In mid-August last year, Barclays’ chief executive John Varley and HSBC’s
chairman, Stephen Green, held a reception for leading Anglican and Catholic
bishops. The setting for this meeting of God and Mammon was on the 31st
floor of Barclays’ sparkling headquarters in Docklands’ Canary Wharf, where
the walls are lined with paintings by, among others, LS Lowry and the
carpets are so thick you cannot hear your footsteps.
Both bank bosses are deeply religious – Green is an Anglican preacher, Varley
is a devout Catholic who serves on the board of the Vatican’s British
property fund. The two bankers and their esteemed guests shared a lavish
four-course meal and fine wines at a table decked in a purple cloth.
The aim of the evening was to discuss the role of Barclays and HSBC in the
community in partnership with the Anglican and Catholic churches, so it is
perhaps fanciful to think that Varley and Green should have been seeking
divine intervention to ward off the storm that had started to batter the
world’s financial markets.
Six months later, the turmoil that began in August has devastated the market
value of Britain’s banks and unleashed the unholy wrath of their investors.
While Varley and Green were entertaining, Sir Fred Goodwin, the boss of Royal
Bank of Scotland (RBS), was fine-tuning the details of the RBS-led
consortium’s bid to beat Barclays to take control of the Dutch bank ABN
Amro.
By early October, RBS and its partners – Spain’s Santander and Belgium’s
Fortis – would triumph with a €71 billion (£53 billion) takeover of ABN, the
world’s biggest deal in financial services.
However, Goodwin’s victory is coming back to haunt him. Doubts about the
wisdom of buying parts of ABN, fears that RBS could be hit with further
losses linked to the credit crunch, a potential surge in retail and
commercial banking bad debts as the economy slows and nagging worries about
the bank’s financial strength, have all helped to drive its shares to an
eight-year low.
No wonder the mood is so sour. Since early August RBS shares have plummeted
37%, slashing the bank’s market value by £19 billion to £37 billion. And RBS
is not alone in taking a beating – £82 billion has been wiped off the
combined market value of Britain’s banks since August 9 – the day the
liquidity freeze hit the markets. Many bank shares are now yielding more
than 7%, a level not seen for many years.
After the share-price bloodbath, the big question is how bad can things get
for Britain’s beleaguered banks.
“It is almost impossible to call the bottom,” said one leading London fund
manager. “There is a fear factor out there.”
BARELY 11 months ago, the landscape looked very different. British banks had
reported record profits of £37.5 billion for 2007. Goodwin had successfully
faced down the famous allegations of one analyst who claimed that he was an
“acqui-sition-crazy megalomaniac” who cared more about size than
shareholders.
RBS investors were also pleased by a bumper rise in the dividend. The bank’s
profits had hit a record of £9.2 billion, and the shares seemed to be
finally moving in the right direction.
Since August, it has all turned ugly. The American sub-prime crisis has
claimed the scalps of chief executives at Merrill Lynch, Citigroup and
Switzerland’s UBS. Citi and Merrill have been forced to announce
multi-billion-dollar losses and turn to investors from the cash-rich
economies of the Middle East and Asia to bail them out.
In Britain, Northern Rock has been propped up by £24 billion in emergency
loans from the Bank of England as bidders struggle to fund a takeover deal.
Meanwhile, Alliance & Leicester and Bradford & Bingley have been hit
hard by speculation that they too could be in dire straits, though both
banks have taken action to ensure they will have funds to keep lending into
the fourth quarter of this year.
Many analysts have started to draw comparisons with the turmoil in British
banking 25 years ago. Then, blundering banks were poleaxed by disastrous
loans in Latin America and mammoth losses in property. Today they are
threatened by mortgage-backed securities and exotic off-balance-sheet
vehicles such as conduits – terms that even many sophisticated investors had
not heard of six months ago.
To make matters worse, fresh challenges are emerging as Britain’s economy
slows and consumers rein in their spending.
Many observers believe that RBS looks the most vulnerable. So far, Britain’s
second-biggest bank has revealed total write-downs of £1.25 billion against
American sub-prime mortgages, a similar amount to Barclays’ £1.3 billion.
The RBS write-down was less than expected, but sceptics fear there could be
more to come.
Another problem is RBS’s financial position after the ABN deal. The bank’s
core Tier 1 ratio, a measure of financial strength, has dropped to 4.75%,
uncomfortably close to the 4% minimum required by financial regulators.
This is not new territory for RBS. The ratio fell to similar levels after it
bought the American bank Charter One in 2004 and NatWest in 1999. RBS was
able to rebuild its balance sheet and executives are confident they can do
it again.
However, the bank has been plagued by suggestions that it will need to raise
up to £8 billion through a rights issue.
Last month, Goodwin shrugged off the sub-prime woes and appeared to quash
fears of a rights issue or a dividend cut. He may have sounded optimistic
but investors do not appear to be listening. Since the update, the bank’s
shares have fallen 22%.
Many bankers believe a rights issue would be a disaster – and a huge dent in
Goodwin’s credibility. What is more likely is that RBS will sell assets,
including rail-leasing firm Angel Trains, its Saudi Hollandi retail bank and
a 25% stake in ABN Amro Australia.
RBS executives are understood to feel that the bank has been caught by a tide
of negative sentiment. “The attitude of some investors appears to be: shoot
first, ask questions later. Any sign of weakness is punished,” said one
senior London banker.
Nonetheless, many have questioned if RBS was right to buy ABN’s wholesale
banking business. The deal means that RBS now relies for two-thirds of its
profits on corporate banking and financial markets – sectors that face
tougher times.
The mood in the City is that Goodwin could probably survive a rights issue,
but a major problem at ABN Amro could cost him his job.
FOR the doom-mongers, Britain’s banks are under fire on all sides. “As the
decade of debt comes to an end, the revenue outlook for UK retail banking
has perhaps never been so poor,” said UBS analyst Stephen Andrews.
What makes the looming slowdown so different to those in 1998 or 2003 is the
freezing of the credit markets. “Put simply, if the banks cannot raise funds
to lend, then the availability of mortgages will decline rapidly,” said
Andrews.
The research firm Moneyfacts estimates that lenders have withdrawn about 40%
of all mortgage products and many believe that net mortgage lending could
dive 15% this year.
The credit crunch is also starting to hit the profitability of small and
medium-sized enterprises (SMEs). This is a big threat. SME banking accounts
for about 25% of big British banks’ domestic profits. UBS forecasts that a
slowdown could hit SME banking profits by 5%-6% this year at HBOS, Lloyds,
RBS and Barclays and a further 2% in 2009.
In a chilling analysis last week, James Chappell at Goldman Sachs argued that
banking shares could even fall to the lowly ratings of five times their
earnings of the early 1990s.
However, there are some grounds for optimism. Banks tightened up on their
lending of unsecured loans two years ago. As a result, losses are not expected
to rise unless there is a sharp economic slowdown and leap in unemployment.
And the environment is better than 25 years ago – inflation, unemployment and
interest rates are all much lower.
“People forget that most banks have doubled their profits in the past four or
five years. We will have to show that we can cope with the bad times,” said
one senior banker.
Not everyone is pessimistic. “To my mind the likes of Barclays and RBS are
screaming buying opportunities because the loss in value has already been
factored into the share prices,” said Antony Broadbent, analyst at Sanford
Bernstein.
So what could break the climate of fear? No more surprises at the banking
reporting season, which kicks off in mid-February, would be a start. Better
news on the economy and significant evidence that the credit markets have
reopened would boost confidence.
But if that doesn’t happen, Britain’s banking bosses had better start praying.
