Tuesday, 21 April 2009

Spot the loony

Despite working in a bank I lost the belief that public ownership in itself was a good thing some time ago. Despite this the idea of part privatising the post office within say the next 18 months strikes me as mad for all sorts of obvious reasons.

The stock market is at a major low right now something that would be reflected in whatever the government received for selling off one of our assets. Added to this the continued constraints on the ability to borrow due to the credit crunch would reduce (assuming the debt could even be found) what any business could bid and also means the number of institutions able to bid is teeny, additional factors that would make for a low sale price. Finally, no big business - I’ll rephrase that - few big businesses are daft enough to make a bid without having a good shufty at the books before agreeing a price. I’m sure the latest post office trading data show its revenues have fallen due to the recession, which means a basic valuation based on earning multiples (how much cash the business is likely to generate over the next however many years) would be less now than it was say a year ago or in 2 years time for that matter.

With common sense and commercial realities all screaming “DON’T BE SO FECKIN STUPID”, its no wonder Peter Mandelson, judging by recent reports, looks like he’s trying to recast a stupid business decision as a matter of (dogmatic) political conviction (1). To put this dogma into practice it seems that he’s having exclusive talks with just one potential buyer (TNT) i.e. avoiding the kind of auction that would generate the highest sale price i.e. the best value for public money. But its not just about money he might say, which is fair enough but then in better times there would be far more scope for arranging a beauty contest of potential buyers who coul dbe selected according to additional criteria.

But hey ho it’s not as if government doesn’t have a track record for selling off public assets on the cheap. There was the windfall tax for one thing, a one-off levy Labour charged in 1997 on the excess profits earned by the 33 utilities the Tories privatised and as sure a sign as any that they were sold off too cheaply and regulated too lightly. But, don’t think for an instant Labour are any better given Gordon Brown’s decision as Chancellor to sell off a huge chunk of our gold reserves for hee haw.

So it looks like a fire sale of British taxpayer assets could be happening near you. There again it’s not as if doing so provides much support for the private-good/public-bad credo that’s dominated government thinking for god knows how long, besides the credit crunch there are however many examples now emerging of private sector stupidity and waste.

To get a sense of how feckin stupid may I direct you to chapter 1, table 1.3, page 28 of the latest IMF financial stability report - Table 1.3 estimates that banks will have a cumulative loss rate on European loans and securities of 5% compared to a US figure of 10.2%. So go go Europe we’re better placed than the yanks. Except 5% is horrendous for businesses that exist on charging borrowers a few %% more than they pay to get the funds they lend, in other words charging a margin of just 1 or 2% on loans forecast to end up losing 5%!

This looks like banking is moving from a 2007 and 2008 when the change in liquidity conditions exposed strategic failures (pay too much for a business after we’ve passed the top of the cycle? That’ll do nicely. Develop an over reliance on wholesale funding that’s never been tested? You betcha!) to a 2009 and 2010 when a grinding recession will screw profitability the good old fashioned way via customers insolvencies, defaults, repossessions, etc.

If it’s any consolation it should also keep chucking up examples of how feckin stupid bankers were. The latest I’ve heard involved a non-UK bank that thought British commercial property was the bee’s knees so got into it big time. This was despite not having the infrastructure to cope by which I mean a proper credit risk function and credit process i.e. independent decision-makers tasked with assessing the quality not just the quantity of lending. Instead, the relationship managers went out and agreed in principle to punt as much credit as possible on stupidly generous terms to as many people as they could. They then submitted these applications for approval to a quorum of err relationship managers i.e. the self-same sales reps with sales targets to meet, who sat down and took the big decisions. And you bet these sales targeted plumbs decided to lend lots and lots and lots and lots of cash too cheaply to too many people.

Obviously, that bank is utterly fecked right now, much to the dismay of the taxpayers currently bailing it out. I wonder though if the halfwits who decided to throw it's money away are still in place? My guess is yes most of them probably are along with the senior bods who thought getting sales reps to decide whether to sell was a good idea. To explain why, as we say where I work (with more than a hint of irony), I’m sure the idiots whose decisions made clear they have no commercial judgement whatsoever have the kind of “influencing skills” every organisation will need in the future. And as if all this wasn’t bad enough, the film “In the loop” was good, but no that good. Pants.

(1) Presumably pension obligations will also feature somewhere, except I'd guess any shortfalls here would also be exacerbated by the downturn in share prices while the policies used to calculate fund obligations give big scope for political interference.

Saturday, 4 April 2009

Cat skinning

There’s more than one way to skin a cat and as my neighbour’s keeps using my front garden as a litter tray my preference is for whichever is the most painful. Similarly there’s more than one way to recapitalise a bank. One way, the couldn’t be higher profile if it had a million flaming rockets up its jacksie way, is for government to commit to underwriting bank rights issues (the issue of additional ordinary shares), which sees an issue price being set, then government buying up however many of the new shares private investors chose not to invest in (typically because the rights issue price is higher than the shares were trading at in the immediate run up to the issue).

It’s just I’m thinking another, cheekier approach is going on right now. This other approach involves the more traditional thang of banks retaining earnings to bolster their capital bases. Here, hang on a mo for a quick digression; a bank’s capital gives it the wherewithal to afford losses made on lending and investing. So the bigger the capital base the more confidence you can have in a bank, hence the government emphasis on recapitalising banks to rebuild confidence in them. Ahhhh!

Right, digression over, so aye, recapitalistion via retained earnings. The primary way banks boost earnings is by increasing the margin between what they pay to raise funds (e.g. interest paid on deposits) and what they charge the borrowers of those same funds. This all got complicated by the credit crunch. In fact it’s still complicated. One of the markers of the extent to which confidence was lost in banks was the margin that suddenly appeared between the Base rate set by the Bank of England and LIBOR rates, LIBOR being the London Interbank Offered Rate, or what one bank charges to lend another one. Due to the crisis of confidence banks are still contending with (essentially the realisation that big banks can fail), LIBOR rates stopped closely following base rate.

Instead they shot up. The resultant spread between LIBOR and base rate provides both a yardstick for measuring confidence in banks and a guide to actual bank funding costs. One final point, the spread that emerged broke the connection between base rate and the interest rates actually paid by borrowers, undermining traditional monetary policy. Oops, again I’m digressing. Anyhow, regardless of what base rate was/is, mortgage rates jumped up, and have stayed up because LIBOR remains so relatively high.

This is surprising from a housing market perspective because the typical loan to value on mortgages has plummeted since the middle of last year, which matters big time because it means, on average, every new mortgage/remortgage is getting progressively safer and safer.

Here, a quick, simplified, example – I borrow £90 to buy a £100 house, so that’s a 90% LTV, which was what first time buyers typically got in the years before the credit crunch. Now say my house is repossessed and sold, cos that’d be in a fire sale, chances are it’ll be sold for only £80. So rather than pay the outstanding £10, I declare myself bankrupt and the bank loses £10. Now, say the same thing happened, but I’d only borrowed £79 i.e. a 79% LTV, which would be quite generous today, then the bank would owe me £1 from the fire sale of the house.

So banks have moved themselves from a position where they could lose money on new business to one where they really have to go some to do so. Yet despite this conservative step-change in credit policy and loan quality, mortgages still feel awfy, awfy expensive. Plus we don’t hear that much these days about banks being all nasty and refusing to pass on interest rate cuts (unless its to cut interest rates on savings).

Given what actually seems to be happening, I’m thinking mebbe there’s now a tacit acceptance by government that banks can be allowed to screw borrowers over, with this letting them rebuild their capital by themselves.

So if my hunch is correct, then WHOOPEE - government doesn’t have to invest anymore of our money in them, but BOO - because British banking is only part nationalised, private shareholders will profit from this as will the bank executives who will be proclaimed business heroes in due course, essentially for being allowed to rip off customers in a market that’s lost around a third of the competition. And BOO2, because banks appear to have swung from not pricing for risk and lending too much too cheaply, to potentially “over-pricing” for the far smaller risk attached to less debt, then they’re stuffing the housing market because no one can afford the equity needed for a first time buyer mortgage.

Theres more BOOs, but I figure you get the point.