The Regulatory Viewpoint
The FSA has sought to make a virtue of “restricting” dividend payments, and “forcing” (some) UK banks to issue new shares for equity-based compensation payments.
Whereas we are not privy to the one-on-one discussions held between banks and their regulators, the evidence might suggest that Lloyds, RBS and HSBC have borne the brunt of such scrutiny. Meanwhile, the Bank of England’s Financial Policy Committee (FPC) has maintained its uncompromising rhetoric – still calling for banks to raise fresh capital.
Although precise definitions of the key regulatory measures continue to evolve, the most useful measure of capital strength is a bank’s core tier 1 ratio. This closely equates to shareholders equity less a reduction for intangible assets (goodwill) on the balance sheet.
Following its exit from the Asset Protection Scheme, RBS has the lowest core tier 1 ratio at 10.3% 30 June pro forma, while Lloyds stands out as being the most exposed to the UK economy, but with “only” £100bn RWAs allocated against £347bn UK Retail customer loans, (inc. £23bn unsecured). At 31 December 2011, HSBC had the lowest core tier 1 ratio of just 10.1%.
Going forward, Barclays has “maintained flexibility” with a block listing ahead of potential new issuance to meet equity-based compensation in 2013 and beyond. It has yet to take a decision over whether to continue to purchase shares in the market.
As for Standard Chartered, as anticipated, it had an unusually high level of SCRIP take-up (c.60%) for its 2012 interim dividend given the temporary disruption to its share price in early August – but aside from that, minimal new equity issuance.
To be clear, it is not our view that any UK bank should be required to issue further fresh equity.
For the two banks with the “weakest” capital position – RBS and Lloyds – we expect planned ongoing balance sheet shrinkage to prove (more than) sufficient to maintain adequate capital ratios throughout the Basel 3 transition.
Moreover, we do not anticipate that any Lloyds dividend will be declared before February 2014, and even then we are only looking for a nominal 1p per share. For RBS, any resumption of dividend payments will, we believe, come later.
One consequence of the “dilution by stealth”, caused by issuance since the UK Government’s final investment on 31 December 2009, has been to reduce the Government’s stake from 84% to 80%.
Without any additional capital injection, and without any sell-down of the Government’s holding at a loss, we expect this to continue to decline at c.1% per annum.
Rhetoric from the Bank of England and the FSA?
We give credit to the Bank of England and Financial Services Authority for belatedly owning up to a number of their key policy mistakes during the crisis.
Specifically, we welcome the recent reversal of their position on the (excessive) liquidity reserves which were being stockpiled by the banks at their behest with negative consequences for banks’ profitability, the rebuilding of confidence in financial markets, and the supply of credit to the real economy.
A combination of the easing of such reserve requirements and the launch of the Finance for Lending Scheme should both improve both the pricing and availability of credit.
However, on the issue of bank capital, we do not regard the rhetoric coming from either the Financial Services Authority or the Bank of England’s Financial Policy Committee (FPC) as remotely helpful.
The latest FPC minutes again called for banks to “supplement internal capital generation by seeking opportunities to raise capital externally”. We can only conclude this is a comment made for a politically motivated agenda, rather than with any genuine reference to the true capital requirements of the UK banks.
In contrast to a number of European peers, every UK bank has now outlined capital plans that are consistent with migration through the Basel 3 transition while maintaining minimum core tier 1 capital ratios at 10% or more.
Expect to see more ‘stealth by dilution’
Ultimately, our expectation is that Lloyds, RBS (and others) will resist regulatory/political pressure for any material fresh capital raisings. The UK Government’s own stake in these banks may serve to mitigate against allowing some of the worst excesses of additional regulatory-inspired value destruction to be implemented.
However, at the margin, in a similar manner and scale to 2012, we expect to see ongoing dilution by stealth. Investors should, we believe, be able to differentiate between the affected banks and those (e.g. Standard Chartered) which remain in a position to “stand above the fray”.
As HSBC’s widely admired Group Finance Director, Iain Mackay, caustically remarked last August (in reference to the FPC) “They believe banks are capable of reinforcing their capital by cutting the variable compensation of their employees, by restricting dividends to their shareholders, and by raising capital in the marketplace. Funnily enough, generating profits doesn’t seem to figure in their calculations.”