Nick Beecroft, Senior FX Consultant at Saxo Bank, comments on sterling’s collapse:
Monday morning we have witnessed what can justifiably called the beginnings of Sterling’s collapse. So long as the markets could harbour some hope that the next government, in only 3 months time, would be a fiscally prudent, business-friendly Conservative one that would act swiftly to reduce the UK deficit and borrowing mountains, the pound was able to just about hold its own against the Euro, ( which is itself entering a possibly fatally damaging period), but today the damn burst and it could not even do that, let alone against the almighty dollar-as of now perceived as the ‘best, worst’ major safe haven currency. This weekend’s UK election polls-predicting a Labour Government, ruling over a ‘hung’ parliament, put paid to that dream.
Expect a test of 1.40 within a month and, as the global landscape turns ever-more ugly on the back of deflation and sovereign debt concerns, a continuing flight to the US Dollar, taking Sterling down below 1.20 by the summer.
Now, that might be considered a rather alarmist view, but it’s one Prudential needs consider because its $35.5bn acquisition of AIG’s Asian business leaves the life assurer on risk.
Consider the following. The Pru is proposing to fund the deal through $25bn of cash, $5.5bn of new shares, $3bn of mandatory of convertible notes and $2bn of preference shares.
The cash component is split between a $20bn underwritten rights issue and $5bn of senior debt.
Now, to raise $20bn at an exchange rate of $1.50, the Pru needs a cash call of £13.3bn. But, according to Monday’s statement from Pru, the rights issue won’t start until May and the deal won’t close until the third quarter.
So, what happens if sterling falls further between now and the rights issue/deal closing? The answer, obviously, is that it will end up costing the Pru a lot more.
One broker estimates that if the cable rate is $1.35 in June, the size of the cash call rises from £13.3bn to £14.8bn — and that’s not taking into account the $10.5bn in paper and notes. At $1.35, another $750m of paper would have to be printed.
Prudential, of course, may have already hedged its FX risk and there have been rumours swirling round the market to that affect on Monday morning. Indeed, HSBC, which is one of the Pru’s advisers, is rumoured to have been in the market selling sterling and buying options.
And that might just explain the sudden tumble sterling took mid-morning.
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Aside from sterling, there is another risk to this ‘transformational deal’ – a bid for Prudential itself. If there is someone out there looking at Pru they now face a choice: move quickly or lose the life assurer forever because it will be effectively bid proof if the AIG deal deals goes through.
Now, some people might think that is fanciful but consider what happened to NatWest when they launched a friendly £10.7bn bid for Legal & General in 1999. Its shares plunged and a couple of weeks later Bank of Scotland bid for NatWest. However, that deal was never consummated because RBS then launched a bid for NatWest. And that eventually pushed BoS into the arms of Halifax, creating HBOS.
Could the Pru’s move on AIA set off a similar game of musical chairs?
Related links:
The HSBC of the insurance world (updated) – FT Alphaville
Pru agrees to buy AIA for $35.5bn – FT