The current economic malaise has been felt by pretty much everyone but one group who has been hit harder than most is shareholders. Most shareholders have seen a large decline in the paper value of their shares, whether their share exposure is through individual companies or tracker funds. Shareholders have also seen dividends cut or stopped, creating the double whammy of a capital value reduction and a decline in income. Even allowing for the fact that all shareholders have been affected by the recession, there is one group of shareholders that have been particularly affected and that is people who own bank shares.
Having worked for a bank for many years, I fall into the category of people who have discovered just how badly a major recession can affect the profitability and market confidence of seemingly very profitable and safe banks. If we wound the clock back to the beginning of 2007, very few people would have predicted that major banks, on both sides of the Atlantic, would have gone bust or have faced the embarrassment of having to go cap in hand to shareholders to raise extra capital through Rights Issues. That is exactly what has happened, in some cases, and it hasn’t stopped there. With countless billions written off the balance sheet, due to toxic debt, even the injection of Rights Issue capital hasn’t been enough in some cases. This has left governments in an extremely awkward position. Do they let major banking institutions go to the wall or do they step in and prop up the banks, at considerable cost to the taxpayer? In most cases, so far, they have decided to bite the bullet (and the political brickbats) and have stepped in to part-nationalise the high street banks.
A couple of examples, in the UK, have been Lloyds Banking Group and Royal Bank of Scotland. Lloyds TSB were asked to step in to rescue another stricken Scottish bank, HBOS, but have subsequently floundered with their capital ratios worrying low. As a result, the government now owns part of Lloyds TSB. Additionally, they’ve had to take a 70%+ stake in another historic bank, Royal Bank of Scotland.
The biggest fear for shareholders of these institutions is that it could end up in a full nationalization. In that case, the banks would cease to trade on the stockmarket. They would be wholly owned by the government and shareholders would find that their shares would be worthless. Of course, this is the last thing that the government wants to happen as it would be extremely unpopular. So far, the government has been at pains to stress that they don’t expect full nationalization to occur and they are working with the banks to get through this difficult time.
However, even part nationalization is bad news for shareholders. When the government takes a stake in a company, it means that more shares have to be issued and this dilutes the shareholding of all existing shareholders. If we take a simple example, let’s assume that there were only 100 shares in existence and you owned 10 of them. You would have a tenth ownership of the company. However, if 100 new shares are created to give the government 50% ownership, then you now have 10 out of 200 shares. Instead of owning a tenth of the company, you now just own a twentieth. This extra issuance of shares tends to have the effect of reducing the share price and also means that, if the company can afford to pay out a dividend, it will have to share the dividend out between more shareholders.
In reality, there is little chance of any dividend payments until such time as the banks can buy out the government’s share and this will require a return to profitable trading and is likely to take several years. That assumes, as well, that the trading conditions become more favourable and that we don’t have any further severe downturns.
Many shareholders of banks have seen the value of their shares drop substantially and the withdrawal of dividend payments. It will be a long haul before we see our shares yielding the kind of returns that we became used to during the good years. However, on a positive note, in the same way as banks and retailers are often the first to suffer during a recession, they are also often amongst the first to recover when the green shoots of recovery appear. Let’s hope that doesn’t take too long to come to fruition.