Royal Bank of Scotland on BBC2

Some readers may have watched the BBC2 programme on Tuesday about the collapse of the Royal Bank of Scotland (RBS). It showed the hubris of Fred Goodwin – suites at the Ritz, private jets and a new headquarters opened by the Queen in which he had an enormous office. But when I posted a brief comment on the Stockopedia blog to the effect that the bail out had political overtones, it got some criticism. Indeed to my mind the programme seemed to suggest that Alistair Darling and Mervyn King were heroes who rescued the bank, and the country, from financial disaster and there was no contrary opinion on the merits of what they did.

So here’s some more explanation of the problems of RBS and how they should have been tackled.

RBS certainly was acting aggressively before the crash in 2008. It had one of the lowest capital asset ratios of any bank and then proceeded to acquire ABN-AMRO after competing with Barclays in a bidding war. RBS seemed to expect the profits from ABN-AMRO to improve its cash flow. Although it’s not easy to see the cash flows in banks, they can run out of cash particularly when loans they have borrowed become due for repayment.

One needs to understand that all banks operate on a knife edge – they have massive liabilities backed by massive assets, with only a thin slice of shareholders equity in the middle. So you will find in the December 2008 balance sheet of RBS that it had assets of £2,401,652 million, liabilities of £2,321,154 million and shareholders’ equity of only £80,498 million.

When the financial crisis arose as a result of the realisation that the US sub-prime mortgage market was heading for a fall, liquidity in the bank loan market disappeared. That is what caused the crash at Northern Rock – see: https://roliscon.blog/2017/09/02/northern-rock-10-years-after-collapse/ for past comments on that. Northern Rock was not balance sheet insolvent which would have triggered administration, it was cash flow insolvent. It just ran out of cash because folks were withdrawing cash from the bank and it could not refinance the short-term loans it had taken out in the money markets. Similar problems caused the collapse of Lehman Bros and Bradford & Bingley and the former had world-wide repercussions. The whole world was suffering a banking liquidity crisis.

There were of course subsequent steps taken to tighten up on the bank asset ratios which meant they had to raise more capital. That put many banks into an even more difficult situation. There also was a growing realisation that many banks had assets on their balance sheet that were questionable in value, i.e. debts might not be repaid but they had not been written down because of defective accounting standards (see more in today’s FT on that subject).

In addition the UK Government made the mistake of nationalising Northern Rock and Bradford & Bingley which told any international investor of equity, or even debt, into UK banks that they had no real security. The Government could prejudice their investment using the new legislation that was introduced, at the drop of a hat.

As the BBC programme described, there came a day when RBS had to tell the Governor of the Bank of England that they would run out of cash in a few hours. The collapse of RBS would certainly have undermined the whole UK banking system with other banks also crashing as they had outstanding loans to RBS. The Government’s answer was to launch a massive “recapitalisation” of RBS and other banks via forcing then to sell equity stakes in return for cash. They were given no option but to accept overnight. This effectively meant a nationalisation of RBS because they acquired control of it, along with major stakes in other banks.

Was there a different way they could have taken? Banks frequently run out of cash because of the narrow equity they hold. They can go for years without a hiccup, paying out good returns to shareholders in the meantime, until minor events disrupt this idyll. But the Bank of England can always provide loans to relieve the cash flow pressure if nobody else will. The Bank can of course effectively print money if necessary to do that. RBS did of course undertake a massive rights issue (the largest ever) to strengthen its balance sheet but that was not sufficient. Could they have got by with funding from the Bank of England when the crunch came? I suggest they might. I suggest the prime reason for the approach that was taken was the desire of the Labour Government (headed by Gordon Brown and Alistair Darling) to take control of the banking sector.

In reality other countries tackled their similar problems in different ways. But the UK was the most severely hit by the financial crisis. It was of course not just RBS that had exposure to US sub-prime mortgages. Other major world banks had similar difficulties. But the approach taken in the UK destroyed confidence in the UK financial sector in very short order.

That does not of course make any excuse for the mismanagement of RBS by Fred Goodwin and the general incompetence of the board of RBS in the critical period. But it is all too easy to lay the blame for the UK banking crisis on one individual – it’s called “personification”. But there were no heroes either.

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

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Tesla, Unilever, EasyJet IT Write-Offs and Cash Holdings

The big news today is that the US Securities and Exchange Commission (SEC) have charged Tesla CEO Elon Musk with securities fraud. This charge relates to his comments on Twitter that he would likely be taking Tesla private. To quote from the SEC complaint: “Musk’s statements, disseminated via Twitter, falsely indicated that, should he so choose, it was virtually certain that he could take Tesla private at a purchase price that reflected a substantial premium over Tesla stock’s then current share price, that funding for this multi-billion dollar transaction had been secured, and that the only contingency was a shareholder vote. In truth and in fact, Musk had not even discussed, much less confirmed, key deal terms, including price, with any potential funding source”. Mr Musk vigorously rejected the charges, as did the company.

The full SEC complaint is here: https://www.sec.gov/litigation/complaints/2018/comp-pr2018-219.pdf

Comment: it is of course the oldest trick in the book if you are unhappy with the share price of your company to announce a potential bid from yourself or a third party. Making such an announcement via Twitter, if that was the motivation which has yet to be proven, would certainly be something new though. Making any announcements via Twitter is exceedingly risky and Tesla’s advisors must be tearing their hair out over this sequence of events. Who else if anyone reviewed the tweets before they were sent? Probably nobody I suspect. And anyone who uses Twitter will know it’s very easy to let typos, grammar errors and Spoonerisms creep in. Such important announcements should only be issued by the proper regulatory news channels. Elon Musk should have known better.

But if Elon Musk was forced to step down from Tesla, which might be the outcome, would it matter? I suspect not. The merit of Tesla as a company is in the technology in the cars which is still ahead of most potential electric car competitors. I have driven a Tesla Model S and it is a very good car indeed. But unfortunately my wife thinks I don’t need to buy expensive, flash cars to impress people any more so I’ll have to wait for the cheaper Model 3 to become available in the UK.

Unilever and Shareholder Voting

Unilever is planning to consolidate the two arms of the business in Holland, and drop the dual listing. UK shareholders would end up holding shares listed only in Holland, and as a result the dividends would be subject to Dutch withholding tax which is currently at the rate of 15%. Such taxes always cause problems although sometimes they can be refunded by submitting claims to do so. There is also the possibility that the withholding tax will be dropped. Another difficulty is that as Unilever is in the FTSE100, any funds running a FTSE-100 tracker would have to sell the shares. The Investors Chronicle ran a longish article on this subject and suggested it was a “no-brainer” for UK shareholders to vote against it.

But it seems that might be easier said than done. According to a report on Citywire, any shareholders in nominee accounts (i.e. in ISAs, SIPPs or other broker accounts – which means most UK shareholders now) will have to “rematerialize” their shares if they want to vote them, i.e. convert them to a paper share certificate. The company is not accepting votes submitted by nominee operators. Dematerialising shares is typically a costly and time-consuming process and is actually impossible to do if the shares are in an ISA or SIPP which have to be held in nominee form. This is truly outrageous news and any shareholders holding Unilever shares who wishes to oppose the move by the company should complain to the FCA, your Member of Parliament, the Company Chairman Marijn Dekkers, and anyone else you can think of.

[Postscript: the issue here seems to be the votes for the Court Hearing where the number of individual voters is taken into account. But for the shares held by a nominee operator, which may represent many thousands of underlying beneficial owners, only one vote would be counted even if it was submitted as there is only one holding on the register. ]

It has been reported that a number of institutions might oppose the unification of the company but it would certainly help to get retail shareholders voting.

Incidentally I attended a meeting today with Link Asset Services (one of the largest registrars) where the problem of retail shareholders not voting was discussed. I’ll write a separate blog post on that later.

EasyJet

If you recall, I mentioned previously the large expenditure on a “big-bang” IT project at Abcam which is clearly over-budget and over-time. That might have contributed to the 35% share price drop immediately after their recent preliminary results announcement. Now EasyJet have made a similar announcement today in their trading update. To quote: “…easyJet has now made the decision to change its approach to technology development through better utilisation and development of existing systems on a modular basis, rather than working towards a full replacement of our core commercial platform.  As a result of this change in approach, we are recognising a non-headline charge of around £65 million relating to IT investments and associated commitments we will no longer require. EasyJet will continue to invest in its digital and eCommerce layers that will enable it to continue to offer a leading innovative, revenue enhancing and customer friendly platform.”

That £65 million is no small sum and just shows you how IT is so critical to how businesses are managed in the modern world. Similar problems arose at TSB where they attempted to replace their old Lloyds systems with completely new software which was allegedly not adequately tested. But any IT professional will tell you that you cannot test and anticipate all the problems in a diverse customer environment ahead of going live with new technology. The NHS was another prime example of a “big-bang” approach to IT system development that ended up costing the Government, and us as taxpayers, at least £10 billion (that’s not a typo – it was ten billion and more). Evolution rather than revolution is the way to develop IT systems as EasyJet and Abcam seem to be learning, the hard way.

Cash Holdings

I suggested in a previous blog post that a newly available easy-access deposit account might be a suitable place to move cash from your stockbroking account to get a decent rate of interest rather than none. The problem of course is that most retail investors have most of their money in ISAs and SIPPs and taking cash out is problematic.

For ISAs, you may not realise that you can actually take cash out of a “flexible” ISA (which most ISAs are such as Stock & Share ISAs or Cash ISAs) and put it back in later. This was a recent change to the ISA regulations. However you can only do that within the same tax year without affecting your ISA allowance.

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

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Time to Consider your Cash Holdings?

It was obvious from a recent FCA review of “platforms” (i.e. stockbrokers), that many retail investors held large amounts of cash in their portfolios. When folks are feeling the stock market has had a rather long bull run, perhaps they feel it is wise to keep a high level of cash. Or perhaps it’s because they simply can’t be bothered to move it when their high-street bank is offering such trivial rates as 0.2% per annum on deposit accounts. Needless to point out perhaps that unlike in the good old days, most stockbrokers do not pay interest on cash holdings.

But interest rates are rising and new entrants to the savings market are starting to pay decent rates – still not as good as inflation but a lot better than zero. For example, Goldman Sachs have just launched an account named Marcus (after one of their founders). It will be paying 1.5% AER although that includes a bonus rate of 0.15% for the first year only. That probably makes it the top paying “easy access” savings account at present.

It’s an on-line only account and you can only put in up to £250,000. Otherwise it looks to be fairly straightforward apart from the usual complexities of opening a bank account and proving who you, that you are not money-laundering or a suspicious person.

This is definitely a useful initiative and if they get enough customers it might prod the high street banks and stockbrokers to think again.

See https://www.marcus.co.uk/uk/en for more information.

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

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Pay-outs from Labour’s Dividend Plans

I said in my last blog post that the Labour Party’s plans to take 10% of a company’s shares and pay the dividends into an employee trust did not make much sense. I have actually worked out what the implications of such a scheme would be on a few large UK public companies. These are the figures (after 10 years and assuming 10% of the total dividend is therefore paid to employees):

  • BP pays £6.15bn in dividends and has 74,000 employees: £8,310 per employee.
  • Shell pays $10.87bn in dividends and has 92,000 employees: £9,846 per employee.
  • M&S pays £304m in dividends and has 84,000 employees: £360 per employee.
  • Tesco pays £82m in dividends and has 448,000 employees: £18 per employee.

The latter two do of course have many part-time employees. How they might be treated is unknown so I have assumed they get an equal share. Tesco has also been paying a low dividend of late because of past financial difficulties but even if it returned to previous levels, the pay-out to each employee would be low – hardly sufficient to motivate them.

In the case of the oil companies where they have relatively few employees in a capital- intensive business, the pay-out would exceed the £500 cap in year one, so it would be mainly the Government that benefited.

This seems a perverse result to say the least. Are M&S and Tesco employees so much less worthy than BP and Shell employees? Whether an employee got any worthwhile share of the dividends would much depend on the kind of company they worked for.

Another odd result is that the Government would collect a lot more in tax (the amount above the £500 cap) from capital intensive companies than from those with lots of employees.

The more one looks at this, the more perverse this scheme turns out to be.

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

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The Impact on Investors of the Labour Party’s Plans

I commented briefly yesterday on the plans by John McDonnell of the Labour Party to give employees shares and possible future nationalisations – see: https://roliscon.blog/2018/09/24/labours-plans-for-confiscation-of-shares-and-rail-system-renationalisation/

More information is now available on the share scheme and the more one studies it the more one realises that whoever devised it does not understand much about business and the stock market. In other words they were typical politicians with no experience of the real world I would guess.

The scheme would apparently operate by companies with more than 250 employees being forced to hand over 10% of the shares in a company to an employee trust fund. That would be over a period of time – possibly ten years – and presumably that would be by the issuance of new shares rather than confiscating existing shares, but it still means 10% dilution for investors.

Shareholders normally get a vote on the issuance of new shares but presumably that could be legally subverted. Otherwise the scheme would cover about 11 million employees. However, foreign owned companies would not be covered so that excludes perhaps a third of the employees (the Labour Party apparently admits they would not be and it is difficult to see how legally any such law could be enforced on them).

One simple way for companies to avoid the scheme would be to move their country of registration elsewhere – no need to change where their shares are listed, just move domicile. We could see a host of companies re-registering in such places as Panama! An unintended consequence that I am sure the Labour Party would not like.

The shares accumulated in the trust fund would pay dividends to the individual shareholders out of the dividends paid to the fund by the company. But there would be a cap of £500 per employee. Any amount payable above that cap would revert to the Government. It is estimated this might generate £2 billion a year to the Government after 5 years – another large tax hike in addition to proposed increases in Corporation Tax the Shadow Chancellor is promising.

Employees could not buy or sell the shares held on their behalf, so presumably could not take them away when they leave or retire. So in practice those companies with high staff turnover would see the dividends accumulating for the benefit of the Government, particularly if the £500 cap remain fixed, i.e. unindexed.

But the company could avoid paying out this windfall to the Government simply by not paying dividends. Many companies don’t pay dividends anyway. Alternatively they could pay a dividend in shares (a “scrip” dividend), or offer to buy back shares occasionally via a tender offer or market share buy-backs– these would not be dividends and hence would be excluded.

Another problem with the scheme is that companies who had a few less than 250 employees could decide not to expand and hence become subject to this scheme, i.e. this would discourage companies from growing which is not what the Government wants. Alternatively they could create new separate companies owned by the same shareholders to expand their business and avoid it that way.

Apart from the 10% dilution that will hit not just direct investors but those investing via pension schemes, you can see that this scheme is not just daft because of its unintended consequences and likely avoidance, it’s an insidious way to raise taxes on companies and investors very substantially.

The only good aspect of the scheme is that it would help to give employees a stake (albeit indirect) and hence interest in the company they work for. It might also ensure some representation of their interests because the trust fund would be controlled by employees and could vote the shares. But there are much better ways to provide both those benefits.

In conclusion, the idea of an employee trust fund sounds attractive at first glance but it has not been properly thought through. A lot more consideration needs to be given to come up with a workable scheme that does not prejudice companies and their investors. Any foreign investor who saw such a scheme being imposed on his UK investment holdings would promptly run a mile – and don’t forget that most of the UK stock market is now owned by foreign investors. The impact on the Uk stock market, and the economic consequences of investors taking their businesses and investment money elsewhere beggars belief.

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

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Labour’s Plans For Confiscation of Shares and Rail System Renationalisation

Jeremy Corbyn made it clear in a speech last night that the rich will be under attack if Labour gets into power. John McDonnell, Shadow Chancellor, will present his plans today to give 10% of shares in all larger companies to employees over a period of years. The Daily Telegraph described it as a Marxist plot to control businesses while Carolyn Fairburn of the CBI attacked it as a “new tax that adds to the impression that Labour sees business as a bottomless pit of funding”. The proposal seems to be based on setting up a trust for employees into which the shares would be deposited and from where dividends would be paid to employees.

Comment: It will certainly dilute existing shareholders so readers of this blog might find they and the pension funds that invest in shares are proportionally poorer. Although it sets a bad principle, if the numbers being proposed are enacted it might not have a major impact on companies or investors. Enabling employees to have a financial interest in the profits of a company is quite a sensible idea in many ways. But it might simply encourage companies to take their business elsewhere. If they are registered in another country, how will the UK Government enforce such legislation?

Last week Chris Grayling, Transport Secretary, announced a review of the privatised rail system. That follows the recent problems with new timetables where the regulator concluded that “nobody took charge”. John McDonnell said that he could renationalise the railways within five years if Labour wins the next election – it’s already a manifesto commitment. Perhaps he thinks he can solve the railway’s problems by doing so but this writer suggests the problem is technology rather than management, although cost also comes into the equation.

The basic problem is that the railways are built on inflexible and expensive old technology. There has never been a “timetable” problem on the roads because there are no fixed timetables – folks just do their own thing and travel when they want to do so.

Consider the rail signalling system – an enormously expensive infrastructure to ensure trains don’t run into each other and to give signals to train drivers. We do of course have a similar system at junctions on roads – they are called traffic lights. But they operate automatically and are relatively cheap. Most are not even linked in a network as train signals are required to be.

Trains run on tracks so they are extremely vulnerable to breakdowns of trains and damage to tracks – even snow, ice or leaves on the line cause disruption – who ever heard of road vehicles being delayed by leaves? A minor problem on a train track, often to signals, can quickly cause the whole line or network to come to a halt. Failing traffic signals on roads typically cause only slight delays and vehicles can drive around any broken-down cars or lorries.

The cost of changes to a rail line are simply enormous, and the cost of building them also. For example, the latest estimate for HS2 – the line from London to Birmingham is more than £80 billion. The original M1 was completed in 1999 at a cost of £26 million. Even allowing for inflation, and some widening and upgrading since then the total cost is probably less than £1 billion.

Changes to railway lines can be enormously expensive. For example, the cost of rebuilding London Bridge station to accommodate more trains was about £1 billion. These astronomic figures simply do not arise when motorways are revised or new service stations constructed.

Why invest more in a railway network when roads are cheaper to build and maintain, and a lot more flexible in use? At present the railways have to be massively subsidised by the Government out of taxation – about £4 billion per annum according to Wikipedia, or about 7.5p per mile of every train journey you take according to the BBC. Meanwhile road transport more than pays for itself and contributes billions to general taxation in addition from taxes on vehicle users.

So here’s a suggestion: scrap using this old technology for transport and invest more in roads. Let the railways shrink in size to where they are justifiable, or let them disappear as trams did for similar reasons – inflexible and expensive in comparison with buses.

No need to renationalise them at great expense. Spend the money instead on building a decent road network which is certainly not what we have at present.

Do you think that railways are more environmentally friendly? Electric trains may be but with electric road vehicles now becoming commonplace, that justification will no longer apply in a few years’ time, if not already.

Just like some people love old transport modes – just think canals and steam trains – the attachment to old technology in transport is simply irrational as well as being very expensive. Road vehicles take you from door-to-door at lower cost, with no “changing trains” or waiting for the next one to arrive. No disruption caused by striking guards or drivers as London commuters have seen so frequently.

In summary building and managing a road network is cheaper and simpler. It just needs a change of mindset to see the advantages of road over rail. But John McDonnell wants to take us back to 1948 when the railways were last nationalised. Better to invest in the roads than the railways.

It has been suggested that John McDonnell is a Marxist but at times he has denied it. Those not aware of the impact of Marxism on political thought would do well to read a book I recently perused which covered the impact of the Bolsheviks in post-revolutionary Russia circa 1919. In Tashkent they nationalised all pianos as owning a piano was considered “bourgeois”. They were confiscated and given to schools. One man who had his piano nationalised lost his temper and broke up the piano with an axe. He was taken to goal and then shot (from the book Mission to Tashkent by Col. F.M. Bailey).

Sometimes history can be very revealing. The same mentality that wishes to spend money on public transport such as railways as opposed to private transport systems, or renationalising the utility companies such as National Grid which is also on the agenda, shows the same defects.

The above might be controversial, but I have not even mentioned Brexit yet. Will the Labour Party support another referendum as some hope and Corbyn is still hedging his bets over? I hope not because I think the electorate is mightily fed up with the subject. In politics, as in business, you should take decisions and then move on. Going back and refighting old battles is not the way to succeed. All we should be debating is the form of Britain’s relationship with the EU after Brexit.

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

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Abcam, Pay and Voting

As a long-standing shareholder in Abcam (ABC), I have just received the Annual Report and I am not happy.

Abcam rather surprised the market when they issued their preliminary results which showed a massive investment in a new Oracle IT system was in difficulties. Clearly the project is over-budget and over-schedule. Costs are ramping up in other areas also and the result was a lowered broker forecast and an instant collapse in the share price – down over 30% at one point on the day. It’s been recovering since but it certainly looked like a case of mismanagement of the IT function. As a former IT manager of a large public company, I have seen this kind of thing before so I am none too impressed. Massive commitments to a big-bang approach to a new IT system which is sold on the basis that it will solve all your problems, but rarely does. So that will be one thing to raise at the AGM which I plan to attend.

But remuneration will be another issue to be questioned. The CEO, Alan Hirzell, seems to be doing a good job but his pay last year was £1.8 million. The company is now proposing a new Remuneration Policy which will increase the maximum potential LTIP award from 150% to 400%. In my view this is outrageously generous – I normally vote against any bonus scheme that awards more than 100% of salary as it promotes risky behaviour of the worst kind as we saw in the financial crisis with banker’s bonuses. The CFO will also get an LTIP with a maximum 200% bonus. Although there will be performance targets the justification given is that it will “promote the underlying philosophy of share ownership among our Executive Directors and reward the sustainable delivery of long-term profitable growth”. Hogwash is my comment.

So I will be voting against Louise Patten who is Chair of the Remuneration Committee as I did last year, and against her two colleagues, Mara Aspinall and Sue Harris who also have too many “roles” at other organisations in my view – contrary to ShareSoc guidelines. Also I will be voting against the new Chairman, Peter Allen, who should know better than to allow this kind of pay package to go forward. Plus I will be voting against the Remuneration Report and Remuneration Policy recommendations. In addition, there is a resolution to approve a change to the 2015 Share Option Plan for staff which permits nil-cost awards which seems unjustified so a vote against that also.

Note that they are also introducing a new all-employee share purchase plan which is not even being put to shareholders – not required under AIM rules they say.

Incidentally Louise Patten has an interesting career history. To quote from Wikipedia “In 2006 she started as a non-executive director of Marks & Spencer plc. As chairman of the Remuneration Committee, she was responsible for approving a bonus scheme which was criticised for making it easier for executive directors to change the associated growth targets”. She was also a non-executive director of Bradford & Bingley when the company failed and was nationalised in 2008. There may be more interesting information that I could not see because in Google a search for “Louise Patten” retrieves only a few entries with the statement “Some results may have been removed under data protection law in Europe”.

I suggest other shareholders vote against the aforementioned resolutions likewise.

But it is easy to vote if you are on the register of the company and have been sent a proxy voting form. Equiniti, the company’s registrar, do provide an easy on-line voting system unlike other registrars, although for some peculiar reason they do not advertise the fact this year. All you need is the three numbers on the voting card and you can vote here: https://www.shareview.co.uk/views2/asp/VoteLogin.asp . No need to register or remember your log-in and password – just vote. As I said to a Link Asset Services representative at another AGM last week, why don’t they provide a simple system like that? They just wish to collect email addresses in my view by having people register and there is no security issue as they claim as it’s very unlikely that anyone would intercept the proxy voting card.

Registrars do need regulating by the FCA in my view, as I have said before, to put a stop to this kind of nonsense.

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

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