Tuesday, October 7, 2008

Risk Drama = romance -> tragedy/12.5 + farce*0.25 - goodwill/100

High drama yesterday followed by a pause in Europe and USA while markets tread water by shifting into commodity stocks and watching the banks drown. Despite the $1.4tn loans plan to US banks by the Fed, investors are slow to express any enthusiasm; they may be resigned to hitting 9,000 anytime soon? Here in London, the regulators go to Downing Street to discuss the £50bn preference share investment in leading UK banks over tea ad biscuits. Announcements may be made before the US closes. Matters have come to a head following the decision by EU ministers not to wait on a €300bn bad bank fund, and instead allow each coutry to freely undertake its own saving plans.
After HSBC, the next 4 big UK banks are currently priced at roughly £50bn after HBOS roughly lost 40%, RBS 30%, Barclays 20%, Lloyds 15%. Last night Government buying preference shares (a real bailout)was discussed and junior HMT mandarins briefed the BBC saying that the banks had not asked for money though this became the rumour by the time trading started this morning and was denied by Barclays and RBS i.e. we were waving not drowning! The downgrades and threat of further risk downgrades below AA- necessary for unsecured borrowing have brought the banks to their knees.
The issues to be discussed over tea and biscuits are how to infuse banks with government convertible bonds or shareholdings without diluting existing shareholders, which is not possible unless as a direct result of the deal the banks' shares soar upwards. The dilution effect could be anything from 25% to 50%. Temporary or not the effect is that the banks will be sufficiently nationalised for the Government to dictate pro-cyclical or anti-cyclical stance of the banks as we bump along the bottom of a recession. If they take the Belgian approach to Fortis as a template Government may also seek to separate out the toxic assets into remote entities i.e. securitisation under government guarantee akin to its underwriting of interest payable on student loan company securitised loanbooks. Fortis had written down its structured credits (including US sub-prime exposures) to €43bn by June and now (crudely) wrote the lot down to €10bn (senior tranche to 25%, mezzanine and basement tranches to 10%). The running of this book is all that remains to the Fortis brand. The major UK bank brands will not be so discarded. But, if the banks can be cleaned out of their most toxic exposures (into something like Lloyds of London did with its asbestos claims runoff vehicle Equitas i the late '80s). If this is done simultaneously with UK Government buying large percentages via preferece shares, then the dilution effect on existing shareholders may be minimised.

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