Another day, another reckless throw of the dice (30)

This is The Big One, e.g. from The Daily Hatemail, RBS and Lloyds cancel bonuses for bankers - in return for £40bn MORE of taxpayers' cash.

The politicians will waffle on about "stabilising the banking system" (1) and "encouraging banks to lend to businesses" (2) and "getting value for the taxpayer" (3), of course. To their credit, they appear to have steered the debate in a completely different direction, i.e. breaking up the large taxpayer-owned banks (as instructed by the EU) to "encourage competition" - despite the fact that a few months ago the government was boasting about having arranged Lloyds TSB's "rescue" of HBOS when all that happened was that HBOS dragged Lloyds TSB down all the quicker, so double points there.

(1) Missing the point. The government allowed them to get themselves into this mess, and once they were in it, debt-for-equity swaps could have sorted this all out a year or two ago. Note that it says that Lloyds' rights issue "will be accompanied by a debt conversion offer expected to generate £7.5 billion."

(2) If the government really wanted to help businesses, it could just cut taxes by £40 billion. It wouldn't even need to do this all in one go, it would be sufficient to offer a £10 billion cut this year and make it clear that this would be permanent; this would simultaneously reduce businesses' need for credit and make them a better credit risk. So that can't be the reason.

(3) What does that have to do with anything? Maybe they'll make a profit on this, maybe they won't, but if taxpayers wanted to invest in banks, then they are free to do it on their own account.

So the real reason for all this is to encourage banks to lend to mortgage borrowers to keep the house price bubble inflated, and as long as the government controls over half the banking system, they have the whip hand. When I first started this series on their efforts to keep the bubble going - which commenced nearly three years ago - I didn't think it would work. To my horror, it does appear to be working and the house price crash has been flattened off, or even reversed, over the past six months. I think we've gone a bit beyond "Spring Bounce" by now. The question is, how long can they keep it up?

OK. Who's lying to whom? And why?

The Bank of England said last week that "around 7%-11% of UK owner-occupiers with mortgages were in negative equity in the spring of 2009." There are 11.7 million outstanding mortgages in the UK, so that would give us between 800,000 and 1,300,000 in negative equity.

Lloyds/HBOS said back in February that about 16% of its borrowers were in negative equity. Lloyds/HBOS has 28% of the market, so whether you pro rate it up at 540,000 ÷ 8% or assume 11.7 million mortgages x 16%, it gives up a figure of about 1,900,000 in nequity.

Right. Lloyds/HBOS may have been hamming it up a bit in the hope of more bail-out money, and the Bank of England may have been playing it down a bit in order to boost confidence (which is part of their remit), but that's still one heck of a discrepancy.

Another day, another reckless throw of the dice (25)

From The Times:

HBOS, which is part of Lloyds Banking Group, will consider offering a new mortgage to customers in negative equity whose existing deal, such as a fixed rate, is about to expire.

Normally such borrowers would see the rate they pay revert to the lender's standard variable rate (SVR) and would be unable to remortgage if the new loan were greater than the current value of the property as a result of the decline in house prices.

But Halifax and Bank of Scotland, which are both part of HBOS*, are offering the rates on 95% loans to some remortgage customers needing to borrow more than the property value – up to 120% of the value in some cases.

* Allow me to insert the missing words: "Halifax and Bank of Scotland, which are both part of HBOS, which itself is part of Lloyds Banking Group which is 65% owned by the taxpayer..."

Hmm. I'm not convinced that this is the best use of taxpayers' money, but hey...

H/t QG at HPC.

Mark's Negative-equity-o-meter: Update

It turns out that my original back-of-fag-packet estimates were probably correct, i.e. there are 11.7 million outstanding mortgages and let's assume that loan-to-value ratios were evenly distributed at the top of the market, so for every one per cent fall in prices from peak, you'd expect +/- 117,000 more households to go into negative equity.

There were two stories this week, the first was that GfK NOP had interviewed 60,000 people and extrapolated this up to assume that there were already 3.8 with "loans worth more or close to the value of their homes.". The didn't define "close to", but let's assume that half of those are actually in negative equity as at today, or 1.9 million. The second is Lloyds Banking Group's claim that 540,000 of their borrowers are in negative equity. Lloyds TSB and HBOS together have 28% of the mortgage market, so that would pro rate up to 1.9 million as well.

According to the Nationwide, the average house price is down by 20% from the peak in late 2007, which would give us a figure of 95,000 mortgages in negative equity for every 1% fall in house prices. That's a bit less than 117,000, so let's split the difference and call it 100,000 additional cases for every 1% fall from peak.

Another day, several more reckless throws of the dice (24)

And here's the second batch of today's crop of crap:

4. "Alistair Darling, the UK chancellor, is set to drop the £480m annual interest bill charged to Lloyds Banking Group on a taxpayer loan in exchange for a promise by the bank to provide billions of pounds in extra mortgage funding and loans to small businesses. Mr Darling is prepared to convert £4bn of government preference shares – which carry a 12 per cent coupon – to ease financial pressures on Lloyds and as part of a wider deal to boost lending in the economy. Although talks are continuing this week, the preferred shares are expected to be converted into other forms of non-voting equity..."

WTF? They are giving this bank £480 million a year of our money, in exchange for more reckless lending - we know it's going to be reckless because ...

5. "Taxpayers may become liable for £500bn worth of bad loans and investments made by Royal Bank of Scotland and Lloyds Banking Group, the BBC has learned. It would be part of the government's Asset Protection Scheme, under which taxpayers insure banks against future losses from such assets."

*rant*

I've done the numbers on this, the total losses suffered on UK residential mortgages by UK banks will be in the order of £40 billion, to which add an unknown figure for US sub-prime and commercial loans that go bad, total losses £100 billion, tops. Where does £500 billion come from? Doesn't the government realise that the banks will merely exaggerate the size of their losses, collect the guarantee payments and in future, over the next decade, maybe, miraculously recover far more than their original estimates?

*/rant*

3. "Local councils face a £6bn fall in contributions from property companies this year as developers halt work and renegotiate plans in the face of the industry’s worsening crisis... In the financial year to March 2008, EC Harris estimates local authorities received as much as £9bn in planning contributions, also called section 106 agreements. It predicts a fall to £3bn this year and £2bn next year."

*sigh*

S106 agreements are the stealthiest of stealth taxes. Everybody (but me, it seems) loves bashing property developers - but all they do is respond to demand from the likes of you and me. Bashing property developers is like car drivers slagging off oil companies ... oh, right. S106 agreements actively discourage new developments - like the various Planning Gains Supplements that have come and gone over the decades, and as we now see, receipts fluctuate wildly and plummet when times are bad.

Chances are, the government will just hike taxes on incomes and production to make up the shortfall via the revenue support grant, thus putting more people out of business and out of work, and thus locking us in to a recessionary spiral.

Hey ... how about scrapping S106 agreements and rolling them into Land Value Tax, which would be a much more reliable source of tax revenues? LVT would also put the onus on councils to get the best value for money to make the area as attractive as possible, hence keeping rental values and house prices as high as possible to ensure that the money keeps rolling in, in a sort of virtuous spiral etc etc?

*/sigh*

UK banking crisis in perspective (2)

When I did my first round up of this in April 2008, I guesstimated the losses from reckless UK residential lending at between £28 billion and £50 billion.

HBOS has written off about £6 billion of residential mortgages so far (£3 billion last year, £3 billion this year) and house prices will fall at least another twenty per cent, so let's double that to £12 billion. HBOS also has around one-fifth of the UK mortgage market, but was at the more reckless end, so £50 billion looks 'about right'. At the time I made my guesstimate, nobody realised that there would be a government bail out. I'll give myself a bonus point because the amount they stuck in of £37 billion is pretty much in the middle of my range.

Just for fun, I reworked the table from my earlier post, if you divide their market capitalisation (as at April 2008) by their gross assets (as at December 2007), and then sort the rows in descending order of the result in column C, this ties in pretty well with how much their share price has fallen over the last twelve months (Standard Chartered is a blip). The 'Tier 1' capital ratios as at April 2008 (see earlier post) of these banks all looked pretty much the same, so in future we can dispense with 'Tier 1' ratios as being a complete fiction, somehow or other, the stock market knew perfectly well a year ago which banks were most likely to survive.

Anyways... the point of all this is that there are people who say that "banks are too big to fail"*.

Take it from me, they are not, the losses might well be a lot more than £50 billion, because then there's corporate lending, in which HBOS seemed to have excelled - at picking lousy risks - and also an unknown amount that UK banks invested in sub-prime crap from the USA and so on. So maybe the total losses will be £100 billion (around 7% of UK GDP, £1,500 billion). As at present, the balance sheet total of UK banks is around £6,000 billion, a ridiculously large figure because there is so much double counting involved. If you net off all the inter-bank stuff and assets/liabilities that are matched economically but not legally**, then their balance sheet total is more in the order of £1,500 billion.

So, without going into legal niceties, shareholders will be wiped out and up to 7% of their creditors (i.e. longer-term bondholders) will have to be paid in shares instead of cash, or will have to wait a bit longer for their money than they expected, or might not get much of it back. Such is capitalism, risk and reward and all that.

That's that fixed, next.

* Interestingly, people trot this out, whether they support the bail out or not, merely because they can't see an alternative. I wouldn't be surprised if the banks exaggerate their own balance sheet totals to make themselves seem more powerful and important than they really are. This is a bit like EUphiles and EUsceptics being broadly agreed that the EU is getting more and more powerful. It's not - it passed it's high water mark with the Irish 'No' and now they are flailing around trying to make it look like they are all-powerful, but they aren't. Of course we still need to keep kicking the EU until it's been snuffed out, but there's no panic any more, a more pressing issue right now is kicking the banks while they are down.

** For example, the bank has sold foreign currency forward to Company A and hedged its bets by buying the same currency forward from Banks B, C and D. Really, these two net off - unless Banks B, C and D welch on the deal and the spot rate has gone against them, the net asset or liability on these two position will always be a small profit. And accountants are very fussy about not netting stuff off, it went out of fashion a decade ago.

Crest Nicholson in £500m debt-for-equity swap

Here's another good example from late November that I overlooked:

Crest Nicholson is solving its unmanageable debt problem by talking its lenders into a debt-for-equity deal that would cut its borrowings from £1bn to £500m... Its major lenders have agreed to a debt restructuring plan, the result of this being that the level of debt will halve to £500m in exchange for them taking 90% of the equity, leaving management with the remaining 10%.

This is the free market solution to these problems, with no government intervention or taxpayers' money involved. When 'credit' was in abundance, Sir Tom Hunter borrowed a shedload of cash from HBOS* to take Crest Nicholson private, i.e. buy all its shares that were previously quoted on the Stock Exchange. The gamble went wrong but there is still some underlying value to the company's assets, i.e. its land bank (which will probably fall 80% in value, but there will still be something left). HBOS thought it was lending money and Sir Tom thought he was buying shares. Now that the dust has settled, it turns out that HBOS was buying shares and Sir Tom has lost the gamble and ends up with a lot less than he hoped for. A debt-for-equity swap is just the opposite of a leveraged buy-out, in other words.

My point being, debt-for-equity swaps would work just as well for banks. There is no need for anybody to lose money on the transaction, provided bondholders were given shares with a market value equal to the market value of the bonds that are converted. Existing shareholders get diluted down, but they end up with a smaller slice of a more securely funded business, so they needn't end up worse off either. For the taxpayer it's a Big Win, of course, as well as for the wider economy - there'd be no part-nationalised banks and more securely funded banks would, all things being equal, be in a better position to provide finance.

* OK, technically, they formed a 50/50 joint venture.

Does this surprise anybody?

Shock, horror:

...HBOS has come out with a warning that bad debt provisions for the current year will top around £8 billion which is nearly half of the £15.5 billion of emergency capital raised earlier this year.

*sigh*

1. About a fifth of UK residential mortgages are with HBOS and I estimate the total losses to UK banks thereon at £40 billion, a fifth of £40 billion is £8 billion.

2. These are provisions, not actual losses, which may turn out to be a bit more, or indeed less. Then you can add on stuff for lending to businesses and investments in US sub-prime rubbish and so on.

3. It's hardly headline news if they end up losing all their emergency capital - that's why they raised it, n'est-ce pas? Seeing how difficult/expensive this is, you'd expect them to raise just enough to cover their losses, so it's reasonable to expect them to actually lose it all as well.

*/sigh*

Another day, another desperate throw of the dice (10)

From an article in The Times, uncovered by Drewster and Sold Out over at HPC:

The Financial Services Authority said yesterday that more than half a million Halifax customers on tracker mortgages should benefit from further interest rate cuts even though the small print on their loans supposedly prevents them from doing so...

Jon Pain, the FSA's retail market manager, said yesterday that this 3 per cent threshold, or “collar”, could be unenforceable. He said collars should be included in a lender's key facts illustration (KFI) - the mortgage documents given to every borrower. Halifax removed the details of its collar from its key facts in 2005.

That would be bad enough ... but what's this?

It emerged yesterday that the removal of details of the tracker loan collar from the Halifax mortgage key facts in 2005 was the result of concerns that the FSA raised over the complexity of the Halifax's mortgage documentation. The regulator was worried that the 11-page key facts statement was overblown for a document designed to highlight the key elements of the loan, and asked for it to be trimmed back. The collar detail was one of the items removed and relegated into the smaller print of the larger mortgage document.

"Bank of China looking at HBOS bid"

Continuing my occasional series* on the inevitability of China (and to a lesser extent Japan) taking over Western banks, here's another scoop by Robert Peston.

* Underlying logic here; previous real life examples here and here.

Er ... Vince?

From today's Metro:

HSBC was accused of 'profiteering' yesterday after a senior executive signalled it may not pass on interest rate cuts in full to its customers. The bank's chief operating officer, David Hodgkinson, said there could be 'stickiness' in rates* even if the Bank of England lowered them as expected later this week...

His remarks were seized upon by Liberal Democrat treasury spokesman Vince Cable. He said: 'It is difficult to see the justification for Mr Hodgkinson's comments. When the whole banking industry owes so much to taxpayers for their very survival, any bank will find itself on very thin ice if it is found to be unfairly profiteering from its customers.'

IIRC, HSBC and Barclays were the only two major banks who politely declined the taxpayers' shilling, along with Nationwide Building Society. Is he perhaps confusing 'HBOS' with 'HSBC'? Tut tut.

* Aka 'pushing a piece of string'.

Tee hee!

In the cosy world of The City of London, the top boys just shovel piles of (shareholders') cash at each other, e.g. when banks are issuing shares, they even appoint other banks as 'advisors'. There is a practice called 'underwriting new issues', whereby Big Investment Bank is promised oodles of issuing shareholders' readies in exchange for a vague promise to pick up any shares than the issuer can't sell in the market. And Big Investment Bank uses that cash to pay eye-watering boni to its senior employees; shareholders in Big Investment Bank don't see much of it.

Without going into technicalities, it looks as if Morgan Stanley and Dresdner Kleinwort have finally been hoodwinked by HBOS. For the first time in ages, underwriters might actually made a loss on a deal. In which case, the shareholders in Morgan Stanley and Dresdner Kleinwort's parent, Dresdner Bank AG are the ones being robbed.

Nice one, Andy Hornby!

H/t Fubar at HPC.

Barclays to raise £3 bn ... and then some

As predicted here, Barclays are next in line for a rights issue.

The amount does seem on the low side, it's less than 10% of current market capitalisation of £31 billion, as opposed to my ball-park figure that banks will have to raise approximately 20% of their current market cap.

Remember also that Barclays' gross assets of £1,227 billion are roughly double those of HBOS (£667 billion - see page 11); so Barclays will only get away with this if the fraction of assets that they have to write off is less half that of HBOS, who are to raise £4 billion shortly.

Fun with numbers (3)

According to the Halifax House Price Index, the average house price in April 2007 was £196,252, and in April 2008 it was £189,027 (see page 4 of 4). They reckon that's a fall of 0.9% year-on-year.

Er ... £189,027 divided by £196,252 is 96.3%. Isn't that a fall of 3.7%?

Or put it this way; the average price in August 2007 was £199,600, so prices have fallen 5.3% in 7 months, that's about 9% annualised. So there.

"HBOS will attempt to raise £4bn"

As I calculated before, UK banks will have to have rights issues of about £1 for every £5 market capitalisation.

HBOS is now going for a £4 billion rights issue, against a current market capitalisation of £18 billion.

As a rough guide, you can assume that the next to do rights issue will be those with the lowest ratio of market cap-to-gross assets, i.e. Barclays, Alliance & Leicester and Bradford & Bingley.

HSBC and Standard Chartered look pretty 'safe' for now; Lloyds TSB is borderline.

UK banking 'crisis' in perspective

Total UK personal debt (mortgages, credit cards etc) was £1,409 billion at the end of 2007. That's roughly the same as gross domestic product or nearly £60,000 per household. But there can't be a liability without an asset, rather unsurprisingly, total household bank deposits are around £1,000 billion.

The banks only have to worry about those people who can't afford to pay their mortgage and who are in negative equity. Let's assume that house prices fall by one-third to their long term average price/income ratio (reversing the last three or four years of price rises) and that a fairly catastrophic* five per cent of people lose their jobs. There are about eleven million people with outstanding mortgages so let's assume the banks repossess 550,000 homes** and suffer a loss of £50,000 on each one. That'd be a loss of £28 billion, which sounds like a heck of a lot, but it's only 2% of the total money that banks have lent out.

A brief summary of the main UK banks*** is as follows:


There seems to be a heck of a lot of double-counting (total assets over £5,000 billion!), but even assuming that banks have to write off as much as £50 billion and thus have to raise another £50 billion in cash from their own shareholders, via rights issues, like RBS, this is on average only asking shareholders for another £1 for every £5's worth of shares that they currently own.

In RBS's case, it's more like £1 cash for each £3's worth of shares****, but hey, so be it. And that £50 billion is only one-twentieth of all the money that households have on deposit with banks, so all the bank's shareholders are being asked to do is swap a cash deposit for more shares. Which they can then sell in the market and stick the money back in the bank if they want.

* i.e. one-and-a-half million workers. Unless it's those one-and-a-half million superfluous public sector workers, of course.

** There were 190,000 actual repossessions (not just 'repossession orders') in the years 1990 to 1992. This time is going to be a lot worse.

*** Excluding Nationwide (a building society), Abbey (owned by Johnny Foreigner, so who cares) and Northern Rock. Total assets as at 31 December 2007 per published accounts and market capitalisation is as at today's date from the rather excellent Yahoo finance section.

**** The rights issue is supposed to raise £12 billion, against a current market capitalisation (the total value of all shares in issue) of £38 billion.

"Bank of England rescues HBOS from brink of collapse..."

There's no smoke without fire.

Whether there was any truth in the rumours; whether this was ruthless insider trading; or whether it was blatant market manipulation is neither here nor there. The fact that so many chaps at the Stock Exchange were prepared to believe them speaks volumes.