UK Banking
SPECIAL REPORT
20th January 2009
When I joined the Chartered Bank (then part of Standard & Chartered Banking Group) in 1976 the UK banking scene offered customers huge competitive opportunities both in the domestic and international markets but as banking consolidation accelerated it became abundantly clear that customers became third choice after shareholders and bank employees as City bonuses magnified. With the advent of ‘big bank’ in 1986 the UK regulator (now FSA) started interfering in the mechanics of how the London Stock Exchange operated but also in other areas such as the banking industry. Whilst reading the recent finance group, Cattles PLC statement I was appalled to discover that Cattles application for a retail banking licence was made to FSA and NOT the Bank of England. For many of us the Labour government’s antics with referring interest rate policy to the Bank of England has resulted in the ‘Old Lady’ failing in it’s role to police and supervise the UK banking industry. As “lender of last resort” there is clearly an impartial role here as senior bankers debate interest rate policy and try to appease the money market rates and forces of the market whilst supposedly acting as chaperone to UK banking. If the City of London’s credibility is to survive the overhang of recent events I believe that the UK government needs to return this interest rate process to HM Treasury immediately, strengthen the bank’s oversight role and investigate the actions of the London Stock Exchange for allowing a continuous repetitive backwardisation since 12noon till yesterday’s close whereby it was almost impossible for an orderly market in RBS’s shares to be conducted. A suspension of RBS’s listing should have prevailed but in fact only those with SETS (Stock Exchange Automated Trading System) access could deal preventing many investors from transacting business in the security. Notwithstanding this the extraordinary lack of transparency in bank balance sheets and off-balance has clearly torpedoed any attempts to stabilise the system since October last year.
The real problem that politicians, regulators, auditors and other practitioners need to address is that the derivatives tail globally is now estimated at US$600 trillion (£428 trillion @ 1.40). Assuming that UK businesses have say 10% exposure to this and conservatively control another 10% acting in their capacities as agents/advisors then the UK’s exposure to CDO’s, SIV’S and a host of other predominantly synthetic derivative instruments could be calculated at £86 trillion. Now it’s fair to say that not all these derivative positions are necessarily toxic but taking a conservative estimate of say 20% problematic, 50% possibly problematic then UK’s banking exposure could be somewhere in the £17 trillion to £43 trillion ball park (from now till 2025). Madness? Perhaps not! With RBS potentially putting £2 trillion transparently onto UK plc’s depleted balance sheet in the foreseeable future the likelihood is that if that happens and an orderly unwinding of RBS’s toxic positions took place alongside non-toxic assets (the sale of 4% stake of Bank of China was a typical fire sale valuation) then a liability to UK plc and tax-payers could easily accelerate to nearer £20 trillion of losses alone. Realistically massive banking write-offs need to happen hereon but the accounting mechanisms and laws governing insolvency are being severely tested and many believe as I do that these banks should enter into administration allowing for rump asset sales going forward (eg Coutts is a great brand within RBS; HSBC could off-load First Direct). The expected time-frame of offloading the government investment in banks such as RBS, Lloyds TSB, Northern Rock are totally unrealistic and UK shareholders do need to see that creditors and investors may actually retrieve a 1p or so per share rather than being absorbed into the UK plc p&l and balance sheet.
As at today the UK banking industry is on its knees and the resulting reaction to the level of £sterling internationally could be disastrous. Closer collaboration with ECB could again be disastrous as EU bankers struggle to cope with their own severe problems. More consolidation is likely but shouldn’t be encouraged for competitive reasons. In fact the reverse should happen and the sooner ABN can be restructured and hived-off from RBS the better; ditto National Westminster. What really needs to happen hereon in Europe (and there are those like myself who were saying this back in October) is that new stock banks are formulated asap with the backing of the central banks with green lights from the regulators. For regulators to hold up new banks and brokerage licences in the modern financial era is totally unacceptable. Good business plans with credible managements should be backed and supported by central bankers, the stock exchanges and the regulators immediately. I don’t think that LSE and FSA in London have any idea the damage their onerous application processes are having and in this regard I would expect Swiss banking to benefit from further backlashes in UK.
As I write Barack Obama is being inauguarated as 44th President and Lloyds TSB are languishing down -15 at 50p after a far from convincing discussion on Sky News last night between Sir Victor Blank, Chairman of Lloyds TSB and Jeff Randall, the City commentator. The outlook for Lloyds TSB is stretched indeed after the extraordinary acquisition of HBOS which surprised many in the City for its illogical and risky nature. The opportunities of a combined 30% share of the UK mortgage market looks ill-conceived to me as property ownership in UK comes full circle. Similarly arab investors are nursing terrible losses (as yet uncrystallised) in Barclays which may be in the sights of Standard Chartered who appear to better placed than any of their competitors including their main rival HSBC. Further cash calls, government aid, and insurance are more than likely but without new banks being allowed to pitch for a share of the UK market then the outlook looks horrendous for citizens and businesses. There are still some good names in banking left (Arbuthnot, C Hoare) and a host of names that could be rejuvenated and it is imperative that some modern competition is created asap. There are some great opportunities for corporate financiers if only the regulatory regime could fast-track new applications.
Hold tight for a rocky ride!
I continue to recommend that clients buy fixed income and precious metals rather than deposit balances in excess of £50,000 into UK banking system at present.
Tuesday 20 January 2009
Friday 16 January 2009
**For the record*** My MARKET WARNING letter dated 16th August 2007
I'm not sure why I didn't post this at the time but the following letter was sent to my clients on 16th August 2007;-To ALL Hoblyn Clients
Our ref;- RPH/CT/marketwarning
16th August 2007
Dear Client(s)
Since writing to all my clients on 14th May predicting an unprecedented credit crunch a severe and unprecedented problem has indeed arisen in the US banking system. Although there are many interpretations and reasonings as events unfold it would appear that the inability of low quality (“sub-prime”) borrowers to repay mortgage arrears has led to falling property prices in the Mid-West and Florida starting a spiralling effect into the rest of US market. Doubts remain about the state of the largest mortgager, Countrywide as well as various mainstream Investment Banks, including Bear Stearns, Lehman and Goldman Sachs after hedge funds have been caught out holding illiquid positions. As margin calls persist these same banks are being forced to liquidate elsewhere. For years this type of “down wave” or “domino effect” has been predicted and although it’s impossible to gauge how the fallout will pan out it’s important to realise that the property bubble in UK is still intact. It has been apparent to me for most of the past decade that excessive valuations have been abundant in western retail property markets and I have had grave doubts about the so-called housing shortages as millions of homes remain empty as a result of excessive speculation. A comparison with the early ‘70’s secondary banking crisis and the bear market then could be made today although I fear that the current crisis, one mainly of shaken confidence so far, could lead to a fully blown bear market as the reality of unfathomed losses materialises and a US$500 trillion derivatives market attempts to unwind. It is ironical then that the hedge market could be the creation of the biggest market correction ever. The recommendations made after Enron and LTCM have been mainly ignored. Creative accounting and lack of transparency could well make many of the analysts redundant as cataclysmic financial events unfold.
In essence the bear market is long overdue. A technical double top or head and shoulders may well have formed between the top in December 1999 and June 2007. If this is the case the prognosis for equities is not good. Asset deflation could well accelerate as Central Banks dither on the best way to safeguard investors interests. I fear that any lowering of interest rates hereon could just add fuel to the fire.
As I said in May, “I continue to recommend only UK equities with a reliance on international scenarios, exposure to oil majors (BP & Royal Dutch Shell ‘B’), exposure to London based precious metals stocks (Randgold, Hochschild) and a moderate exposure to general miners, higher cash levels and a review of all property related investments”.
Our ref;- RPH/CT/marketwarning
16th August 2007
Dear Client(s)
Since writing to all my clients on 14th May predicting an unprecedented credit crunch a severe and unprecedented problem has indeed arisen in the US banking system. Although there are many interpretations and reasonings as events unfold it would appear that the inability of low quality (“sub-prime”) borrowers to repay mortgage arrears has led to falling property prices in the Mid-West and Florida starting a spiralling effect into the rest of US market. Doubts remain about the state of the largest mortgager, Countrywide as well as various mainstream Investment Banks, including Bear Stearns, Lehman and Goldman Sachs after hedge funds have been caught out holding illiquid positions. As margin calls persist these same banks are being forced to liquidate elsewhere. For years this type of “down wave” or “domino effect” has been predicted and although it’s impossible to gauge how the fallout will pan out it’s important to realise that the property bubble in UK is still intact. It has been apparent to me for most of the past decade that excessive valuations have been abundant in western retail property markets and I have had grave doubts about the so-called housing shortages as millions of homes remain empty as a result of excessive speculation. A comparison with the early ‘70’s secondary banking crisis and the bear market then could be made today although I fear that the current crisis, one mainly of shaken confidence so far, could lead to a fully blown bear market as the reality of unfathomed losses materialises and a US$500 trillion derivatives market attempts to unwind. It is ironical then that the hedge market could be the creation of the biggest market correction ever. The recommendations made after Enron and LTCM have been mainly ignored. Creative accounting and lack of transparency could well make many of the analysts redundant as cataclysmic financial events unfold.
In essence the bear market is long overdue. A technical double top or head and shoulders may well have formed between the top in December 1999 and June 2007. If this is the case the prognosis for equities is not good. Asset deflation could well accelerate as Central Banks dither on the best way to safeguard investors interests. I fear that any lowering of interest rates hereon could just add fuel to the fire.
As I said in May, “I continue to recommend only UK equities with a reliance on international scenarios, exposure to oil majors (BP & Royal Dutch Shell ‘B’), exposure to London based precious metals stocks (Randgold, Hochschild) and a moderate exposure to general miners, higher cash levels and a review of all property related investments”.
Tuesday 13 January 2009
Review 4 Q 2008 7th January 2009
A senior partner of a major firm once said- “Look here my boy, if I knew what to do, I would not be here advising you, I would be on a yacht in the South of France” – a UK Private Client stockbroker probably circa 1974
With FTSE100 producing its worst ever performance for 2008 with a decline of 31.49% over the year and mostly factored during the September-November period I am not going to predict how FTSE100 will end in 2009 suffice to say that I do not expect an economic recovery for quite some time yet. Although every Wall Street strategist is ‘bullish’ for 09 it is important to remember that the very same ‘experts’ were bullish for 08; as my stockbroking father always said, “there are no experts in this business!”. My gut feeling though is that FTSE100 may well trade nearer to 4,000 than 4,600 where it is currently hovering and I wouldn’t be surprised to see S&P retest 800 during 09 despite Barack Obama’s economic stimulus.
The last quarter saw some extraordinary events many of them predicted by market observers. The bail out (TARP) of the world banking system was indeed unprecedented (a word that has been overused many times since) but like many market professionals I saw little merit then (and still do) in throwing tax payers future earnings at dubious balance sheets surrounded by black holes and ongoing derivative failures. The credit crunch, albeit predicted by many, did not play out as many thought. Whilst bank shares were crunched and hedge funds were forced to liquidate (where they could) positions the bottom fell out of base commodities dragging even precious metals prices and stocks across all sectors down with them. This was not meant to happen but it did. Furthermore the oil price once touching the high of $147pbo remarkably fell off the cliff next door and lost $100pbo in the same time frame; strangely the two oil majors on the FTSE100, BP and Royal Dutch held up pretty well over this period. The lesson to be learned I think is that many of the falls were liquidity driven so today there are plenty of opportunities for value investors and true fundamentalists adopting technical disciplines alongside differing strategies.
With the ban on short-selling of financials being lifted imminently (and many disagreed with it in the first place including myself) I wouldn’t be surprised if many more financial calamities occur (or get exposed like Bernie Madoff’s ponzi designed to scalp hedge fund investors). Whilst politicians call for more regulation it is important to note that rules are in place already. Although Sir Andrew Large (ex-Deputy Governor of the The Old Lady) calls for a new independent body that would provide early warnings of systemic problems and have the tools to discourage excessive borrowing many other people in the City would say that that is the Bank of England & FSA’s role in the first place. I gravely doubt more regulation is the answer whereas more emphasis on leaving practitioners to adjust the nuts and bolts and more expert oversight by these regulators is what is required. Hedge funds need to be regulated just like asset managers and private client stockbrokers. Quite why it has taken so long for governments and regulators to work out why Hedge Funds grew so alarmingly in the last few years surprises quite a few of us in the industry. The lack of regulation has clearly been the main attraction for boffins to leave investment banks and join the ‘hedgies’ on attractive 2/20 terms. That game is over as investors now try to escape the clutches of these over-priced illiquid operations. The fall out has already started and perhaps many will leave the hedge fund industry and reignite the investment banking industry which has been pulverised (Merrill’s and Goldman’s have become commercial banks; Lehman’s and Bear have disappeared) and written off even by the Sage of Omaha who’s own flame has flickered after he bought $5bn of preferences shares in Goldman’s. I don’t agree that the investment banking model is ‘dead’. The problem occurred when gearing and lending occurred in the late ‘90’s favouring the early birds in the hedge industry and it then outgrew itself; there are clearly skills needed from the redundant investment bankers but any new organisations do need to get back to basics where they fully understand their customers. The same could be said for commercial banks in the UK!
The strategy for 2009 should be therefore for UK domiciled investors to avoid financials, retails and industrials and focus on value plays (companies with strong transparent balance sheets, with well-covered dividends), precious metals stocks and funds, international earners (most base metals and oil stocks should be tradeable throughout 2009 as volatility remains historically high), UK government gilts (switching to Index Linked 2nd or 3rd quarters), selective corporate bond funds, emerging markets trusts; basically solid yield, transparent earnings, modest growth and p/e in single figures is the order of the day. Due to the continued volatility it is extremely difficult to recommend stocks on a 1 year+ view but depending on market conditions I am still recommending Hochschild (my favoured pick for 2009 with c.£90m in cash; Mkt Cap £420m; yield 3.4%; 2008 High 467 Low 65 now 138p), Randgold, Anglo American amongst the metals, Royal Dutch & BP, Templeton Emerging and have added Yamana Gold (a Canadian miner, Mkt Cap £3.5bn) at 525p and Henderson Far East 214p yield 5.6% to my extensive lists of stocks that I follow. Please contact me to discuss any stocks or investments that you may have concerns about or may be interested in.
Generally speaking I would favour a portfolio weighting such as 30% Fixed Interest (incl bond funds,etc), 20% cash, 50% equities (overseas earners mainly incl. up to 25% in precious metals) until a clearer picture emerges throughout 2009. I believe it is too early to make a call for a basket of UK equities; some observers have already made incorrect calls on UK equities (eg. Anthony Bolton ex-Fidelity). There’s every likelihood that an avalanche of earnings downgrades and profits-warnings, rights issues (I suspect Rio Tinto is gearing up for one very soon), other failures (both corporate, hedge funds and even private equity troubles) may sink FTSE100 below 4,000 (possibly as low as 3,300) in 1Q 09 so I remain extremely cautious for long-term investors. There are, however, many trading opportunities presenting themselves at present and in particular I am getting excited by the potential moves in Gold and Silver; Platinum remains difficult to call with the Detroit situation delayed until April/May. Gold resistance is being touted at $936pto (currently $843pto) and I think once this level is breached then the previous $1033 high could be tested quite quickly and the following levels tested, $1163, $1332 & $1461; a trading range of $1200-2000 is forecast for 3rd and 4th Q’s 09. With Woolworth’s and a host of other retailers having already failed I suspect that even the larger operations will be suffering by the summer. The outlook for property is still dire and I would guesstimate that another 20-30% fall could be seen this year but the real eye-opener will be in commercial property where it rather looks as though the semi-national banks have cooked up potential losses in the ballpark of £75-100bn which Mr Darling has to contend with shortly. It rather looks as though the only truly independent UK bank will be Standard Chartered going forward; the outlooks for Barclays, HSBC & Lloyds (with HBOS regrettably) is truly difficult to fathom although it looks as though a full-blown bailout of RBS (NatWest and Bank of Scotland to be repackaged and sold off within 2 years) by UK plc is on the cards.
As the anonymous senior partner mentioned in the above heading implied, if any of us could consistently predict the future we would indeed be spending more time with the successful hedge fund managers who’ve cashed in their chips already and own a fleet of gin palaces in Dubai, Monaco and all points east and west.
With FTSE100 producing its worst ever performance for 2008 with a decline of 31.49% over the year and mostly factored during the September-November period I am not going to predict how FTSE100 will end in 2009 suffice to say that I do not expect an economic recovery for quite some time yet. Although every Wall Street strategist is ‘bullish’ for 09 it is important to remember that the very same ‘experts’ were bullish for 08; as my stockbroking father always said, “there are no experts in this business!”. My gut feeling though is that FTSE100 may well trade nearer to 4,000 than 4,600 where it is currently hovering and I wouldn’t be surprised to see S&P retest 800 during 09 despite Barack Obama’s economic stimulus.
The last quarter saw some extraordinary events many of them predicted by market observers. The bail out (TARP) of the world banking system was indeed unprecedented (a word that has been overused many times since) but like many market professionals I saw little merit then (and still do) in throwing tax payers future earnings at dubious balance sheets surrounded by black holes and ongoing derivative failures. The credit crunch, albeit predicted by many, did not play out as many thought. Whilst bank shares were crunched and hedge funds were forced to liquidate (where they could) positions the bottom fell out of base commodities dragging even precious metals prices and stocks across all sectors down with them. This was not meant to happen but it did. Furthermore the oil price once touching the high of $147pbo remarkably fell off the cliff next door and lost $100pbo in the same time frame; strangely the two oil majors on the FTSE100, BP and Royal Dutch held up pretty well over this period. The lesson to be learned I think is that many of the falls were liquidity driven so today there are plenty of opportunities for value investors and true fundamentalists adopting technical disciplines alongside differing strategies.
With the ban on short-selling of financials being lifted imminently (and many disagreed with it in the first place including myself) I wouldn’t be surprised if many more financial calamities occur (or get exposed like Bernie Madoff’s ponzi designed to scalp hedge fund investors). Whilst politicians call for more regulation it is important to note that rules are in place already. Although Sir Andrew Large (ex-Deputy Governor of the The Old Lady) calls for a new independent body that would provide early warnings of systemic problems and have the tools to discourage excessive borrowing many other people in the City would say that that is the Bank of England & FSA’s role in the first place. I gravely doubt more regulation is the answer whereas more emphasis on leaving practitioners to adjust the nuts and bolts and more expert oversight by these regulators is what is required. Hedge funds need to be regulated just like asset managers and private client stockbrokers. Quite why it has taken so long for governments and regulators to work out why Hedge Funds grew so alarmingly in the last few years surprises quite a few of us in the industry. The lack of regulation has clearly been the main attraction for boffins to leave investment banks and join the ‘hedgies’ on attractive 2/20 terms. That game is over as investors now try to escape the clutches of these over-priced illiquid operations. The fall out has already started and perhaps many will leave the hedge fund industry and reignite the investment banking industry which has been pulverised (Merrill’s and Goldman’s have become commercial banks; Lehman’s and Bear have disappeared) and written off even by the Sage of Omaha who’s own flame has flickered after he bought $5bn of preferences shares in Goldman’s. I don’t agree that the investment banking model is ‘dead’. The problem occurred when gearing and lending occurred in the late ‘90’s favouring the early birds in the hedge industry and it then outgrew itself; there are clearly skills needed from the redundant investment bankers but any new organisations do need to get back to basics where they fully understand their customers. The same could be said for commercial banks in the UK!
The strategy for 2009 should be therefore for UK domiciled investors to avoid financials, retails and industrials and focus on value plays (companies with strong transparent balance sheets, with well-covered dividends), precious metals stocks and funds, international earners (most base metals and oil stocks should be tradeable throughout 2009 as
Generally speaking I would favour a portfolio weighting such as 30% Fixed Interest (incl bond funds,etc), 20% cash, 50% equities (overseas earners mainly incl. up to 25% in precious metals) until a clearer picture emerges throughout 2009. I believe it is too early to make a call for a basket of UK equities; some observers have already made incorrect calls on UK equities (eg. Anthony Bolton ex-Fidelity). There’s every likelihood that an avalanche of earnings downgrades and profits-warnings, rights issues (I suspect Rio Tinto is gearing up for one very soon), other failures (both corporate, hedge funds and even private equity troubles) may sink FTSE100 below 4,000 (possibly as low as 3,300) in 1Q 09 so I remain extremely cautious for long-term investors. There are, however, many trading opportunities presenting themselves at present and in particular I am getting excited by the potential moves in Gold and Silver; Platinum remains difficult to call with the Detroit situation delayed until April/May. Gold resistance is being touted at $936pto (currently $843pto) and I think once this level is breached then the previous $1033 high could be tested quite quickly and the following levels tested, $1163, $1332 & $1461; a trading range of $1200-2000 is forecast for 3rd and 4th Q’s 09. With Woolworth’s and a host of other retailers having already failed I suspect that even the larger operations will be suffering by the summer. The outlook for property is still dire and I would guesstimate that another 20-30% fall could be seen this year but the real eye-opener will be in commercial property where it rather looks as though the semi-national banks have cooked up potential losses in the ballpark of £75-100bn which Mr Darling has to contend with shortly. It rather looks as though the only truly independent UK bank will be Standard Chartered going forward; the outlooks for Barclays, HSBC & Lloyds (with HBOS regrettably) is truly difficult to fathom although it looks as though a full-blown bailout of RBS (NatWest and Bank of Scotland to be repackaged and sold off within 2 years) by UK plc is on the cards.
As the anonymous senior partner mentioned in the above heading implied, if any of us could consistently predict the future we would indeed be spending more time with the successful hedge fund managers who’ve cashed in their chips already and own a fleet of gin palaces in Dubai, Monaco and all points east and west.
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