Cameron Vexed by Bailout’s $5 Billion Interest Costs

Photographer: Carl Court/AFP/Getty Images

British Prime Minister David Cameron. Close

British Prime Minister David Cameron.

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Photographer: Carl Court/AFP/Getty Images

British Prime Minister David Cameron.

The U.K. pledged more money rescuing banks during the credit crunch than on any project in British history outside of world wars. And the cost keeps rising as the government looks for ways to get its money back.

While U.S., French and Swiss banks repaid bailouts, the U.K. hasn’t received any return on its 66 billion pound ($103.2 billion) rescue of Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc. (LLOY) The annual interest payment on the debt incurred acquiring controlling stakes in the banks is about 3.2 billion pounds, according to a JPMorgan Chase & Co. estimate.

That’s about what British taxpayers spent on military operations in Afghanistan last year and exceeds the forecast of 2 billion pounds from a proposed levy on banks. While the government would like to sell the bank stakes, it can’t because the shares are fluctuating below the level the state paid for them. In addition, a government commission isn’t scheduled to decide for another year whether to split the retail and investment-banking businesses of Britain’s largest lenders.

“They should have lent money to these banks, not bought shares in them,” said Conservative lawmaker John Redwood, 59, who advised former Prime Minister Margaret Thatcher on privatizations in the 1980s. “If the government succeeds in getting all the taxpayers’ money back with proper reward, then that’s a good achievement. But it’s not guaranteed.”

Selling Stakes

Analysts (RBS) and investors are divided over how long it will take the government to sell its stakes, with estimates in a Bloomberg survey of five analysts ranging from three to eight years. Stephen Hester, 49, chief executive officer of Edinburgh-based RBS, said last month that he’s ready for the government to start selling its holdings immediately, as the bank posted a half-year profit for the first time since 2007.

That’s not likely to happen, at least not until the commission reports its conclusions, because the findings may affect the value of the banks, according to government officials who declined to be identified because the talks are private. The commission, chaired by John Vickers, a former chief economist of the Bank of England, starts collecting evidence on Sept. 24.

“The government investigation into separating the banks rules out any sale in the short term,” said Jeremy Scott, the global financial services chairman at PricewaterhouseCoopers LLP, who wrote a report saying it may take up to seven years to sell the stakes. “The markets are not favorable at the moment, even if you wanted a sale.”

Gold Reserves

Prime Minister David Cameron could use the money from a share sale. His Conservative-led coalition is under pressure to tackle a deficit that hit a postwar high of 11 percent of gross domestic product in the year through March. The government unveiled an emergency budget on June 22 with plans to cut spending by a quarter on average in all departments except health and international aid. The Treasury’s fiscal monitor forecasts 490,000 public-sector jobs will be lost by April 2015.

The timing of the share sales may prove as controversial as former Prime Minister Gordon Brown’s decision to dispose of all of Britain’s gold reserves a decade ago. Brown sold 400 tons of gold, a stack almost as big as two London taxis, in a two-and-a-half year period ending in March 2002.

Gold prices have risen about 270 percent since then, leading to criticism that Brown’s decision to sell the reserves at a 20-year low cost the country about 7 billion pounds. Chancellor of the Exchequer George Osborne said this year that it was “one of the worst economic judgments ever made by a chancellor.”

850 Billion Pounds

“The timing is going to be a difficult decision,” said Paul Mumford, who helps manage about $1 billion at Cavendish Asset Management Ltd. in London, which owns RBS and Lloyds shares. “Undoubtedly people may draw a comparison with Gordon Brown selling the gold if the government sells the bank shares and the price shoots up.”

The government invested, loaned and pledged more than 850 billion pounds rescuing stricken banks during the financial crisis that started in 2007, the National Audit Office, the U.K. public-spending watchdog, said in a December report describing the outlay as unprecedented. It’s equivalent to each U.K. household having about 3,000 pounds of stock in RBS and Lloyds.

Next month marks the second anniversary of the Oct. 7, 2008, bailout amid concern by then-Chancellor of the Exchequer Alistair Darling that RBS, the nation’s second-largest bank, and Britain’s biggest mortgage lender HBOS Plc didn’t have enough money to open their doors the next day.

Defeating Hitler

The government took an 83 percent stake in RBS and bought 41 percent of Lloyds, which acquired HBOS. It also took over all of Northern Rock Plc and parts of Bradford & Bingley Plc after bailing out the banks, and agreed to insure 280 billion pounds of RBS’s riskiest assets for an annual fee. The U.K. provided a further 450 billion pounds in guarantees to increase liquidity.

The annual interest cost on the 66 billion pounds of bonds the government had to sell to finance the rescue of RBS and Lloyds isn’t included in official estimates of the outlay for the bailout, meaning the actual bill may be as much as 19.7 billion pounds more, or 30 percent higher, JPMorgan’s analysis shows. That assumes the government can’t sell its stakes until 2014, six years after it used taxpayer money to save the banks.

Aside from World War I and World War II, the bank rescue was the costliest undertaking in British history. The U.K. spent 300 billion pounds defeating Adolf Hitler’s Germany in World War II, according to the Penguin Atlas of World History, about 3.5 trillion pounds on an inflation-adjusted basis today.

‘Devise and Execute’

U.K. Financial Investments Ltd., which manages the government’s bank holdings, declined to comment on the cost of the bailout or when share sales might begin. The Treasury, which declined to comment on interest costs, said in a statement that the UKFI will “devise and execute a strategy for disposing of the government’s investments in an orderly and active way.”

In a budget submitted to Parliament in March, the Treasury scaled back its estimate for the eventual cost of bailing out the U.K. financial industry to 6 billion pounds. It lowered its estimate from 50 billion pounds because of a recovery in financial markets and after Lloyds raised capital rather than paying the government to insure toxic assets.

The U.K. currently has a 3.35 billion pound paper profit on its stake in London-based Lloyds, after the shares gained 49 percent this year, and a 1.87 billion pound loss on RBS, even after its shares rose 64 percent. RBS and Lloyds are among the best-performing bank stocks in Europe and the U.S. this year after returning to profit earlier than analysts expected.

Breakeven Price

The calculations are based on the average price the government paid for shares in the banks after injecting capital in 2008 and 2009. The so-called breakeven price is 49.9 pence for RBS and 63.2 pence for Lloyds, according to UKFI. When working out the price, UKFI subtracted fees paid by the banks for setting up the bailout and 2.5 billion pounds paid by Lloyds for exiting the government’s insurance program.

RBS closed at 49.02 pence today in London trading and Lloyds at 77.41 pence. Since the start of the financial crisis in August 2007, RBS has plunged 90 percent, making it the second-worst performing bank stock in Europe after Bank of Ireland Plc. Lloyds has fallen 73 percent. The bank’s CEO, Eric Daniels, said today he will step down in the next 12 months, and the lender said it will form a committee to find his successor.

RBS, which on average lost 36 million pounds a day in 2008 and 2009, posted net income of 9 million pounds in the first half of the year. Lloyds, still reliant on 132 billion pounds of government and central bank funding, reported half-year net income of 596 million pounds, its first profit since the rescue.

‘Popular Capitalism’

Hester says RBS’s biggest problem is retaining staff at its investment bank, where restraints on pay, including deferrals and clawbacks imposed after the bailout, are driving some employees away. About 1,000 investment bank employees left last year over bonuses, which cost the lender 1 billion pounds in lost profit, Hester said in February.

As part of the terms of the bailout, RBS and Lloyds halted dividend payments in 2008, and the lenders won’t resume paying them until at least 2012, which has suppressed the share prices.

UKFI will recommend that the Treasury start selling its bank stakes when the lenders are free of state funding and when a sale offers the best return for taxpayers, according to government officials. UKFI only has a mandate to recommend selling to achieve value, which depends on market conditions, not to ensure stakes are sold at a profit, the officials said.

The government said in June that it plans a discount sale of bank shares to the public to foster what Cameron termed “popular capitalism.” It is also considering selling shares to institutional investors and using convertible bonds to dispose of the stakes, UKFI said in its annual report last year.

‘Reaping Bigger Profits’

“The government has a fighting chance of making some sort of profit on the holdings, and it will be politically damaging not to do so,” said Richard Hunter, head of U.K. equities at Hargreaves Lansdown Plc, a London-based asset manager and retail stockbroker. “The biggest problem is the technical aspect of finding a way to sell the two massive holdings in RBS and Lloyds.”

Disposing of so many shares runs the risk of depressing the stocks’ prices, he said.

While the U.K.’s decision to take direct stakes in banks may force it to hold them longer than it would like, the government stands to benefit from rising share prices, according to Charles Davis, an economist at the Centre for Economics and Business Research in London.

France, U.S.

“Holding the banks for longer gives the government a better chance of reaping bigger profits,” said Davis, whose firm estimates that British taxpayers stand to make about 19 billion pounds from the rescue. “Banks are getting their balance sheets in order and should become increasingly profitable over the next few years.”

If Davis’s forecast is correct, the U.K. government may make more money from rescuing its banks than Switzerland, France or the U.S.

Switzerland made a profit of about 1.2 billion francs ($1.18 billion) from bailing out UBS AG (UBSN) after spending 6 billion francs buying mandatory convertible notes in 2008. The French government made about 2 billion euros ($2.62 billion) from its rescue of banks, including BNP Paribas (BNP) and Societe Generale SA (GLE), after injecting emergency capital the same year. The U.S. government has received about $16 billion in dividends and interest payments on its investment in banks, insurance companies and automakers through the Troubled Asset Relief Program, according to the Treasury.

Sweden’s Lesson

Britain’s bank rescue also exposes taxpayers to more risk, Davis said. And the cost of financing the bailout continues to climb -- already more than 6 billion pounds, according to JPMorgan’s estimate.

The lesson from Sweden, which nationalized two big banks in the 1990s, is that it will take longer than expected to sell the stakes, said Bo Lundgren, Sweden’s minister for fiscal and financial affairs in the 1990s. The government still owns 19.9 percent of Nordea AB (NDA) almost two decades after taking over its predecessor, Nordbanken, which went on to merge with Gotabank, which also had been nationalized.

“What you need to do is try to privatize them as soon as possible, though not when the markets are bad,” Lundgren said. “Governments are not very good owners in the long run.”

To contact the reporters on this story: Andrew MacAskill in London at amacaskill@bloomberg.net; Jon Menon in London at jmenon1@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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