The British government is taking on the toxic assets of its two most troubled banks. But is it a good deal for the taxpayer? Cris Sholto Heaton reports.
What’s the latest banking bailout?
The British government is to underwrite over half a trillion pounds worth of toxic assets held by its two most troubled banks, Royal Bank of Scotland (LON:RBS) and Lloyds (LON:LLOY) (now struggling due to the ill-advised takeover of HBOS). Under the scheme, first outlined in January but now being fleshed out, RBS will pay to insure £325bn of its loans. It will still bear the first £19.5bn of losses, but 90% of any others will be met by the government. Lloyds is also set to insure £250bn in the same way. Other banks, such as Barclays, may also participate. These are big numbers: the face value of insured loans for RBS alone amounts to 23% of British GDP.
What do we get in return?
Participating banks must pay an insurance premium-like fee to the government, in the form of cash or shares. In RBS’s case, it will be £6.5bn worth of shares, while the government will also inject up to £19bn of new capital into the firm to allow it to meet its share of expected losses. This would potentially take the government’s stake in RBS to as much as 95%. For Lloyds, terms are still under discussion, but are likely to involve increasing the government 43% stake to majority control, a move the bank has so far resisted. Offloading the risk on these loans should free up capital for the banks to increase lending to small businesses and homeowners: RBS has committed to raise lending by £25bn a year in 2009 and 2010.
Is the government finally getting ahead of the game?
These new measures are certainly more realistic than the optimistic assumption of last autumn that £37bn in capital and a forced merger between Lloyds and HBOS would fix the sector’s woes. More capital or more guarantees will probably be needed, since the condition of both banks’ loan books is deteriorating at a spectacular pace; bad debts in HBOS’s gung-ho corporate lending division have soared from 2.9% of loans in 2007 to 11.9% in 2008. It is also exposed to rising repossessions and mortgage arrears through its Halifax unit. In addition, Northern Rock is to be split into a good and a bad bank (see below), and the good half has been ordered to lend £14bn in new mortgages over the next two years.
How about other banks?
The big news this week was that HSBC is to carry out a $17.7bn (£12.5bn) rights issue. The bank says that this is partly to raise the firepower for distressed acquisitions. But having extra capital to set against future write-downs will be on its mind; it announced a $15.5bn loss in its US lending business, led by write-downs at Household Finance, the huge subprime lending unit it acquired in 2002. HSBC’s move is significant, because it professes to be a conservative bank boasting some of the best capital ratios in the City, and has tended to face up to reality ahead of its peers during the crisis. So if even it needs to raise so much extra capital, there’s a high risk that rivals will have to follow. Take Barclays, for example. Its share price has been hammered – falling 7% on Tuesday alone – as investors fret over whether it will need to raise further equity capital simply to fund the insurance premium it will have to pay to participate in the government’s asset purchase scheme.
What does all of this mean for the British taxpayer?
Trouble and expense. The new boss of RBS, Stephen Hester, has admitted that the bank could be relying on taxpayer support for at least five years. And exactly how much more cash that could involve is unclear, as RBS is “in the lap of what happens in the outside world”. The alarming thing about the catastrophe insurance being offered to the banks by the British government is that no one really still knows what many of the assets being underwritten are worth. Meanwhile, the Office for National Statistics has estimated that the various bank bail-out schemes could add £1.5trn to the UK’s public debt, taking the total to between 70% and 100% of GDP. And that spells big future tax rises, plus spending cuts, long after Gordon Brown’s gone.
What are other countries doing?
America is still trying to rescue the deeply insolvent Citigroup without uttering the dreaded word ‘nationalisation’. The latest steps include swapping $52bn of preferred stock, mostly owned by the US government and several sovereign wealth funds, for common stock. This will improve Citigroup’s capital base and eliminate the cash drain of $2.8bn in preferred dividends each year. The US government has already guaranteed $300bn in toxic assets and Citigroup is supposed to be shedding non-core assets to raise cash. Other problem banks include Bank of America, following its takeover of Merrill Lynch, and mortgage lender Countrywide. Meanwhile the black hole that is insurer AIG continues to suck in cash: an extra $30bn this week alone on top of a $26bn debt-for-equity swap. And European banks face a whole new raft of problems in the form of central and eastern European debt write-offs.
What is a bad bank?
Bad banks have been used in the past to separate the supposedly healthy banks from their toxic assets. Bad assets are absorbed by a bad bank – usually government-owned – that can hold them indefinitely and try to recover what it can. The remaining ‘good bank’ should then be free to raise fresh money from investors and restart lending. The RBS, Lloyds and Citigroup solutions don’t totally remove bad assets from those banks. Northern Rock’s restructuring, however, will do so, which should make it easier to reprivatise in the future.