To calm the financial panic, the British government has stepped in to save three major banks. So far the markets like the news
Hoping to stem financial meltdown and avoid a deep recession, the British government on Oct. 13 moved to take stakes in three of the five largest British banks at a cost of $62.5 billion. So far, Royal Bank of Scotland (RBS), Lloyds TSB (LYG), and HBOS (HBOS.L) have agreed to take government funding, while Barclays (BCS) continues to resist. The move was part of a three-point British plan that also includes a $338 billion Bank of England facility to boost liquidity and up to $422 billion in possible guarantees for interbank lending.
At this point the news has been well-received by the markets, which had been under relentless selling pressure. The benchmark FTSE 100 index ended the day up nearly 8.3%, though shares of the three banks opting for government ownership were all down. HBOS was hardest hit, falling about 27% on news that Lloyds TSB would be lowering an outstanding offering price to take over the mortgage lender.
While part-nationalization of the banking system is not an appealing prospect for investors, it looks like the only alternative to avoid continued erosion in the value of bank shares—and even, quite possibly, major bank failures. "The British government's plan was the only thing that could help support the banking industry," says Peter Hahn, a fellow at Cass Business School in London and a former Citigroup (C) banker.
With these moves, which were first outlined Oct. 8 (BusinessWeek.com, 10/8/08), the British government has taken the pole position in trying to solve what has rapidly become a global financial crisis. On Oct. 12 other European countries signed on to what appeared to be the general outlines of the British approach. Germany, for instance, outlined a program on Oct. 13 to provide up to $672 billion in loan guarantees and possible capital injections, while French President Nicolas Sarkozy announced a similar plan the same day at a cost of up to $491 billion. The British also seem to be having some influence in the U.S., where the Bush Administration is considering modifying its bailout plan to provide capital injections into troubled institutions.
A Boost for Brown
The British initiative has also immensely improved the domestic political standing of Prime Minister Gordon Brown, who has been transformed in a matter of weeks from a leader facing huge poll deficits and calls for a leadership contest from members of his own party in Parliament to an international financial statesman. Whether Brown can win the next election, which must be held by 2010, is still in question, but he is in his best political shape in more than a year with the critics, at least temporarily, silenced. On Oct. 13, Brown, reveling in this new status, called on the world to build a "new Bretton Woods…a new international financial architecture" appropriate for the age of globalized finance.
There is immense pressure on Britain and Brown to prevent an implosion of the world financial system. Along with New York, London has been one of the key drivers—and beneficiaries—of the financial innovations of the past two decades. Of the British banks targeted by Brown's plan, only Barclays is a major player in the trading, corporate finance, and merger advisory that form the core of activity in the City of London, Europe's closest equivalent to Wall Street. Instead, the City is mainly dominated by the likes of Morgan Stanley (MS), Goldman Sachs (GS), Deutsche Bank (DB), and UBS (UBS). If they are allowed to fail or fall into steep decline, Britain will be hurt, but Brown needs other financial powers—especially the U.S.—to help support those banks.
France stepped up to the plate Oct. 13 with a plan to make $491 billion available to aid banks and insurers, including as much as $54.6 billion that could be used to recapitalize banks. At a news conference, Finance Minister Christine Lagarde said the government either would take direct stakes in distressed banks or in other cases provide capital to healthier banks to boost their so-called Tier 1 capital ratios to at least 9%. That would "level the playing field" with British banks, which are expected to achieve a roughly 9% capital ratio under that country's bank bailout plan, Lagarde said. The remaining $436.4 billion in the aid package would be for government guarantees of interbank loans for up to 5 years. "If we did nothing, the financing of households and businesses would be in danger," she said.
Whether the bold steps taken by Britain and other governments will turn the tide is still very much in doubt. One top British business figure said he thought the government had "not done enough, nor early enough," to keep confidence from being lost. He said he thought the coming recession was likely to be much worse than the downturns of the early 1990s and early 1970s, which are still remembered with shudders. And he noted that bank lending officers remain "panic-struck" while blue chip companies are still having trouble rolling over debt. Indeed, despite the trillions of dollars in promised bailouts, interbank lending rates remained stubbornly high on Oct. 13. The key three-month dollar LIBOR rate, for instance, only fell slightly, to 4.75%, from about 4.82% on Oct. 10.
More Government Control
More than half of the government's $62.5 billion will go into RBS, where the government will buy $25 billion worth of ordinary shares (at a roughly 13% discount to last Friday's closing price) and $8.45 billion in preference shares with a 12% coupon. The other bank injections will also take the form of a mixture of ordinary and preference shares. Depending on the extent to which shareholders exercise their rights to take up shares, the government could wind up with about 60% of RBS and 40% of a combined Lloyds TSB and HBOS once their merger has been completed.
The result could be that more than 50% of British mortgage lending and a big chunk of small business loans could fall under the aegis of government-controlled or -influenced banks. As part of the price for the new capital, there will be top management changes at RBS, most notably the departure of Fred Goodwin, the embattled RBS chief executive, who led a banking consortium—also including Fortis (FOR.BR) and Spain's Santander (STD)—that won a protracted battle last year to take over Dutch investment bank ABN Amro for $101 billion. That deal has proved disastrous for all but Santander (BusinessWeek.com, 10/1/08) and ABN shareholders.
Goodwin will be replaced by Stephen Hester, CEO of British Land (BLND.L), a large commercial real estate company. Hester also held senior banking positions at Credit Suisse (CS) and Abbey National, now a unit of Santander.
HSBC (HBC), Britain's largest bank, has delighted in pointing out that it doesn't need or want government money, instead choosing to inject $1.3 billion "from its own resources" into its British subsidiary, HSBC Bank. Barclays, the other major bank, is twisting and turning to avoid the stigma of falling under government control. On Oct. 13 it outlined steps to raise $11 billion in capital, including $1.7 billion from an unidentified existing shareholder, possibly a sovereign wealth fund. CEO John Varley said the banks that took government money would "be more constrained" in their decisions, possibly leading to an advantage for Barclays.
But Barclays, which recently snapped up much of Lehman Brothers' U.S. operations after the investment bank collapsed, is clearly straining to avoid the government's reach. As part of its capital raising, it will eliminate the $3.4 billion dividend it expected to pay for the second half of 2008. Barclays says it plans to resume paying dividends in the second half of 2009. It also concedes that if any of the measures it outlined on Oct. 13 don't come off, including a new $5 billion share offering, it will come back to the government for the money.
Alistair Darling, the British Chancellor of the Exchequer, says over the long run the government can't run the banks. But it has obtained a commitment from its new wards to maintain lending to homeowners and small businesses at 2007 levels, to support schemes to head off mortgage foreclosures. The banks also must drastically curtail executive compensation until the new preference shares are paid off.
Reflecting such pressures and the new economic environment, Hester, the incoming RBS CEO, said the bank, which has pursued rapid international expansion including in China and the U.S., would overhaul its strategy to reduce risk and rebalance "our businesses toward our very strong customer franchises." He left little doubt where those were. "It is clear that the U.K. is the greatest source of strength and cash flow," he said.