The prospect of a bad bank being used to mop up others’ toxic assets is one that has been surfacing in both the US and UK of late (not to mention Germany).
Yesterday the possibility helped shares of Britain’s banks tick up. But, should UK investors be so keen?
JP Morgan’s crunched some numbers and they’re maintaining underweight recommendations on Lloyds/HBOS, Barclays and RBS precisely because of the questions that surround the prospect — and potential structure — of a bad bank.
From JPM bank analysts Carla Antunes da Silva and Amit Goel (emphasis ours):
Remain UW until full details – [it's] unclear which banks would be potentially be involved, but we expect at least those with a government participation. We would be more positive on those implementing these potential measures and are curious to see what route Barclays takes. Given the variability of outcomes, risk of inaction and risks associated with implementing a ‘bad’ bank, we remain UW on the UK banks.
…
Whilst in previous reports we have referred to the need for a ‘good bank’, ‘bad bank’ structure this note shows that we under-estimated the potential charge to existing shareholders. Whilst taking the losses ‘up front’ for the banks would likely lead to significant new capital needing to be raised, we believe that this is the price that needs to be paid for investors to truly become comfortable with the sector.
Under a ‘good bank, bad bank’ plan, toxic assets would be transferred to a government vehicle, leaving the taxpayer with the risk — minus a haircut for the banks. Taxpayers still have potential for some upside if the assets start performing. In any case moving the assets, according to JPM, would help clean the rest of the banks, making them investable once again. But, as noted above, the plan would affect existing shareholders:
As shareholders would likely have to put fresh capital in, the government would also be sending out the message that shareholders are taking the cost for the ‘excess’ risks taken. In terms of the government shareholding, for the government the result may be neutral, as they will own the ‘bad’ assets 100% post transaction, but with the full haircut.
The bad bank could either be funded via government debt or deposits, JPM says. The first would involve the government buying toxic assets with paper it issues to banks (a sort of quantitative easing for banks). The second, in contrast, would involve the government taking toxic assets in exchange for assuming a matching portion of banks’ deposit liabilities. According to JPM:
… the exact impact for investors will depend on the terms and structure used. Given the large degree of variability in approach, we believe that without the detail it would be premature to be positive. If a ‘good bank’ ‘bad bank’ idea were to be carried out, we think that the time to buy the UK banks would be in the recapitalizations that would ensue (depending of course on how they are trading at that time).
But make no mistake, the analysts think something needs to be done.
By JPM’s numbers, if the banks in question were to take all of the credit losses on their bad loan books today, they’d be insolvent. In the meantime, they estimate deficits at Lloyds/HBOS, RBS and Barclays at £13.4bn, £6.44bn and £3.19bn respectively.
So who’s afraid of that big bad bank now?
Related links:
How to get credit moving, UK edition – FT Alphaville