Investment Management Blog - Montague Capital

It’s not really surprising that Royal Bank of Scotland has muscled its way to the front of the UK banks’ rights issue queue.  Firstly, it has for a long time been counting as capital types of paper which stretched accountants’ credulity to the limit.  A “normal” interpretation of qualifying capital rules would have left it far below regulatory requirements even before the proverbial started to hit the fan in wheelbarrowloads and erode the capital base last summer.  Secondly, the acquisition of ABN Amro at the very top of the market (or even way beyond it?) doubtless satisfied Sir Fred Goodwin’s “pan-galactic domination” approach to growing the business, but the wholesale money markets are now closed to any attempts to pay for that shopping.  There is little quite as dangerous as a CEO who has so lost touch with reality.  The UK equity market has had its head in the sand for far too long on RBS.  Given the parlous state of its balance sheet, rumours of a £12bn rights issue maybe don’t sound big enough.  The extra cash may get the bank through today’s known problems, but leaves little scope for the unknowns that are yet to hit home.  To try to excuse this by claiming it is being forced to comply with new, stricter rules is pathetic.  RBS should never have drifted so far away from prudent financial management in the first place.  Investors have already paid the price in one of the worst share price performances an already dire UK banking sector can offer.  Now that recent 10% increase in the dividend looks like a snowflake on a summer’s day too.  When the other major banks follow suit Barclays may get an easy ride.  While it was never clear that it should have been sniffing around ABN Amro in the first place, at least Barclays’ CEO John Varley had the eminently good sense to walk away from the deal early.  When the other banks do follow suit with their own rights issues, the opposition of HMG and the Bank of England to helping the banks out of a mess of their own making will fade.  That will help the monetary system in particular and the economy in general, but it will not trigger a return to the good old, mad old times for the UK’s banks.  They have a serious and expensive hangover to work off first.

As for the US….

On Wednesday JP Morgan Chase suggested that the worst of the US banking crisis may now be over.  Yesterday news from Merrill Lynch and Citigroup confirmed that it is not.  Merrill announced a FY08Q1 net loss of US$1.97bn and wrote of another US$4.5bn to add to the “final” cumulative figure of US$24bn announced the last time it had results.  About half of the “capital cushion” of US$4.2bn it claimed to have had at the start of the year has now been wiped out, so the begging bowl is going to get passed around yet again very soon.  4,000 jobs are also likely to go.  Meanwhile, Citigroup is suggesting that it may be about to take as much as 20% out of the bank’s cost base.  That’s about another 25,000 jobs.  All this will make the expense ratios look better, but these banks’ revenues aren’t likely to recover any time soon, at least not until an increase in bankruptcies stops the shrinkage and leads to more bottom-fishing bargain-hunting M&A work.