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To nationalise or not to nationalise?

Banking stocks have had a nauseating ride over the past two weeks. On January 23, the Office for National Statistics confirmed everybody’s fears- the UK is officially in recession.

The gloomy news weighed on the UK stock market, dragging the index below the 4,000 level for the first time this year with banking stocks leading the decline.

But this week, the FTSE staged a dramatic U-turn helped by an open letter from Barclays reassuring the market that 2008 pre-tax profits would be “well ahead” of £5.3bn and that it had made a good start to 2009. It also confirmed it would not be seeking capital support from shareholders or via state funding.

The market appeared to swallow this news and by mid-morning shares in the bank had risen by around 67 per cent.

Questions remain over the specific composition of Barclay’s balance sheets with more details expected next month in the bank’s annual results. These details are expected to colour the market once again and revive fears amongst the UK public that full-scale nationalisation is unavoidable.

So is full public ownership of the major banks really the answer? Not for Blue Sky Asset Management. This week the structured product provider revealed that its protected income plans risk losing 100 per cent of capital invested at maturity if one of the banks listed within their portfolios has their share value decimated to zero upon full nationalisation.

Blue Sky launched the first of its protected income plans back in January 2008, delivering returns based on the performance of five banking stocks including HSBC Holdings, Royal Bank of Scotland, Barclays, HBOS and Lloyds TSB.

It has since launched three further issues of the plan along with the accelerated recovery plan which went live in June based on the same portfolio of banking stocks.

Following the official merger of HBOS and Lloyds TSB this month to create Lloyds Banking Group, Blue Sky replaced HBOS with Standard Chartered within PIP portfolios and adjusted strike prices to reflect previous share price falls in HBOS.

The PIP plans provide 100 per cent capital protection at maturity, subject to a downside portfolio barrier level of 65 per cent. Should any stock breach this 65 per cent barrier at any time during the investment term, capital is lost on a one for one basis in line with the fall of the worst performing stock from its original level.

If the residual value of a single stock becomes zero either through bankruptcy or post-nationalisation, 100 per cent of the capital is lost at maturity.

The silver lining is that investors would continue to receive income payments of 10 per cent each year for the full investment term, therefore 60 per cent. Taking into account the amount of original capital invested and income payments payable, the net loss to investors should therefore be 40 per cent.

Blue Sky says if the bank is given a more ‘orderly nationalisation’ the residual value of the share may allow for a replacement stock within the PIP. However, the strike price of any replacement stock will need to be adjusted to reflect its previous share performance.

Blue Sky has written to IFAs outlining the possible impact to the PIP series to help them assist clients appropriately should wider nationalisation come to pass.

Blue Sky Asset Management chief executive Chris Taylor says: “Either route is not an ideal situation and events since the plan were started have been a result of unprecedented market action. The government is clearly doing everything not to nationalise the banks.”

Lowes Financial Management managing director Ian Lowes says: “By investing in a particular sector or set of stocks, these plans go against our beliefs as far as diversification is concerned. Blue Sky did put a good argument together about the banks being in a depressed state and that the diversification was still there with the five banks but this was proven to be invalid.”

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