It’s fast becoming an industry-wide phenomenon.
Subscribe to any market news-wire and wait for a statement with the following text — ‘we’re not going to launch a rights issue’... Count to twenty and if they haven’t by then launched a rights issue, you’re obviously not looking at the banking sector.
Hence, today’s official declaration by Bradford & Bingley came as no surprise to anyone. The mortgage lender confirmed rumours that it is to raise £300m in a cash call, in a 16 for 25 rights issue at 82p.
The cash raising represents a 36% discount to the ex-rights price and even more to last night’s closing price. This stands to brings Bradford & Bingley’s tier one capital ratios to a healthy 10.1%. And guess what else this means? You guessed it, like RBS and HBOS before it, the firm is going to pay its forthcoming dividend in shares.
"The improved financial strength will ensure we are even better placed to pursue our strategy of providing high quality savings and mortgage products in a competitive market," said chief exec Steve Crawshaw.
That line’s a lot more plausible than this blinder from a month ago, "Contrary to press speculation, Bradford & Bingley is not intending to issue equity capital by way of a rights issue or otherwise. Bradford & Bingley has a strong capital base, above its regulatory requirements, and as a result of the Board’s conservative approach, has funded its business activities through 2008 and into 2009."
Oh dear. Who’d be a banking stock investor? Not only do their balance sheets lie, their board of directors do too.
The spin going on in bank press-offices is incredulous but I should probably get off my high horse. There is a very good reason why banks are coy about admitting the trouble they’re in.
‘Boy plungers’ are rife in the sector and a rumour is quite enough to send share values significantly lower through the might of their leveraged short selling. And when sentiment is as weak - as it is in banking - what goes down stays down irrespective of fundamental value. This is a market driven by fear not by reasoned judgement.
Nonetheless, for the past six months (or more), commentators have inexplicably been recommending that you buy banks... Let me try and explain why, and more importantly, why this is way off base.
Value Traps Galore
Reading the papers you’d have good reason to feel a little conflicted right now. Many commentators are oddly bullish on the banks. One driver of this optimism is the dividends. Banks have always paid big yields and the falls in share price has only increased this in percentage terms. Easy money.
Except it isn’t.
For starters, even yields of 8% - 9% are not compensating the massive capital losses — Bradford & Bingley shares have fallen 44% from its peak. This isn’t ideal, but not a major issue if you don’t plan to sell the shares any time soon.
What is a problem is the trend to paying dividends in shares rather than in cash. The precedent was set by RBS, continued by HBOS and now Bradford & Bingley AND Alliance & Leicester are intending to follow their rivals’ lead and hold back the cash.
The difference between paying dividends in cash and in shares is major. Apart from the cost of transaction fees and tax, if you do cash out, you have to consider the dilutive effect of issuing new shares. For every new stock released to the market, the profit of the company is watered down a little bit more, a process which lowers stock prices.
I understand the pro-bank rhetoric — in fact, even my own value stock scoring system rates Bradford & Bingley and other bank stocks very highly. However, mechanical screening has its limits and those limits are being highlighted by this credit crunch. Don’t fall into these value traps.
Why opt for these companies above all others?
There are enough other good stocks and sectors out there. You can afford to give these ones a miss.
Could Barclays be next?
The trend would suggest that Barclays is next, not to mention the evidence. The UK’s third largest bank recently had its long-term credit rating cut to AA by ratings agency Fitch, due to "earnings and risk volatility" in its investment banking unit. They have one of the worst capital balances in the sector.
However, at the recent AGM they argued that they have no reason to launch a massive RBS style mega rights issue. Analysts are hoping for Barclays to clear things up in this week’s trading update but John Varley refuses to be drawn. "You would never take that choice off the table, because you want to have all the tools available to pursue your strategy," said the Barclays boss.
Internally, Barclays know that they must take action.
Whether that be through a rights issue or through selling stakes to sovereign wealth funds - a solution that has gained momentum since appointing a Chinese board member last month - remains to be seen. What’s certain is that there is a very simple way to escape the turmoil. Avoid banks.
We, at The Fleet Street Letter forewarned readers of the credit crunch before the carnage took hold and today we see new risks looming over a sector that has been flying high over the past two years
Theo Casey
