Why I Still Won’t Invest in Banks

I do not hold any bank shares at present, and have no plans to change that policy. But I thought it would be worthwhile to look at the results announced by Lloyds Banking Group (LLOY) yesterday for the third quarter. That particularly is so now that the revelations about the HBOS takeover are coming out on a daily basis.

The announced results were positive. The prospective dividend yield on Lloyds is now near 6% and the p/e is about 9, which is all that some investors look at. But I learned from my experience of investing in Lloyds and RBS before the financial crisis of 2008 to look at the balance sheet.

The latest figures for Lloyds Banking Group show total assets of £810 billion and liabilities of £761 billion, which you might consider safe. But if you look at the asset side there is £161bn in “trading and other financial assets at fair value”, i.e. presumably marked to market. They have £27bn in “derivative financial instruments”, which Warren Buffett has called “weapons of mass destruction”, and £480bn of “loans and receivable”, again probably marked to market.

Shareholders equity to support the £810bn of assets is £49bn. Which does not strike me as particularly safe bearing in mind what happened in the financial crisis. For example, that small bank HBOS, which Lloyds bailed out, eventually wrote off £29.6bn alone on their property loans after everyone suddenly realised that their lending had been injudicious and the loans were unlikely to be recovered in full.

In addition, banks can conceal their assets and liabilities as we learned at RBS and more recently in the Lloyds case. Indeed tens of billions of loans from Lloyds and others to HBOS were concealed and hidden from shareholders in the prospectus with apparently the consent of the FSA.

So I follow the mantra of Terry Smith of Fundsmith who said in 2013: “We do not own any banks stocks and will never do so” having learned from my own experience that it is a very risky, and cyclical sector. I am not convinced that improved regulation, and better capital ratios have made them “investable” when one can invest in other companies with far fewer risks.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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ADVFN Results and More on Lloyds

ADVFN Plc (AFN) published their results for the year to June yesterday. I have a very small holding in the company (acquired for reasons I won’t go into). ADVFN are information providers on the stock market, primarily to private investors. Many people monitor their bulletin boards although like many such boards frequented by private investors, they are somewhat of a curate’s egg so far as serious or sophisticated investors are concerned.

But they certainly have a large following – they say they have 4 million registered users. Does this enormously large mailing list ensure they have a profitable business? In reality no.

Indeed last year they barely managed to break even (£47k operating profit) on £8.2 million of turnover. That is however a massive improvement on the previous year when they lost £650k on similar revenues.

At least they showed postive cash flow but the net assets of the company are £1.7 million so they have a long way to go before they show a decent return on the capital employed. Current liabilities also exceed current assets. At least they have changed their strategy so as to stop further investing with a focus on “profits rather than growth”.

Regretably this kind of business model just shows that private investors are reluctant to pay money for good information provision. Folks can sign up a lot of “free subscribers”, which is no doubt ADVFN’s customer base, by spending money on marketing but monetising those eyeballs is another matter altogether. Relying on advertising to do so is also getting more difficult as Google and social media platforms are tending to dominate that market.

The other moral of this story is that one needs to be wary of investing in companies with unproven business models. It’s easy to spin a good story about the enormous demand for a given service, but the real proof of the pudding is when the model generates profits (and cash as well of course). Companies like Uber and Deliveroo appear to be chasing the same mirage. Lots of people like the services and are willing to pay their low prices, but whether they can compete profitably is another matter.

Lloyds TSB/HBOS case. My previous blog post was on the topic of the current legal case being heard in the High Court. One of the witnesses called in the case is Hector Sants, former head of the Financial Services Authority (FSA) at the time of the takeover of HBOS by Lloyds. His evidence is to be heard in secret, for reasons unknown. Indeed, even the fact that this was to be so, was kept secret until challenged by media organisations.

Why is this relevant? Because it was suggested at the time that without the takeover of HBOS, Lloyds would not have had to raise extra capital (and it was that which diluted shareholders interests). But the FSA told them they would still have to raise more capital even if they did not proceed with the takeover. Some shareholders allege that this was a forceful encouragement by the Government to go ahead, regardless of the interests of their shareholders. Perhaps that might have been in the public interest, as was similarly argued on the re-capitalisation of the Royal Bank of Scotland (RBS) and other banks, which was effectively a partial nationalisation. But many shareholders are more concerned with their own immediate interests rather than the public interest although it could possibly be argued that ensuring no melt-down of the UK financial sector took place was also in their interests. So Mr Sants evidence might be very revealing about the motives and actions of the Government, but the public may not learn much about it, even at this late date.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Lloyds Litigation, Collective Redress, and CLIG AGM

I went to the High Court in London this morning to hear the grilling of witnesses in the case brought by shareholders over the acquisition of HBOS by Lloyds. But I was disappointed to find when I got there that the first session was to be held in private – presumably the judge wants to discuss some legal issues with counsel for both sides. So I went to the AGM of City of London Investment Group (CLIG) instead where I hold shares.

The aforementioned legal case will be running for some weeks yet to hear various witnesses – it’s being held in Court 15 at the Rolls building in Fetter Lane if anyone cares to drop in. I shall try to visit another day when I am in London.

This was the first opportunity I had to attend the Lloyds hearing but the national media have reported the opening submissions by the respective QCs. To remind you this is a case where disgruntled former Lloyds TSB shareholders are suing the former directors (Sir Victor Blank, Eric Daniels, Truett Tate, et al), and Lloyds Banking Group as a company, over the takeover of HBOS in 2008. This resulted, directly or indirectly, in a massive share price decline and the cessation of dividends. The commercial loan book of HBOS turned out to be very poor quality, and Lloyds had to take on more capital to meet its capital ratio requirements.

What’s the legal basis of the claim? Simply that the prospectus issued to Lloyds TSB shareholders at the time was defective. Among other things that it failed to disclose the true position of HBOS and the fact that the company had received emergency funding in the form of secret loans from the Bank of England, the US Federal Reserve and Lloyds. A prospectus needs to be honest, not misleading and not omit significant information. The litigant’s QC, Richard Hill, said that “shareholders were indeed mugged”. He also argued that Lloyds was under pressure from the Government to conclude the deal, otherwise HBOS would have had to be nationalised because it was on the verge of collapse, when the directors of Lloyds loyalties should have been to their shareholders.

The defendents QC argued the claims have no merit because it was in the best interest of shareholders. In addition, that they would have voted for it regardless if they had been aware of the aforementioned loans. Bearing in mind that a lot of institutional investors held both Lloyds and HBOS, you can understand that point perhaps. The usual defence of the directors having taken expert advice on the matter from a host of advisors has been invoked, but how they can overcome the defective prospectus argument remains to be seen.

Now one topical item of news today is the disclosure that the EU is looking at establishing a pan-European framework for collective redress. See this press release from shareholder representative organisation Better Finance for more details: http://betterfinance.eu/fileadmin/user_upload/documents/Press_Releases/en/Financial_services_users/PR_-_COLLECTIVE_REDRESS_-_231017.pdf

There are many difficulties in the way of shareholders pursuing litigation or enforcement action over investment abuses. One just has to look at the HBOS/Lloyds case and the Royal Bank of Scotland (RBS) cases to see how difficult and expensive they are. The RBS case, which was a similar claim over the prospectus issued in 2008, has recently been settled. But only a minority of shareholders affected are likely to get compensation, and it will only be a small proportion of their losses. Legal and other costs will consume a large proportion. One only has to look at the time these cases have taken to get into, or near, a Court (nine years) that tells you there is something seriously defective in the process. Many of the claimants are likely to have died in the meantime as the shares of these banks were typically purchased by pensioners for retirement income.

The problem is the UK has no direct equivalent of a US “class action”, or the arrangements for collective cases as operates in Holland. There are “Group Litigation Orders” in the UK, but these are not directly equivalent and the Lloyds and RBS cases have relied on a representative group of litigants. Many other European countries have similar problems. So this initiative looks potentially useful, although if Brexit proceeds, the UK might miss out on participating in this concept, albeit that it might be many years before it progresses into reality because changing legal systems in a country can be complex and is often resisted by vested interests. Simplifying legal processes is not always in the interests of lawyers for example.

The complexity and length of the legal processes, and the difficulty in raising funds to finance such cases, as evidenced by the Lloyds and RBS cases, surely demonstrates that reform is necessary. But it will be interesting to see the outcome of the Lloyds case.

Just brief coverage of the CLIG AGM follows. There were about half a dozen shareholders present, but the company was also holding a seminar for investors (current and potential) in the afternoon so I presume most people would have gone to that instead.

CLIG is an investment company that specialises in holding closed end investment companies (e.g. investment trusts), with a large exposure to the far-east. The CEO is long standing director Barry Oliff who is finally planning to retire in a couple of years time, so one question raised was about succession planning – it is in motion apparently. As one shareholder intimated, it will be important to maintain the culture that Barry Oliff has established where there is great openness about the performance of the company (comprehensive disclosure of the business model and the likely outcome of profit trends). Barry even tells shareholders at what price he will be selling some of his large shareholding and when.

This company regularly gets substantial votes against its Remuneration Report, and it was no different this year. Two million proxy votes against, no doubt by institutions prompted by proxy advistors because they have a bonus scheme which does not follow the normal rules. It is more group performance related, than individual person related. They choose to be “different”. Barry explained that he thought individual targets provided the wrong incentives and that group bonuses encourage staff and customer retention. Another director said it was more like a traditional “partnership”.

Anyway the shareholders are probably happy because the share price has increased over the last year and the dividend (already high) has been increased for the first time in five years.

As I intimated in another recent blog post, it is always useful to attend AGMs, and this one was no different. According to a report in the FT, a number of US companies are moving to “virtual” AGMs, but are getting some objections from shareholders. Surely the best solution is to combine the physical meeting with an on-line equivalent so you get the best of both worlds. A virtual on-line meeting can be usefui for those shareholders who have difficulty in attending in person, but certainly actually meeting the directors is more useful in many ways.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit, and the Finances of the Young

The national media continue to try to turn news into controversy. Their words are often incendiary and designed to provoke debate and therefore attention – as a means no doubt of promoting their publications. So their headlines become “verbal click-bait”.

As most people now read news on the internet, the publishers could be considered as acting as “trolls”. Here is the definition in Wikipedia of an internet troll: “In Internet slang, a troll is a person who sows discord on the Internet by starting quarrels or upsetting people, by posting inflammatory, extraneous, or off-topic messages in an online community with the intent of provoking readers into an emotional response or of otherwise disrupting normal, on-topic discussion…….”

Written words are not the only example. Laura Kuenssberg of the BBC has adopted a similar verbal approach in her reporting. It’s not just Labour party members who should be complaining about her hysterical style.

There were a couple of news items this week that caught my attention in this area. There were several comments on the report issued by the FCA on family finances. The report indicated that half of UK adults were “financially vulnerable” and that those in their 20s and 30s were reliant on borrowing (personal loans and credit card debt). It reported that one fifth of 25-34 year olds have no savings at all with many struggling to pay bills. But this was interpreted by some of the media as the new “generational divide”.

But was it not always so? I certainly don’t recall having much in the way of savings at the age of 30 and lived from month to month, sometimes using credit card debt. In other words, I doubt that the situation has been changing over time; although the elderly have become better off lately due to rising state pensions I am not convinced the young have been getting poorer. But the media like to put a “spin” on any news item to grab attention.

As the report shows, the elderly do have more savings as one might expect but they are not evenly distributed. One amusing statement in the report is “A high proportion of retirees do not know how much savings they have”.

It’s a report well worth reading although rather long at almost 200 pages. Here is one useful titbit of information from it: “Around one in five (22%) 45‑54 year olds hold a stocks and shares ISA and the same proportion hold shares or equities directly”. It would have been good to obtain more detail information on that but it just shows there are a lot of shareholders out there.

Another example of media hysteria is the reporting on the Brexit negotiations. Will it be a hard or soft Brexit? Will the bill be £20 billion or £100 billion? Are Tories threatening to quit if there is any compromise, or revolt against the rule of Theresa May? Will Jeremy Corbyn scupper the whole affair by underming the Bill going through Parliament to support it? Who really knows, but it all makes for good headlines.

The Financial Times has become one of the leaders in scare mongering over Brexit with regular articles of a polemic nature by Martin Wolf and Simon Kuper on the topic. The latest example was by Martin Wolf in yesterdays FT. Now I have never thought much of Mr Wolf’s opinions on financial matters since he supported the nationalisation of Northern Rock, but his latest article (headlined “Zombie ideas about Brexit that refuse to die”) is pure hysteria. I don’t mind the occasional editorial opinion piece on Brexit, or some reporting on the potential technical difficulties if not slanted, but this piece was just propoganda in essence. It pointed out all the difficulties associated with a “hard” Brexit where no trade deal is agreed beforehand, but that is well known and most folks do not think that is likely. It certainly did not give a balanced view of the arguments for or against Brexit and what our negotiating stance should be. In reality there is likely to be a compromise of some kind – that is what politics usually ends up being about – compromise after compromise. Indeed it is one of the frustratations of anyone in the political world that achieving revolutions, rather than compromise, is not just difficult but exceedingly time consuming.

It is certainly regrettable that the Financial Times, since its takeover by Nikkei in 2015 has become much more politicised, and there is less factual reporting and more opinion. Perhaps it is just pandering to the views of most of its readers (the London-centric financial players and international businessmen) but if they expect to influence politicians or the wider community they will be disappointed.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Interesting AGMs, or not – Rosslyn and Dunelm

This morning I attended the AGM of Rosslyn Data Technologies (RDT) for the first time. I picked up some shares in a deeply discounted placing that qualified for EIS relief a few months back. One has limited time to research a company on offer when a placing comes up. It looked sound enough at the time although the historic financials did not impress. Prospects looked better after an acquisition although this company has been around a long time without becoming a shooting star. Bearing in mind the software sector it operates in – a somewhat niche area – I doubt it will show rapid growth either although the analyst forecasts I looked at before the meeting (from a single broker I gather) suggests a substantial rise in revenue and breakeven in the current financial year – partly from the merger no doubt.

Incidentally in case anyone from HMRC is reading this bearing in mind the current review of VCT/EIS tax reliefs, I would just like to say that I would certainly not have invested in the placing without the attraction of EIS tax relief. I considered the valuation at the placing price only “fair” and with the risks apparent, it would not have been attractive without the tax relief.

But at AGMs of small companies like this one, it is possible to learn a great deal. I will just mention a few things – there may be a more extensive report on ShareSoc’s web site later.

The Chairman was absent in the USA (not usually a good sign), so another of the directors, Barney Quinn chaired the meeting, and well. He read out a prepared statement (not issued in an RNS oddly), saying there had been good progress and they had been focussed on integration of the businesses since the start of the year. He mentioned the securing of a major partnership with D&B (see Annual Report).

I queried the very high debtors (accounts receiveable) which were about 6 months of revenue. Apparently this is due to work in progress on projects being recognised as revenue but not yet billed to clients (which tends to be on completion). To my mind, it’s still excessive though.

It seems to be taking some time to develop the market for the products/services and it seems their broker is currently reconsidering their forecasts and I suspect the existing ones are optimistic from what was said in the meeting – but we may soon see no doubt.

Anyway I learned quite a bit about the business and the management seemed to be competent on a brief acquaintence but a couple of long-standing shareholders turned up late for the meeting and said some negative things about the progress and valuation of the business. The company could really do with some more media coverage if they were to attract more investors and another shareholder suggested ways they could do so.

So it’s always good to attend AGMs, but one I will not be going to is that of Dunelm. This year it is Stoke at 9.30 am on the 21st November. Last year it was at a similar inconvenient and early time in Leicestershire.

A couple of year’s ago I attended their AGM in London (again at an early time), and complained about the remuneration arrangements. Have the more recent AGMs been deliberately arranged to avoid private shareholders like me from attending? I would not be surprised if that was the case. So I have voted against the Chairman, against the Remuneration resolutions, and against other directors also for that reason. It really is not acceptable for the directors of companies to pick inconvenient dates, times or locations for General Meetings.

I don’t object to going to Stoke but I do object to having to get up at 5 o’clock in the morning to be sure of getting there on time. But if anyone lives closer, and would like a proxy appointment from me to attend the AGM, let me know.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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On-Line Estate Agents & Crowdfunding

I was watching the BBC television news last night when a story appeared on the wonders of a 19 year old who was already alleged to be worth £10 million after developing an on-line estate agency called Doorsteps. Yes it was great free publicity for the company.

Bearing in mind the continuing debate among investors about listed company Purplebricks (PURP) I thought it was worth a quick look. Purplebricks has a stock market valuation of £950 million despite rising losses. Will the business model work, particularly in the USA where it needs to be successful to justify the valuation? Nobody knows.

Some commentators have suggested that there are few barriers to entry into the on-line estate agency business (i.e. anyone can get into it as evidenced by the fact someone still at school did so).

A traditional estate agent will charge several thousand pounds to sell an average house (but you only pay if they do so). Purplebricks charges £1200 in the London area, and £850 elsewhere. But Doorsteps charges only £99!

Doorsteps raised £390,000 from investors via crowdfunding platform Crowdcube at a pre-money valuation of £12 million from over 490 investors. But if you look at who owns Doorsteps it is a company called Upside Capital Ltd that was only incorporated at the end of December 2016. Not exactly a long track record then is it.

Will Purplebricks put traditional estate agents out of business, or will Doorsteps put Purplebricks out of business? I suspect the answer to those questions will be a complex one but I’ll have a stab at it.

Firstly can Doorsteps conquer the market while still charging so little? Bearing in mind that they will have high marketing expenditure, still need to employ local “agents”, and pay management, admin and IT overheads, I rather doubt it. With few barriers to entry, there will no doubt be other entrants offering to do it for £95 rather than £99. Result, lots of companies with little business individually and all losing money. Who might win out on that race to the bottom is anyone’s guess. For investors it looks like an area where you are likely to lose money irrespective of which horse you back.

This myriad of low-priced entrants might also damage Purplebricks business model, who in addition already have other competitors such as Yopa, Tepilo, Housesimple and Emoov operating at different price points. It’s beginning to look like a market which has grabbed the public’s, and investors, imagination and which will soak up enormous amounts of capital as the companies all try to out-spend each other to grab market share.

One interesting aspect is the ease with which Doorsteps managed to raise money on Crowdcube. Crowdcube have over 400,000 registered users and the few hundred who invested in Doorsteps probably put in a few hundred pounds each. In effect they were punting on an investment in a private company (and hence with limited investor protections), on a company with no track record, and with an inherently risky business plan.

I fear that the crowdfunding approach to raising capital from investors as evidenced in this example will lead to a lot of disappointed investors in due course.

But having said all of the above, it is very clear that the estate agency market is changing rapidly. Some people won’t wish to pay upfront to sell a property, but others may be happy to take the chance of “no-sale”. Paying £1200 on the chance that a sale will be made and quickly may be attractive to some house sellers, particularly when their past experience of traditional agents may not be great (estate agents have a reputation for sharp practice over many years). So if Purplebricks can establish a good reputation (which has yet to be proven), and spend enough to grab a decent share of the market, they may establish a sound business, but how profitable it will be is anyone’s guess. In addition, traditional agents will react to do more on-line offers at lower cost as some are already doing. One can see that this market will become a price battleground as there seems to be little differentiation between the differing on-line competitors. That’s a recipe for low returns on capital and poor returns to shareholders in the long-term.

When the product being offered is the same, service and reputation will be a key differentiator I suggest in this market. Competing on price alone looks like a dubious business strategy however.

Note: I have held Purplebricks in the past but do not do so presently because the more a company is debated on bulletin boards and by share tipsters the less attractive an investment it tends to become. It just leads to irrational speculation, both up and down.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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HBOS and Lloyds Legal Case

This week sees the start of the legal case in the High Court by investors in the Lloyds TSB over the acquisition of HBOS – opening submissions are on Wednesday and it’s scheduled to run through to March next year. Anyone can attend these hearings of course but I think it will take a very patient person to sit through all of it. I have submitted written evidence on behalf of the litigants (represented by Harcus Sinclair) but it seems I am unlikely to be called for cross-examination by the defence which is somewhat disappointing.

I cannot comment further for that reason, but the claim is in essence based on the allegation that relevant information was not disclosed in the prospectus that was issued at the time in 2008 when investors in Lloyds TSB approved the deal. Lloyds reject that the claim has a sound basis, but the cross examination of former directors Sir Victor Blank, Eric Daniels and Truett Tate should provide some excitement and will no doubt be assiduously reported upon by the press. The directors who signed off the prospectus are of course defendents in the litigation as well as the company.

This is a similar case to that of the Royal Bank of Scotland (RBS) litigation which was recently settled before it got into court, which is the way these matters often end up. Sky News has reported that Harcus Sinclair have offered to settle the case but that has been rejected by Lloyds. As in the RBS case, legal costs on both sides will no doubt be enormous.

Lloyds Banking Group are also involved in claims over the activities of management in HBOS (particularly in the Reading branch) which has resulted in the conviction of several people for fraud. The FT Magazine ran a very good, and lengthy, article on this subject in their October 7th edition. In summary this was where people exploited the fact that businesses in financial difficulty, who were dependent on loans from the bank, via consultancy fees and other strategies extracted large sums of money or gained control of businesses from the original owners. Large numbers of business owners lost their companies and in some cases were forced into poverty as result. This disgraceful episode was very similar to the activities of the Global Restructuring Group at RBS which I covered in a previous article, but will not be raised in the current legal proceedings. Lloyds are compensating the people affected, at least to some extent.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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