On Wednesday morning last week, stock market investors were ambushed by the April Fool that wasn’t. By cancelling some £7.5 billons of dividends on last year’s profits, the last remaining plank of investor support from bank share prices was removed. Accused of reckless lending in the years prior to the last decade’s global financial crisis, the UK banks have been buffeted from all sides by regulators, legal claims resulting from “mis-selling” and ever lower interest rates which damage profit margins.
On the Tuesday evening before, Lloyds Bank had held a telephone call with institutional investors. After 11 years of hunkering down, the spokeswoman seemed to say, risk weighted assets (loans) had more than halved, liquidity buffers built up and equity capital so increased that the bank could blow through almost any adverse conditions imaginable.
And they still wished to pay last year’s dividend. They would certainly support clients that now needed help and would cut back most new business opportunities to ensure resources were available to achieve this. There would be no risk of adverse credit development, she said, because this would be achieved without any relaxation in the bank’s credit standards.
One of the reasons the bank felt able to make this statement to its investors was that until perhaps a few hours before Lloyds, and presumably the other banks as well, had been refusing to implement the SME-aimed business interruption loan policy launched by the Chancellor, Rishi Sunak.
However high the pile of applications became, Lloyds managers had been ordered, apparently, not to process any of them. A rival bank, believed to be HSBC, had sent a one-page instruction to its managers. Any application that fits HSBC normal credit parameters, it wrote, was ineligible for the government’s “subsidised” scheme.
On the other hand, if the application did not meet credit standards, then the bank would also not provide credit on the basis (allegedly) that it was illegal to transfer credit risk to the taxpayer. “I hope you find this clarification useful!”, wrote an HSBC manager to the representative of a business with which this writer is associated.
It would appear that in high level conversations across the country our business grandees have been eyeballing each other over Zoom-enabled computers in discussions as to who is going to pay for the catastrophic economic collapse being engineered by the Government’s zealous adherence to the mathematical recommendations of Neil Fergusson of foot and mouth fame, at Imperial College.
Not us, say the insurance companies, for COVID-19 was never one of our risks. Not us, say the Treasury, proffering small print, seemingly as long as the bible, to ensure the Treasury might never have to perform on the Chancellor’s pie-crust promises. Not us, say employees, who are now in theory protected by the furlough scheme. That is, if that scheme can indeed be trusted. For, in the first instance, as I understand it, employers are still expected to make the imminent payroll payments that they can so ill afford.
All this left just one patsy left at the poker table – Britain’s commercial banks. But perhaps, just perhaps, they appear to have played hardball.
Ironically the banks, blamed for making reckless loans before the GFC, were now being instructed via the business interruption scheme to make reckless loans on behalf of the government. Probably it took the bank CEO’s a while to confirm whether they were really being asked to do what they were actually being asked to do.
Incredibly, and additionally, some of the banks’ shares by last week were already trading X-dividend. In other words, the dividend they were about to “not pay” had already been deducted from the quoted share price.
Thus, the Prudential Regulatory Authority, deliciously, was requiring banks to create retrospectively a false market in their own shares. There was no shortage of reasons for banks to be very difficult about the compliance to the business interruption scheme, and the anecdotal evidence received from Lloyds and HSBC suggests that, up to the last few days, they were being very difficult indeed.
All investors operate, as we are required to, under conditions of uncertainty. Frequently we have to join up the dots. On that Tuesday evening investor conference-call, Lloyds indicated to its investors that the government would pay 80% of the credit losses on any new credit line extended to private businesses under the Government sponsored lending schemes.
All over the country bank managers at Lloyds started to process, with a view to approving, business interruption loan applications. Then last Friday came the happy news that another business I know, which already has bank borrowings, had secured a further £2.2mills of credit from Lloyds under the business interruption scheme.
Investors reacted with dismay to the Lloyds dividend announcement, with the shares promptly falling a further 20% to below 28p. However, the book value of banks is much higher than current share prices, at Lloyds it is at present around 52p per share. With credit losses covered by the Government, book value may even continue to grow.
Thus, Lloyds may no longer be a dividend play but, at current prices, it could prove a successful two-year investment, if not for the reasons envisaged and promoted by its own management. In exchange for the No-dividend pledge surrendered last week the banks potentially extracted something far more valuable. Let’s hope the bank CEO’s forced the Treasury to sign their “commitment” to cover the vast majority of incremental credit losses in blood.
Jeremy Hosking is founding partner of Hosking Patners and a practicing fund manager.