Government warned of valuation risk to bank sale

30 Aug 11
The government has been warned that its plans to privatise the nationalised banks may be undermined by financial institutions undervaluing the sale.

By Richard Johnstone | 30 August 2011

The government has been warned that its plans to privatise the nationalised banks may be undermined by financial institutions undervaluing the sale.

In a new paper for the Centre for Policy Studies, John Chown, the principal of Chown Dewhurst and a co-founder of the Institute for Fiscal Studies, has warned that the government has not always achieved best value in previous privatisations, due to an undervaluing of the shares being issued.

He warns that this under-pricing is due to an attempt by the underwriters of share issues to reduce their risk, and adds this could have an impact on the money that the Treasury receives from selling its stakes in the banks. These include an 83% stake in the Royal Bank of Scotland and 41% of Lloyds Banking Group.

Chown also argues that the fees paid to underwriters, which are financial institutions who agree to purchase shares to be issued at a specified price if the shares are not subscribed to by anyone else by a certain date, are ‘far too high’.

The paper, No to underwriting: how the coalition can avoid being ripped off, argues that in past government privatisations, shares in companies have been undervalued by as much as one-third. Chown highlights that the privatisation of British Telecom in 1984 raised £3.9bn for the government, but the shares were subsequently valued by the market on opening at £5.2bn, and therefore under-priced by around 30%.

He warns that this undervaluing still exists, citing a planned share issue by the Prudential insurance company, in which it issued that shares were to be offered in a deep discounted rights issue at 104p, for shares standing at 171p otherwise. Chown says that for taking this ‘non-risk’ underwriters were to be paid 2.5%, although in the end the deal was cancelled.

He argues that there are a number of steps the government can take to reduce the chances of undervaluing, including directly handling the drawing up of the sale prospectus, and making a decision on how much of the issue will be offered at the maximum available price to investors and how much would be retained on favorable terms for small investors. He also calls for the general public to be able to acquire small shareholdings at a discount, as long as the shares being held for a minimum period, an idea that has been proposed by Deputy Prime Minister Nick Clegg.

Chown said: ‘As an economist, I am an enthusiastic supporter of free, competitive capital markets, but as a tax adviser, involved in many substantial financial transactions, I have noticed that intermediaries do not always act in the best interest of their clients.

‘Privatisation, although a generally very successful policy, was damaged by a significant part of the potential proceeds being denied to the government by self-seeking advice from the intermediaries. The charges for underwriting new issues generally have continued to be greatly in excess of the value of the services offered, and I am very concerned that the coalition avoids being led astray into the old trap.’

UK Financial Investments, the government agency charged with managing the investments, has said it is unlikely that the government will sell until there is more regulatory certainty in the industry.

In its annual report in July, UKFI said that the Euro-zone debt crisis would also impact on when the decision is made to sell.


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