While British politicians continue to procrastinate over the wisdom of a ‘bad bank’ rescue scheme for the sector, a strange thing happened on Friday: shares in UK banks went up.
Ironic given that the FSA’s shorting ban has now been lifted. Clearly, Mayfair’s finest are not as quick-footed as they once were – although we should quickly say that equity markets on both sides of the Atlantic were due some sort of a bounce after suffering the most sustained sell-off since Lehman went under.
No matter. Ian Smillie and Cormac Leech, the bank analysis duo at RBS (whose stuff presumably gets read in Whitehall, given the bank’s partial state-ownership) have provided us with a reality check:
Not unusually at this stage in the economic cycle, the domestic UK banks are technically insolvent on a fully marked-to-market basis. But RBS credit strategists believe that the combination of heavy supply, rising defaults and low recovery rates means that credit asset spreads will hit new wides in 2009. We calculate that the domestic UK banks rely on £1.7trn of wholesale funding, including a £490bn maturity mismatch, and with over £130bn of longterm debt maturing in 2009. This probably means that unguaranteed new lending activity will remain limited, particularly as net interest income gets crushed with the base rate now below 3-3.5%. Credit availability is, historically, a very good lead indicator of economic growth.
RBS reckons UK banks will continue to be loss-making through to 2011 as impairments rise and pre-impairment profits evaporate. Indeed, the models constructed by Smillie and Leech (which assume a cumulative 6 per cent decline in British GDP) point to a further £143bn of provisions and write-downs from here — promising to shred banks’ capital cushions once more.
In fact, there’s already a £36bn equity shortfall, as this table shows:
That makes a fresh government bailout a dead cert and the “reluctant” RBS conclusion is that the outlook for UK bank equity investors remains bleak:
The UK Government will need to announce further initiatives to improve credit availability, in our opinion, and further capital injections appear not to be the preferred method for now. Quantifying and offloading embedded toxic assets sits at the heart of our preferred structural solution for the UK banking crisis, rather than funding or asset guarantees and/or government-initiated lending. Implementing the December Citigroup bail out terms in the UK could double our target prices for beneficiary banks. We upgrade Lloyds from Sell to Hold as the most geared to any equity friendly Government initiative, and undemanding valuation. We lower Barclays, HSBC and Standard Chartered from Hold to Sell.
Related links:
Treasury plans ‘bad bank’ to buy toxic assets – TMG
‘Bad bank’ plan could stimulate UK lending – FT
Who’s afraid of the big bad bank? – FT Alphaville