The U.K. must accept substantial losses on its stakes in Lloyds Banking Group Plc (LLOY) and Royal Bank of Scotland Group Plc (RBS) if the government is to sell off its holdings within five years, say Britain’s biggest investors.
As the government sounds out Middle East wealth funds about buying shares in the banks, the investors closer to home needed to take the lenders back into private hands say taxpayer losses, now at 30 billion pounds ($47.7 billion), are inevitable.
“The Treasury has had to admit the prospect of making a profit on those stakes is now secondary to getting the best value for the taxpayer,” said Richard Black, who helps manage 63.3 billion pounds at Legal & General Investment Management, the biggest investor in the U.K. stock market. “The reality is they aren’t going to pay dividends any time soon. Without dividends, they’re quite unappealing prospects.”
With shares in the two lenders trading at about half the price at which the government bought them in 2008 and 2009, taxpayers are sitting on a paper loss almost equivalent to the country’s annual military budget. That loss may have to be realized if the government wants to lower the 2.8 billion-pound annual interest costs of servicing the bailout at a time of cuts across public services.
Taxpayers injected 45.5 billion pounds into Edinburgh-based RBS and 20.3 billion pounds into London-based Lloyds during the financial crisis in the biggest bank bailout in history. RBS traded at 27.8 pence at yesterday’s close in London, almost half the 50.2 pence price the government paid. Lloyds trades at 33.4 pence, compared with the taxpayers’ 73.6 pence price.
U.K. Economy Shrinking
Weighed down by bad loans from the housing boom in the mid-2000s, a U.K. economy on the brink of recession and about 240 billion pounds of assets still to dispose of, both RBS and Lloyds are struggling to convince investors that they’ve turned their business around.
“These banks have still got a lot of deleveraging of their balance sheets yet to do and so it’s very difficult to know what size they will turn out to be in the end and their ongoing profitability,” said Jane Coffey, head of equities at Royal London Asset Management Ltd., which manages 8 billion pounds of U.K. stocks and is underweight Lloyds and RBS shares. “It’s going to take a long time for them to get into the shape that they should be in going forward.”
A year ago the government was planning to return RBS to majority private ownership by the end of 2014, creating the opportunity for tax cuts before the next general election in 2015. At the time, Eric Daniels, Lloyds’s former chief executive officer, said the taxpayer would get a “handsome return” on its investment.
Middle East Investors
RBS’s shares have fallen 32 percent since while Lloyds’s have slipped 43 percent as the European sovereign debt crisis roiled financial markets and undermined economic growth. Even so, the government held talks with investors including Abu Dhabi sovereign wealth funds about a possible sale of part of its 82 percent stake in RBS, two people with knowledge of the situation said this week.
The U.K. could start selling its stake in RBS at a loss, Jim O’Neil, head of market investments at U.K. Financial Investments Ltd., which manages the government’s holdings in the banks, told a House of Commons Treasury committee on March 14. Business Secretary Vince Cable said last month that the government should use part of RBS to create a business lender to support exports and industrial projects.
Spokesmen at RBS, UKFI and Lloyds declined to comment.
“The government would like to have something positive to show for putting taxpayer’s money in,” said James Ferguson, chief strategist at Westhouse Securities Ltd. in London. “But I don’t think the government will get their money back, personally, because RBS is still sitting on a lot of toxic assets.”
As part of his attempt to return the bank to private ownership, RBS CEO Stephen Hester, 51, has shrunk the company’s non-core division, the parts of the business designated for sale or winding down, by more than 60 percent to less than 100 billion pounds and cut about 35,000 jobs since he took over from Fred Goodwin in 2008. Hester said earlier this year his job is equivalent to defusing the “biggest time bomb in history.”
“Hester was dealt an awful hand of cards and he’s played it as well as he could do,” said Julian Chillingworth, who helps manage 16 billion pounds at London’s Rathbone Brothers Plc. “It’s going to be a long road to recovery. It’s going to take five years plus to turn these banks around.”
Rathbone, which was founded in 1741, is underweight Lloyds and RBS shares.
Lloyds reduced its non-core assets by 53 billion pounds last year to about 141 billion pounds, closed overseas units to focus on the U.K. and announced about 43,000 job cuts. RBS is seen by investors as being ahead in the restructuring of its business as it started earlier, analysts say.
Still, neither bank has paid a dividend since 2008 and both posted wider-than-estimated full-year losses last year and downgraded their profitability targets on the anemic outlook for the U.K. economy, three years after the financial crisis.
Britain’s economy probably slipped back into recession in the first quarter, shrinking 0.4 percent following a 0.3 percent contraction in the last three months of 2011, the Organization for Economic Cooperation and Development said yesterday.
No dividends “restricts the potential investor base because you’re not opening the stock up to income funds, the majority of which would want to see some sort of yield,” said Gary Greenwood, an analyst at Shore Capital Group in Liverpool.
“You get paid almost 8 percent to own Vodafone or get 0 percent for these two with just the hope the share price goes up at some point,” said Black, who manages Legal & General’s U.K. Equity Income Fund (LGUEIIA). “That means you want to have a big discount on what you think the fair price is because you’re not getting any dividend to compensate you in the interim.”
Legal & General holds RBS and Lloyds stock through its index tracker funds.
Not all institutional investors are negative on the banks’ prospects. Trading at between 0.5 and 0.6 of their book value, or assets minus liabilities, the stocks present an “interesting” opportunity to Schroders Plc (SDR), the third-biggest investor in RBS and sixth largest in Lloyds, according to data compiled by Bloomberg.
“If you just look at the amount of progress they’ve made running down non-core assets that would lead you to believe we’re past the darkest days,” said Jessica Ground, a fund manager at Schroders who helps manage 17 billion pounds in U.K. equities. “The fact that the shares are trading at such a discount to book value makes them interesting to us.”
Others remain wary of what assets will remain on RBS and Lloyds’s balance sheets, whether they are priced correctly and how much the banks will able to sell them for now that they have made the easier disposals.
“It’s still impossible to know with any confidence what is really hidden in the balance sheets given their sheer scale,” said Edward Firth, a banking analyst at Macquarie Group Ltd. (MQG) in London. “Everyone accepts that there are toxic assets in there, and nobody -- including the management -- really knows what they are worth. While the balance sheet is infected, it is a very brave individual that would bet the house.”
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