UK should resist temptation to dump bank stakes

April 28, 2010

— George Hay is a Reuters Breakingviews columnist. The opinions expressed are his own —

The UK’s forced investments in the banking sector are in rude health. The 41 percent holding in Lloyds Banking Group and 70 percent stake in Royal Bank of Scotland are comfortably above where the government bought the equity. But that doesn’t mean whoever wins next week’s general election should charge into a sale.

True, the government would get a fair price. RBS expects to make a 15 percent return on equity by 2013, implying it would generate earnings per share of 6.7 pence if all the government’s “B shares” are converted, according to Morgan Stanley. Such earnings would justify a current valuation of 50.3 pence once capitalised and discounted. That compares with a market price of 58 pence and the government’s purchase price of 50 pence.

Lloyds, meanwhile, has just reaffirmed that it expects a profit in 2010. Analysts anticipate earnings per share of around 9 pence by 2012, implying a current valuation of 68 pence once capitalised and discounted back — against a market price of 70 pence and the government’s entry price of 63 pence.

Selling chunks of either bank for a small profit would have superficial political attractions. But it could prove embarrassing if the new government then slapped tighter regulation on the sector. Both the opposition Liberal Democrats and Conservatives have threatened to break up the UK’s big banks, while regulatory reforms from the Basel Committee and proposed bank taxes could eat into margins. Swingeing government spending cuts could also derail the UK’s fragile economic recovery.

A slump in the shares following an opportunistic government sale would leave a bad taste in the mouth. With a total of 70 billion pounds of bank equity to offload, the government needs to think carefully about the after-market performance of any initial sale.

If the recovery gathers pace, the government could face a different accusation — selling the taxpayer short. The more bulllish analysts are saying RBS could even have 15 billion pounds of excess capital in three years.

A quick sale may still look enticing. But the United States has only just begun the process to sell its Citigroup <C.N> stake, with the $4.68 exit price almost $1.50 above its in-price. The UK should at least wait for a similar-sized buffer.

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