The Big British Banking Bailout

The government rescues the banking sector, announcing a huge £37bn investment programme to restore confidence in the financial system.

After the events of last week, we knew it was coming. But this didn't stop the feeling of astonishment when we saw the detail of the government's plan to prop up our ailing banks.

In brief, the decision to let Lehman Brothers in the US collapse a few weeks ago appears to have been the wrong one. The financial system was far more incestuous and inter-connected than the regulators believed and the knock on effects of unwinding Lehman's positions froze the money markets once again. This has triggered failures in Iceland and raised concerns that other banks would soon run into trouble.

The UK pledged its support for our banks last week, saying it would part-nationalise some of them if necessary and hence guarantee inter-bank lending. UK banks were required to boost their capital reserves to cope with the current crisis and had the option of doing this from their own resources or asking the government for fresh funds.

The details of the UK rescue package were announced first thing on Monday morning and other major countries are expected to follow suit with their own set of measures in the very near future.

As part of this package, the government has agreed with the banks that they will maintain, "over the next three years, the availability and active marketing of competitively-priced lending to homeowners and to small businesses at 2007 levels". That's good news for borrowers although it could take some time to work its way through I suspect.

The banks will also provide "support for schemes to help people struggling with mortgage payments to stay in their homes, and to support the expansion of financial capability initiatives". More good news, if a little on the vague side. Provisions will also be made with regards to pay for senior executives, board appointments and dividends.

With regards to the funding, it's easiest to look at what's happening on a bank by bank basis. So here goes in ascending order of ugliness.

HSBC

Our largest bank said last week that it didn't require any of the government's money, having injected £750m of its own funds to boost its capital reserves.

Santander (owns Abbey, Alliance & Leicester and parts of Bradford & Bingley)

The Spanish banking giant has also said it doesn't require any UK government help. As it said when it revealed its plan to take over Alliance & Leicester a few weeks ago, it is injecting £1bn into its UK business and this is expected to take place today.

Nationwide

Nationwide hasn't released any formal statement although it was included on the government's list on institutions that were eligible for assistance. So we can assume that it doesn't require any government money. On a related note, Britannia Building Society also announced this morning that it was in talks with Co-Operative Financial Services regarding a merger.

Barclays

This is where it starts to get ugly. Barclays has turned down the government's offer but still need to raise more money to boost its reserves. It's raising a total of £6.5bn in three separate tranches from external investors.

• £3bn worth of preference shares will be issued by the end of 2008 (preference shares are a halfway house between debt and shares that pay a fixed rate of interest);
• £0.6bn will be raised to fund its acquisition of part of Lehman Brothers, as announced last month; and
• £3bn will be raised by a rights issue to shareholders in February or March of 2009.

In addition, Barclays will pay no final dividend for 2008 but intends to restart dividends in the second half of 2009. Barclays added that it had made higher profits in September than it did in many of the months in the first half of 2008.

Lloyds TSB/HBOS

Now we turn to the banks who are taking the government's money.

The merger of Lloyds TSB will proceed but the terms have been revised. HBOS investors will now get 0.605 shares in Lloyds (rather than the previously announced 0.833) for each HBOS share they currently own.

The combined bank will raise a total of £17bn:

• the government will buy £4.5bn of new Lloyds shares, paying 173.3p per share;
• it will also buy £8.5bn of new HBOS shares, paying 113.6p per share; and             
• it will get £4bn in preference shares paying a coupon of 12% a year. No cash dividends can be paid until these preference shares are repaid in full.

Lloyds TSB shareholders will get a chance to invest more money in the combined bank, in place of the government's funds. This will be done via an offer to all shareholders, details of which will be announced later. Depending on how many shareholders take up this offer, the government could end up owning as much as 43.5% of the combined Lloyds TSB/HBOS.

In terms of current trading, Lloyds said its underlying profits have grown at more than 10% in many areas but that it expected a further hit of just under £900m due to recent problems.

Royal Bank of Scotland

Royal Bank of Scotland is getting £20bn of government money and three of its management team, including chief executive Fred Goodwin, will stand down:

• £15bn of cash will be raised by an open offer to all shareholders.  Any shares not taken up will be underwritten by the government at 65.5p, meaning that it could end up owning as much as 58% of the company.
• £5bn of preference shares will also be issued. As with Lloyds TSB/HBOS, the coupon rate will be 12% a year and no dividends can be paid until the preference shares are redeemed in full.

RBS also issued a trading update saying that, although it remained profitable in the third quarter, results for 2008 would be below previous expectations.

We're bailing ourselves out really

Although we've called this a banking bailout, it's important to remember two key points. First of all, this £37bn is being invested, not spent. Essentially we, as taxpayers, are buying a large stake in two massive banks at dirt-cheap prices. The government has driven a very hard bargain in respect of the price paid and the interest it will get on the preference share element.

I reckon the chances of making a substantial long-term profit on these holdings are exceptionally high. While we're winners in this respect, those of us with pension funds and investments in these banks will lose out to create this opportunity.

Secondly, this is about preserving our economy not bankers' bonuses. We need the banking system to function properly so that wages can be paid, investment can be made in growth and regeneration projects and so on. They will be plenty of time to sling mud and discuss other prevention measures later but for now any attention on who is to blame and which bits of their anatomy we should kick first diverts vital resources away from fixing the problem.

Will it be enough?

I don't know. No one else does either. It should be but the events of the last year or so have demonstrated time and again you can't predict anything with 100% certainty due to the complexity of the world in which we live.

There's really only one more big step the government can take after this though and that is to fully nationalise the entire banking industry. Let's hope it doesn't come to that. However, I suspect it may be that we will eventually look back at last week as a blessing in disguise. The carnage may well have created the urgency needed to fix the problem.

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