We know that the Treasury has a loopy calculator that automatically inserts a political ‘save scalp’ variable into every sum presented, but the knee-jerk moves in the British banking sector on Monday reminded once again that the market is finding the job of core valuation extremely difficult.
Bruno Paulson at Bernstein, an optimistic fellow to say the least, reckons the formula is effectively ‘value given survival‘ times the ‘probability of survival.’
In this binary situation, that makes Paulson a bull. Specifically, he argues that the larger the government’s Asset Protection Scheme, the better it is for the participating banks:
The logic is that the bill only gets paid to the government in the event of the banks avoiding nationalisation, and potential 15-20% reduction in value in that happy scenario is more than cancelled out by the significantly improved chance of surviving having taken up GAPS.
On his figures, the discount to book prices at which UK banks are trading suggests only a 35-45 per cent chance of avoiding full wipe-out of equity holders through nationalisation.
But those numbers were published before the fresh price falls on Monday, which saw RBS, Lloyds and Barclays down between 7 and 10 per cent during early trade. Clearly, survival probabilities have taken a bath.
In fact, from the perspective of equity holders, the weekend’s re-bailout of Lloyds has received a cautious welcome from analysts. As Aaron Ibbotson put it:
Lloyds Banking Group is now substantially less risky, in our view. We estimate that the majority of high risk HBOS loans are covered by the GAPS. This includes: most unsecured personal lending, high risk specialist mortgages as well as leveraged finance and commercial real estate lending. However, this has come at the price of considerable dilution; the fully-diluted share count more than doubled through these initiatives.But the warmth does not extend to Barclays.
The question there remains: if it is to participate in the APS, where will it find the cash?
Related links:
Lloyds shares slide despite PM’s support – FT.com
Lloyds – Lex