The UK government is about to become the de facto largest shareholder in two of the country’s largest banks, HBOS and The Royal Bank of Scotland (RBS). Given the number of times that England has invaded Scotland, it must be especially hard for the RBS management, so the CEO and chairman have decided to resign and move south.
Even though the government will own preferred shares, it will still be putting a huge amount into the firms. In many ways, the banks are no longer "independent". The next question is whether something similar could happen in the US if the worldwide rescue of banks does not take hold immediately.
The British program is rich indeed. A total of $73 billion will go into several banks. According to MarketWatch, "banks will pay a hefty annual interest rate of 12% for the cash and have also agreed not to pay any dividends until all the preference shares have been repaid in full."
The interest rate is breathtaking, but the financial firms had no other options.
The world focus now moves to the US, which has a number of troubled large banks. Washington Mutual and Lehman are already gone. Morgan Stanley (MS) is paying dearly for capital. Wachovia (WB) is becoming part of Wells Fargo (WFC).
None of these M&A transactions solves the problem that mortgages are still defaulting at rates which are the highest in 80 years and the value of banks assets is still being harmed by that drag on the economy. Treasury Secretary Henry Paulson has $700 billion to spread around, but everyone from the state of Massachusetts to the Second Third National Bank of Akron would like a taste. GM (GM) is rumored to be looking for a handout.
Too many analysts have already pointed this out, but there is only so much money to go around.
Even if a bank like Citi sells some of its toxic paper to the Treasury, its troubles are not over. It has exposure to consumer credit card and auto debt. It may have exposure to Lehman defaulted credit derivatives. Some estimates are that the total size of the Lehman pot may be $400 billion. No one knows who holds most of those obligations. But, as the day or reckoning comes, probably this week, all of the information about those liabilities will become public.
Citi certainly holds LBO debt which tends to become distressed in a recession. A poor credit market will also harm its M&A, underwriting, and retail brokerage businesses.
Citi is not out of the woods. The Treasury may have to make a large direct investment in the bank. Paulson says he is ready to do that for American money center firms, if necessary.
Citi’s market cap is down to $76 billion. The Treasury may not begin to buy-in toxic paper for a few weeks. Morgan Stanley (MS) is a fine example of what the market can do when it turns on a firm like a pack of rabid dogs.
If Treasury has to put $40 billion into Citi, it becomes the majority shareholder in the bank no matter how the money goes in. The fact that it is preferred or convertible does not mean much. If Citi does not pay, Treasury has the right to trade their investment in for plain old equity.
The market challenge for US banks is not over yet. Matters may be resolved before the end of the year, but they may not be resolved pleasantly.
Douglas A. McIntyre