How will the privatisation of RBS and Lloyds affect gilt supply?
–Sam Hill is UK Fixed Income Strategist at RBC Capital Markets. The opinions expressed are his own.–
The return of RBS and Lloyds to the private sector is moving up the agenda but as the UK government prepares to set out the strategy for privatisation, the spotlight will, once again, fall on the gilt market and the public finances.
Equity injections approaching £70bn at the nadir of the financial crisis may have provided the banks with a lifeline, but the imprint on the UK’s public finances remains severe. Along with restructuring loans and compensating depositors for failures at other domestic and foreign financial institutions (e.g. Bradford and Bingley, Northern Rock, the Icelandic banks), recapitalising these banks required the government to turn to the gilt market for financing. In financial years 2008-09 and 2009-10 cash totalling £120bn was raised solely for these interventions. This was on top of the £240bn cash requirement needed to plug the rest of the budget deficit.
It was always intended that RBS and Lloyds should only have a temporary period of public ownership but the share prices have not recovered sufficiently to allow the government to fully break even on its investment. On examination though, £13.8bn of the cash raised for supporting Lloyds and RBS was recorded at the time as a permanent hit to the public finances, largely reflecting the loss on buying some shares above the prevailing market level, and should be deemed irreversible. The government therefore has the opportunity to stick to the break-even principle, by targeting privatisation proceeds sufficient to recover the portion of the intervention recorded as temporary. That amounts to £55.1bn, or a 61 pence target for Lloyds shares and 410 pence for RBS.
Even at a 2013 peak of 369 pence, it won’t yet be possible to offload RBS shares, and for taxpayers to break even. Lloyds shares, however, have already reached the 61 pence level. As such, for gilt investors in particular, talk of privatisation carries the hope that any cash raised will bring gilt issuance down from the elevated levels of recent years.
If the government recovers the full £55.1 billion from the privatisation, it would have a significant impact on the gilt supply, accounting for one-third of the entire planned gilt sales for 2013-14. However it is too simplistic to assume that the taxpayer’s full exposure to RBS and Lloyds could both be offloaded in one year and recover the full £55.1 billion.
Uncertainties abound: privatisation could occur over a multi-year period at various share prices; the businesses could be spun-off in parts and discounted share sales to the public with deferred payment are still possible. The political timetable will play its part, but economic conditions and demand for the shares will be important too.
Privatisation proceeds of £55.1bn would represent over 11% of the government’s forecast net cash requirement between now and 2017-18. This might not be a silver bullet, but, if political and economic conditions develop to permit privatisation relatively fast, this could be a dominating factor for the UK’s debt management arithmetic soon enough.