Time to drop ABN bids?
Imagine two Premier League teams playing a high pressure football match when an electrical storm strikes. The onset is rapid and two players on each side are hit by lightning and are stretchered off.
What do you think would happen? Would the game be continued or would it be abandoned?
Well there is something of a storm in the banking world. And in a way it is worse than my fictitious one, because it is not only curtailing the career prospects of bankers but is wreaking havoc on the value of banking assets.
However and a consortium of banks led by have not abandoned their big match.
They continue to battle each other to acquire control of another big bank, of the Netherlands.
Are they right to continue? Shouldn't their non-executive directors and shareholders be asking some challenging questions about whether it is sensible to contemplate the substantial management challenge of integrating ABN - a huge and complex international bank - at a time when valuing even their own assets is tricky.
RBS can't argue that the risks are significantly less for it than for Barclays just because it would carve up ABN and share the bits with its two partners, and . The part that RBS would retain is the division of ABN in the eye of the storm, its global wholesaling and investment banking operations.
Charting the storm
It is probably worth rehearsing the nature of this storm again, though I have charted its course in a series of blogs over the past eight months.
Its most conspicuous current manifestation is that banks are reluctant to lend substantial sums to each other, they are hoarding cash. As a result, interest rates in the interbank market - the price of money borrowed by banks from banks - has risen sharply, so that they are much higher relative to official lending rates than they would be in normal circumstances.
That is gradually filtering through to tighter credit conditions and higher interest rates in what we think of as the real world, viz the price for loans paid by you and me.
Underlying these strange climactic conditions is a collapse in investors' confidence in certain kinds of loans, known in banking parlance as assets. These are loans to US homeowners with poor credit histories, the infamous sub-prime loans. But also they are loans to companies bought with buckets of debt, typically businesses acquired by private equity.
But that is only half the story. These rather basic loans have been converted by investment banks' alchemists into all sorts of other forms of debt, often via so-called structured credit vehicles called collateralised debt and loan obligations.
And in the process of finding buyers for these newfangled securities, the banks have doubly exposed themselves by guaranteeing much of it, either through underwriting the original debt or by providing borrowing facilities to purchasers of it.
Foolishly they have encouraged the acquirers of these securities to buy them with more borrowed money. Debt has been purchasing debt.
What the banks have helped construct is an inverted pyramid of borrowing. By way of an image, think of a tiny cone of equity supporting a colossal and rickety edifice constructed out of loans of varying maturities and degrees of risk.
As more and more debt has been heaped on top, there has been a corresponding rise in the danger of the whole thing imploding.
Greenspan's False Confidence
To put it another way, securitisation - the process of converting loans into securities for sale to investors - has not insulated banks from economic shocks in the way its advocates (led by the legendary Alan Greenspan) have claimed.
In fact securitisation, with loans made in one country sold to investors in another, is actually causing the current shocks to ripple far more widely than would have been the case when banking was a simpler business.
In particular, as I pointed out in my blog Liars' Loans, the collapse in value of many of these tradable loans or securities has led to a very serious run in a huge debt market, that for asset-backed commercial paper.
This commercial paper is being redeemed on an unprecedented scale. In just the coming week, the banks will be asked to stump up £65bn to refinance European commercial paper - or risk seeing a firesale of other assets that would have dire consequences.
Warning for Barclays and RBS
Make no mistake, I am not forecasting that any big bank will become insolvent. Please don't panic. But the probability of a serious worldwide financial crisis has risen.
One possible ghastly outcome would be similar to what happened in Japan in the 1990s. Banks would be forced to hold assets they thought were sellable as long-term loans on their own balance sheets. That would tie up their capital resources and prevent them extending credit to perfectly decent borrowing prospects. And that would significantly depress economic activity.
I don't think anyone can assess with accuracy the likelihood of the financial system seizing up like that for months or even years. But if that risk is a serious one, shouldn't the management of all big banks be devoting their efforts to ensuring their own institutions are in the best possible shape rather than embarking on new adventures?
In these testing times, no banker would surely want to double the strain on their resources and resourcefulness by merging with a bank of similar size to their own. But that is what Barclays and the RBS consortium apparently still wish to do, in their pursuit of ABN.
But for how much longer, I wonder?
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It's true that the bid makes less sense today but there will be siren calls and chief executives will find them hard to resist.
The bankers involved stand to make many millions from the merger in advisory fees, debt and equity issuance. With the M&A market stalled, many investment bankers are depending on this deal to pay their bonus in three months' time.
Also, Barclays seems keen to maintain a "business as usual" message. To withdraw the bid suddenly could perhaps leave some asking what Barclays' senior management knows about their balance sheet that we don't.
Besides, if the current credit crisis drags on, those bankers might get some juicy fees from a Barclays rights issue to tap some cash.
I am sure that Barclays bid will fail as they are trying to buy ABN with their own shares which have collapsed since they made their bid. I am buying Barclays in the expectation of a bounce when they abandon the bid and a relieved market favours them again.
Thank you, Robert, for another another insightful laypersons guide to the economy and current financial crises. I wish the investment and banking world would read your blog: that would put these bankers' - who think that constant change and action of any sort is better sticking to common-sense - heads back on. In fact, what are you doing in journalism? - go make yourself a hefty sum and sort them all out in the process!
Robert - As you said this is testing time for Banks and any wrong move could jeopardise whole institution (specially for Barclays) but could they afford to pull back i.e. Barclays may be bidding for survival rather than consider this takeover as ambitious expansion plan?
The idea that banks are sensible is stretching a point. RBS in particular is driven by the size of Fred Goodwin's ego and it's high time that was punctured.
Put simply - RBS is now far too big. Here in Scotland the general view is that it might as well be based in Timbuctoo for all the real benefit we get out of it.
What we'd give for a Norwegian style regional bank that actually works in collaboration with Govt and industry to grow the economy rather than Fred's bonus and the lot of some anonymous fund managers in the City.
Getting their own institutions in the best possible shape has rarely if ever been voluntary. The culture of neglect has been creeping in for some time. Central bank revision should have identified and stopped it in its tracks, defusing any danger of implosion at the outset. The $64 question is where was the referee? Because it was neither perceived as expedient nor 'politically correct' at the time, inspections have been selected out of the system. No matter how tall in the saddle banks paint themselves, they conform to law like everybody else at the end of the day under the rule of law. It will be for Gordon's 'regulation and transparency' to decide. The referee should have cancelled the match by now, and had the ball rolling on central revision long since.
The headline is wrong: its time for RBS to drop the bid.
RBS is using that rare commodity, cash, and is therefore at great risk from asset prices changing materially. Barclays is (mainly) using its own shares so any losses will not have an impact on its liquidity or future growth.
Barclay's deal is also low risk from an implemantation point of view; RBS's will be complex.
I don't know what about dropping the ABN bid, I suggest the directors and whizz-kids who manage these institutions go back to school and take in NVQ Level 1 in financial management since given recent events, and the nonsense of the US "sub-prime" market it seems quite clear that they are, pretty well to a man (and probably woman) nigh on incompetent!
If they manage to pass that, then they could perhaps strive for the giddy heights of a level 2.
Meanwhile, all us normal folk who rely upon stocks and shares to build up our retirement nest eggs can do little than wring our hands in the horror of it all.
Mr.Preston, you are quite right to point out that it is unlikely that any of our fine banking institutions will go bust. The problem is perhaps they should be allowed to go bust. Barclays clearly never learned their lesson from the old BZW days and have instead used retail investors cash to fund Barclays Capital which bears more in common with a hedge fund than a traditional merchant bank. Management behind both banks will point out that buying ABN Amro is sound business as it is generally regarded as a conservative institution. I would point out that ABN Amro created the first CPDO, (constant proportion debt obligation), anyone interested in this particular piece of financial alchemy can check out the entry on Wikipedia where it is compared to the widely discredited martingale gambling strategy, they might also ask how such a product could have recieved a AAA/Aaa rating.
I agree with Mr.Preston completely, shouldn't the suitors be confirming their own asset quality before taking a cold hard look at what structured delight the Dutch maiden has hidden.
With all of these "injections of liquidity" can one speak anymore of a bank going bankrupt? Money is created out of thin air to bail these fellows out- but not the taxpayer- why don't the Central Banks simply pay everyone's mortgage off as a gift so as not to spoil the holiday spending season?
I agree that this will not make Barclays insolvent, but perhaps it may explain why I am having great difficulties in transferring my 6 year old ISA? "every little helps..." I suppose?
It would be a disaster if Barclays use savers cash to fund the acqusition which stands at a staggering $45 billion at the moment. In the worst case, if Barclays go bust, the savers would loose money (Although I heard the maximum compensation they are entitled is gbp 31,700).
If Barclays doesn't succeed, could they become the hunted? The share price is flat because no-one (apparently including the directors) knows the extent of their potential liabilty to sub-prime. Hunt or be hunted?
"why don't the Central Banks simply pay everyone's mortgage off as a gift so as not to spoil the holiday spending season?"
But Robert, because of interest, there's always more debt than cash. In order to create cash to pay all the mortgages off, they'd also have to create a similar amount of debt. That's the way our money works.
This is the heart of the problem. If you want to grow... Who can you get to create cash by taking on some debt?
Cheap loans! Get em while they're hot! Cheap loans!
Barclays shares are now a steal, I've just piled in on them and I work for them. Jon Varley is talking of 800p by Xmas, I think this is a little optimistic, but I've no doubt we'll be back at the 700p level within 6 weeks. Balance sheet is strong, and the full exposure to teh sub prime market is already reflected in the share price.
I can't see them winning the ABN deal, this will then send shares soaring as Barclays becomes the hunted...get in there now, I guarantee it's only going one way - UP !
What I find most incredible, is that the ABN-AMRO strategy has been one, to lay in wait to be taken over, be that Barclay's or the consortium.
If I went to my bank and demanded a credit line, they would ask me for my business plan. If I stated that my plan is to be taken over, I would be laughed out of the room.
Yet at a board level, this is the strategy that ABN-AMRO is following. These rascals deserve to be turfed out of office.
I seem to be living in a different economic world. In my world there's profit, which can be divided up between stakeholders, and that's real money. Then there's debt, which one can use to fund profit-making investments.the two are not the same thing.
If more people share the limited profits, then everyone should get less. If more 'financial intermediaries' take a slice, then there's MUCH less to go around, however many sleight of hand deals are done to hide the reality.
But if burgeoning financial institutions continue to pay dividends, and themselves huge salaries and bonuses, out of new investors savings it becomes a Ponzi or pyramid scheme.
At the moment the central banks are perpetuating the myth of sound banking by lending more money to this particular Ponzi scheme.
It can't go on for long. What happens then?
You make several points without mentioning several crucial points.
If Barclays pulls out before its shareholders' vote (assuming IF the vote happens they will say 'no' to ABN deal anyway, given the vast overlap between RBS's and Barclays's shareholders), they pay a break fee to ABN.
If ABN pulls out - luckily their shareholder meeting is AFTER Barclays's - then the same applies to ABN.
Given the relative make-up of the shareholders, they will all lose if RBS reduces their offer price or if the deal falls through due to the MAC (market adverse conditions) clause.
Now with this more complete backdrop, you will perhaps revise your view?
Let their shareholders decide what to do; it is a good job journalists are not advisors to the banks.
PS: I live in Scotland too; I do not see what 'benefit' of having RBS as a home-grown bank people want. If RBS really did move out, Scotland will collapse economically. They not only employ 10s of 1000s of Scots in their business (including call centres) but also are a key patron of The Prince's Trust which works on the upliftment of socially downtrodden.
Comments such as Scamp's above show the small-mindedness of a small country's people. RBS - for Fred's ego or not - is a global bank, which is profitable and socially responsible. People need to get over their own pettiness and stop dragging Scotland into the ditches with them.
The bid makes very little sense. Both RBS and Barclays have huge exposures to Structured Investment Vehilcles (SIVs) and buying ABN (itself with very large exposure) will only result in an even bigger problem for both the acquirors. As a shareholder in both Barclays and RBS, I really hope this bid does not go through.
I agree with Scamp. Banks' increasing obsession with Shareholder returns and Executive bonuses means they are using every trick in the book to siphon money from their hard-working customers. Applying monthly account charges as replacement for reclaimed fees is an example of this, where they feel they had a god-given right to those exorbitant fees in the first place.
I have noticed that TCI (the activist Hedge Fund) which originally made all the noise about wanting ABN to be broken up and/or bought has been very quiet lately.
RBS can and should drop its bid for ABN, as the recent fall in banks SP's is clearly a Material Adverse Circumstance.
Meantime private investors should scoop up as many RBS and BARC shares as they can afford. You will never see 7% yield covered 2x on a bank share again any time soon.
Sentiment will weigh against the stock price of whoever wins the bid for ABN. The difference is that RBS knows how to do integration, while BARC does not. Eventually the value in RBS will out, especially if Goodwin pisses off.
AlsoWatching .....
Don't agree at all. You're just demonstrating the sycophantic attitude many Scots have towards the big Scottish banks without looking beyond the direct benefits of jobs.
The idea that Scotland's economy would collapse if RBS upped sticks is ridiculous. Anyway I don't want them to get out of Scotland I just want them to "really" contribute to Scottish economic growth.
Sorry - not impressed that they contribute to the Princes's Trust. How many global companies has that produced? It's a cheap deal for them..
I'd be much more impressed if they put up £5m per annum to invest in Scottish start-ups and university spin-outs but they won't. In fact a couple of years ago RBS didn't even bother to attend a conference on the subject.
Well, this could be a great deal for who ever wins, but itll also be the worst deal ever for both, whoever wins or loses.
The last few months have just shown what the world of banking has done, we are going through human history, only the lame understand what has happened, the people behind it have lost there way through thorghtfulness, no knowledge of the history before and the futures that are to come, its all been there to make profit, the banks have been feeding the frenzy, increasing the prices of the one main asset everyone needs, A HOME.
Its crazy that the true relation, inflation has almost been flat, or negative, but taxes have increased for the least well off, Energy prices have increased, and mortgage cost, and rentals have all increased, but plenty of food prices, the flat screen tv, the laptop computer etc have all fallen, there has only been one industry thats has been making hugh profits in the last 10years, and hey presto, ITS THE FINACIAL SECTOR.
Its all been running on borrowed money, But as we are seeing, as Im beliving the worst is about to come, especially after deals like barclays and RBS, has anyone of there cusatomers, or there shareholders really asked, whos money are they giving away to buy abn-amro, if I was a customer i'ld have walked, if I was a shareholder, good luck to chris, theres a big reason why those shares have fallen and guess what there still falling...
Look, just dont get me wrong, theres always been debt, but theres good debt and bad debt and most of the debt that has been swinging on rounderbouts has been huge, what I learned a number of years ago was a bank could lend so much above there assets, but that was thrown out the window, whatever happens to the people with hughe mortgages to pay off, who lose the property, or the banker who goes bust, you are about to learn the hard facts of life, you borrowed the money, so dont ask anyone else for help.
Did anyone hear of the great depression, I'm watching my back...
One underlying theme to all of this is complexity, its enough to drive you insane.
How are we able to manage such complexity?
The answer is computers, all manner of them. Every facit of our lives is now controlled in some way by an information storage system managed by a computer.
Often these poorly maintained systems act automatically and its in this context that a failure mechanism exists for our financial systems.
One good thing though, computer automation in the bourses has protected us all from panic selling allowing common sense to prevail at difficult times.
Some of these comments have some validity but permeating most of them is the same fundamental "anti-banking" sentiment that at other times manifests itself in vitriolic criticism of "obscene bank profits". Those same profits enable the banks to "extend credit to perfectly decent borrowing prospects" and it would indeed be a ghastly prospect if they couldn't do that, WHATEVER the cause. Yes, many of the current problems are self-inflicted but the same critics will be pointing the finger just as vigorously - and calling for windfall taxes - when normality (and profits)return.
I was also worried, however, as today's huge jump in share price for Barclays has shown, the markets are just volatile as they have always been, and good news pushes shares up just like bad news brings it down.
Barclays share price rose roughly 28 pence today, which if I had got off my backside and invested that £5k last night, I would have been screaming about for the nice little profit gain in my back pocket.
Maybe you should be a little more careful before jumping. Just because the US is crumbling under its incompetence, it doesn't mean the rest of the world should holster its plans for growth.
Dear Robert,
Northern Rocks share price is down to 300 pence, it started the year in January at 1210 penceso its lost more then a third, its lost 75% of its share price and the people know it, so why is it under reported.????
It would seem that thousands of savers are not inclined to listen to Brown, Darling, the Treasury or the FSA and are withdrawing their deposits with Northern Rock as fast as they can.
Why, might one ask, in the face of very strong government assurances which whilst falling short of a guarantee are tantamount to the same, are savers behaving like this?
It's not been said in the press nor have I heard it said by any Northern Rock savers interviewed in the media but the answer surely lies in the fact that the poeple no longer believe or trust our Government.
The pensions debacle under Brown is surely at the root of this mistrust. Savers in pensions were told their money was safe. It was not and many lost their entire life savings and Brown washed his hands of them. Would you want to bet against hime doing the same if Northern Rock went down?
Now, when the word of a Prime Minister might really matter and make a difference in saving a situation which could spiral out of control, it counts for nothing.
We might all pay a price soon because Brown was not prepared to do the honourable thing and look after those he mislead.
The sound of wings in the rafters might just be the chickens coming home to roost.
The statement that banks haven't taken over Northern Rock because they haven't been able to raise the cash is very strange and reveals a lack of understanding of M&A. If and when a bank takes over Northern Rock they don't have to pay up the £100+ billion upfront but will have to take it on their balance sheet which comes along with the matching assets (which are secured mortgage lendings backed by collateral). I would have thought that the ´óÏó´«Ã½ doesn't encourage panic mongering like this. This is detrimental not only to Northern Rock but to other mortgage lenders, housing market and the economy finally.
I am sorry to say this, but although I believe that people have a right to know what is happening with their bank, the reporting of Northern Rock's request for assistance from the Bank of England was not done in a way that would induce confidence. Coming from the North East and knowing that my parents have money in Northern Rock saving accounts I have taken an interest in this and I sat and watched the reports as 'Breaking News' on Thursday night. My immediate reaction was that the way it was being reported could only result in a 'run' on the bank as most people would naturally react with panic to the way this news was imparted. My opinion is that the news could have been broken in a more calm and subdued way and while I am sure this would not have prevented people wanting to withdray money, it might not have made them panic immediately and sit fretting all night wishing it were morning so they could go to their branch. To the best of my knowledge my father has no intention of withdrawing their money and does not think the bank is collapsing but the press reports have caused considerable worry and concern to my mother.
Tony Blair shortly before handing over power referred to the media as a 'feral beast' always on the look out for a headline.
I feel the coverage of the Nothern Rock debacle has been highly irresponsible and hysterical and it highlights a worrying nervous streak in the wider society. Journalists and so called pundits need to behave more responsibly and stop whipping up hysteria and playing on people's fears e.g £2bn being withdrawn in 2 days - where did the Beeb get this figure from?
No one has anything to gain by pushing the economy into a recession. Or do they?