Worried about Britain’s public debt figures? Blame the bailed-out banks.
JP Morgan has published a 48-page note on the UK government’s stakes in some rescued financials; Royal Bank of Scotland and Lloyds Banking Group to be specific. This is rather topical since the recently-elected coalition government will announce its new budget on June 22. LibDems have said there’s no rush to sell Britain’s bank stakes, while the Tories have voiced a preference for rapid disposal.
So, what to do? JP Morgan banking analysts, Carla Antunes da Silva and Amit Goel, come down firmly on the side of selling, with some big numbers (literally) to back up their argument.
Here are the main points:
At the crux of this debate is the conflict of interest of owning large stakes in the banks whilst trying to implement significant regulatory changes in a global forum and balancing this with influencing banks’ lending behaviour. We see 3 main costs to the UK;
- 1 – During the temporary ownership period the stakes account for c.4% of net debt to GDP under the Maastricht definition. Whilst we do not see the stakes as long-term holdings, if fully consolidated, UK net debt to GDP would go from 64% (2009) to 165%;
- 2 – Indirectly, there is a cost to the sovereign from providing guarantees to the sector (both implicit and explicit) – for every 10bps of additional financing costs, we estimate annual costs of c.£1bn for the government;
- 3 – Last but not least, we estimate a financing cost of c.£3.2bn annually of holding these stakes, equivalent to a meaningful 8% of 2010E UK budget interest expense.
So basically if the UK’s currently temporary stakes begin to look longer-term, RBS and Lloyds liabilities would have to be incorporated into public sector net debt figures — and that would send Britain’s debt-to-GDP ratios ballooning. Exactly what you don‘t want given current sovereign jitters.
Conversely, selling the stakes could give a meaningful boost to Britain’s debt figures depending on the sale price. But, according to JPM, the exit price itself isn’t actually that important. What’s more important is that the UK government would be ridding itself of the financing costs referred to above.
Financing costs, in JPM’s mind, are two things.
Firstly, the actual funding requirements for the holdings — in other words the cost of borrowing the £66bn spent on the stakes. And secondly, the effect of stake ownership on sovereign funding costs — ie the impact on the UK’s borrowing costs as a result of the banks’ implicit government guarantees.
In detail:
From this exercise it would appear that whilst the exit prices do have some bearing, it is not critical, and largely symbolic. What is more relevant is that the stake is sold, as the funding requirement still has a noticeable bearing on public finances. This could be especially important when we consider the commentary from Standard & Poor’s credit research. S&P reiterated its negative outlook for UK sovereign debt in Mar 2010 and said that it expects [General Government Gross Debt] to continue to trend towards 100% of GDP, a level which if sustained over the medium term would be incompatible with a ‘AAA’ rating.
Given how close to 100% we may be, the benefit from a sale may be significant. Perhaps the question is, what is the benefit that the government can derive from having more direct control of credit to the economy versus the benefit from a sale? The risk to other stakeholders in RBS and Lloyds being that the government’s interests may not be aligned to theirs and more directed lending could be negative for profitability.
Further, we note that whilst we have discounted including RBS and Lloyds liabilities from the sums, one could make the argument that they will have significant funding requirements over the next few years, and as such may be competing with the governments for credit. This would add relevance to the [Public Sector Net Debt] measure, and hence be a reason for the government to sell sooner rather than later.
We get it. Sell. Sell. Sell. Sell.
Sell government bank stakes for the sake of the UK sovereign, says bank.
Full note in the Long Room.
Related links:
UK should resist temptation to dump bank stakes - BreakingViews
Notch ‘em up, and notch ‘em down - FT Alphaville
The sovereign debt premium – FT Alphaville