpayers supported the bank, it is only right that they should benefit from its return to private ownership.
Portman Capital, a small London financial boutique, has been sketching out the hypothetical shape of such an issuance.
Under their proposal, some 40m to 45m people with national insurance numbers could register for shares at a predetermined floor price. The shares would be free, with the Treasury recouping the base price as investors sell them over a period of years, while the public would profit from any increase above this level. The idea has attracted support from some MPs – the foreword to the original Portman paper was written by Matthew Hancock, once George Osborne’s chief of staff.
The second option would be to make placings to institutions, the standard way to introduce a large company to the stock market. Finally, there could be a placing allied to a substantial retail shareholder offer, perhaps in the style of the big privatisations of the 1980s and 1990s.
Treasury officials are considering several possibilities for eventual disposals, but nonetheless the possibility of a share giveaway appears to have gained traction in recent weeks. While the Treasury rubbished the prospect of such a move when first mooted by the Lib Dems in 2011, George Osborne’s team did not dismiss it out of hand when the idea was revived by Vince Cable, the business secretary, earlier this year.
Running a big “tell Sid” privatisation or giving the shares away to the public both have political appeal, involving or rewarding the taxpayers who bailed out the banks and spreading the gospel of share ownership as well as achieving a quick exit. Giving the shares away also partly neutralises any controversy over the asking price and removes the uncertainty of a stock overhang.
But there are practical drawbacks. Investors have expressed concerns about the difficulties of potentially having tens of millions of shareholders, as has Sir Philip Hampton, chairman of RBS.
Secondly, there is the question of timing. The suggestion that shares could be offered to voters as a pre-election bribe risks incurring the anger of the National Audit Office, to whom ministers must justify their disposal strategy.
Aside from the actual decision of how to reprivatise, there is also the question of the pace at which the process should unfold. The government’s in-price is also expressed as a range rather than a fixed sum in both cases, potentially creating a further question mark around timings. The state bought shares in RBS at between 410p and 500p (adjusted for a share consolidation in 2012) depending on calculation methods. For Lloyds, the buy-in price stands between 61p and 73.6p.
Obstacles to privatisation
Although stock market conditions have improved, banks still won’t be an easy sell. Both RBS and Lloyds have seen their reputations tarnished further since 2008; the bill for mis-selling payment protection insurance at Lloyds has risen to more than £6.5bn, and this week a Parliamentary Commission on Banking Standards lambasted executives at HBOS over their conduct prior to 2008. RBS has been hit by several high-profile IT failures, paid £390m to settle an investigation into manipulating interbank rates, and is now being sued by a group of shareholders over its 2008 rights issue.
They also have plenty of restructuring still to do. Lloyds is partway through a cost-saving programme announced shortly after Horta-Osório took over in 2011, and both are still shedding assets deemed to be “non-core”. RBS has disposed of a large number of assets and exited businesses where it was not a top-tier player, such as cash equities, but still has more to do – including a likely sale or flotation of its US business. There is also the question of capital levels; the Financial Policy Committee thinks Britain’s banks are still £25bn short of capital and wants them to bridge the gap by the end of this year. Lloyds and RBS are thought to account for around £20bn of that total.
Both banks are also grappling with the disposal of several hundred branches as mandated under European state aid rules, a quid pro quo for their government bailouts, which will be of more immediate interest for consumers.
Lloyds has an agreement to sell more than 600 branches to the Co-operative Bank, but there are concerns that the latter’s weak capital position might undermine that deal. RBS suffered a setback when a deal to sell 316 branches to Santander collapsed late last year. The bank is now focused on floating these branches by carving out a standalone business, but is still considering proposals from a number of investors for the business.
All of these issues will need to be settled before a dividend policy, likely to be vital in any sales pitch, can be formulated.
Every now and then come reminders that privatisation is not the only option. Just a few weeks ago, Bank of England governor Sir Mervyn King used an appearance before the Parliamentary Commission on Banking Standards to call for a break-up of RBS, arguing in part that the bank’s shrinkage was a drag on the wider economy. Lord Lawson, the former chancellor, has called for it to be nationalised completely. Even Vince Cable, the business secretary, said before the 2010 election that “the optimal time frame for disposal of nationalised or semi-nationalised assets is probably close to 10 years”.
And finally, there’s the still-weak economic backdrop. Away from the headlines about capital requirements and the cost of settling legacy issues, analysts note that both banks also face muted prospects for revenue growth given the difficult economic outlook. “Recent dire macro data has delivered a very necessary wake-up call,” says Ian Gordon, analyst at Investec Securities. “Valuations became stretched, driven by what we believe were quite unrealistic expectations over the scale and pace of recovery.”
So while the buoyant Hester and Horta-Osório are likely to remain the keenest advocates for a smooth and timely privatisation, the decision is not just theirs to take – and the barriers along the way are many.
What the public thinks
For all the sector’s woes, bank shares remain very widely owned and traded among private investors, writes Jonathan Eley. Around 5 per cent of RBS’s share capital is in the hands of private investors and Barclays, Lloyds and RBS are among the most heavily traded shares at most execution-only brokers.
What do shareholders think should happen to the shares? Roger Lawson, at the Individual Shareholders Society, thinks that those who suffered from past government interference might like to see some recognition of their suffering if the government stakes were sold on. “If they were sold via a private sale, or via some form of public offering, long-standing shareholders might be given some preferential treatment in terms of share price or entitlement,” he said.
“Such an offer might actually deflect the legal actions that are still active, particularly in the case of RBS, which might of course otherwise delay any sale until those actions are resolved.”
He also suggests that another possibility might be to move the government’s stakes into a not-for-profit or mutual form where the general public is simply given a stake in that corporate structure. “At least this would get the liabilities and potential future risks off the government’s back.”
Public reaction to the idea of a share give-away has been mixed. “If we are ‘all in it together’, then I cannot see why everyone – rather than a chosen few investment bankers in the City – should not benefit from any RBS privatisation. The last thing that we should be contemplating is another dose of the Northern Rock approach where the ‘good bank’ was sold on to Virgin and the taxpayer copped it for the losses in the bad bank,” commented Anthony Dunn, on ft.com. However, other respondents described the suggestion as “bonkers”.
The mood on shareholder bulletin boards seems to be largely one of resignation. “RBS is in good shape to move forward after having made adequate provisions for the past . . . Let’s start now and adopt a phased approach to the sell-off of public shares. Initially selling at a loss for the public will probably stimulate future sales at a profit,” commented “Scotmak” on www.fool.co.uk.
The Taxpayers Alliance, which campaigns for lower taxes, says RBS in particular should be returned to private ownership as soon as is practical, rather than increasing exposure through full nationalisation.
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