All Things Must Change

Can the City of London kindly stop moping around like a depressed basset hound. Just a year after we managed to avoid financial Armageddon, the banking system is of course
still not fit for purpose, but none-the-less changes and developments are afoot - which
is good news. However:

Bad news - it would be foolhardy to suggest that the banking issues and problems have
been resolved - far from it. From last year worrying about having banks that were ‘too
big to fail’, we now have a smaller number of larger banks (in terms of market share)
which are still ‘too big to fail’. We still have not addressed the regulation and risk
controls of the unstable mixture of investment and utility banking, and for many they
are still undercapitalised with large write downs ahead of them, and unable to lend
sufficiently at the right margin into a credit-strapped economy.

Good news - changes are afoot.

• RBS has already started the process of divesting 318 branches to someone else
  (offers needed please). LloydsTSB has to do the same for some 600 of their
  branches and of course Northern Rock has been restructured as a functioning
  mortgage bank again and is ready for a friendly purchaser.
• There are also new participants waiting in the wings whose plans are as a result
  of these changes. Tesco and some other supermarkets all have banking
  aspirations of various levels and given that they already have one or two
  branches, such an initiative with a high level of internet access would not
  necessarily be a very complicated structure. Also we cannot ignore the
  aspirations of Sir Richard Branson’s Virgin group who have made it very clear
  that they are interested in entering the arena in some form or another.
• Then we can have the brand new banking ideas that are forming. Blackstone, the
  private equity firm has applied to the FSA for a banking licence to potentially
  establish a banking operation under the possible name of Home and Savings
  Bank. Add to this the concept of Metro Bank and most recently Walton & Cowhich is being created by Panmure Gordon and at last we are seeing some much
  welcomed sparks of entrepreneurialism and initiative coming into this depressed
  market.
• Overseas entrants are also waiting in the wings but it would be helpful if the City
  of London started to get back onto a positive footing again and realise its great
  strengths and not just sigh from its failings. Success attracts success and London still has a lot to be proud of. Thus the opportunity of attracting more banking investment from both China and India is perfectly sensible and both already have a reasonable presence, with even the Chinese entering the UK mortgage market. Even in Brazil, the São Paulo based Itau Unibanco, which is the largest nongovernment lender in Brazil has not denied an interest and they could well be one of the contenders for the hived off branches of RBS and LloydsTSB.
• So if the City wants to gain some respect it should start addressing the negatives
  and encouraging the positives and get back to what it does best - making
  money.

***

Another area that needs to change or at least evolve was highlighted last week in a
fascinating article in the New Statesman by David Blanchflower, the economist and ex-member of the Bank of England’s Monetary Policy Committee (MPC). In this he suitably
castigated George Osborne for his stated policies and seemingly ignored his advice. In
his words, “he seems hell bent on creating the Osborne Dip”. He quotes Dominique
Strauss-Kahn, the head of the IMF to support his argument against the immediate postelection tough-cutting proposals of Osborne “in most countries, growth is still supported by government policies. For as long as you do not have private demand strong enough to offset the need of public policy, you shouldn’t exit”.

He also went on to criticise the MPC itself in its narrowness of brief and remit in looking
so fixatedly at inflation and not only that but at only the narrow measure of inflation,
CPI which excludes house prices. His point being that if they had taken account of house
prices as part of the inflation measurement then rates would have been higher at an
earlier stage, and thus could have helped prevent or at least reduce the credit bubble
that followed. In his view they missed the clues for the recession and acted too late on
rates on the way up and too late on rates on the way down.

In this view it is thus ‘not fit for purpose’. His points are certainly correct, but rather
than disbanding it altogether, it certainly needs reform. Heaven forefend that we return
to control of rates solely back to the murky world of the politicians.

***

Darwinian evolution is taking place at some speed in the world of private equity as well.
Last year the measure of the lack of vibrancy in this sector was shown by the number of
deals - just 117 which is their lowest in 25 years and at value levels going back to 1995.

The prevalent system of private equity was to use borrowing (or leverage) to reengineer
and restructure businesses or their sub units by way of buy out or something similar. Now however with the shortage of borrowing and the days of mega-buy outs gone, the private equity beasts are evolving fast.

The new world is closer to that of a financial version of Burke & Hare, with corporate
cadavers being taken and their bodies being used for ‘other purposes’. More companies
are being brought out of receivership than at any time since 1993. With the new fad for
corporate MFI or ‘pre-pack’ bankruptcy, this has meant that private equity firms need a
new style of staff. Rather than the financial warlocks that could create complicated
accounting structures, they seem to now require good old-fashioned business operators
to rebuild defunct businesses and bring them back to life. This sounds like a wholly
encouraging development; given the number of failures coming through, often with
good companies being squeezed by cash flow constrictions (back to the banking system
again) the opportunities of rescuing good value from untimely failure seem most
positive.

***

And finally... the headline of the week must be...

Floor caves under Weight Watchers weigh-in

No-one injured - but dieters might have extra motivation to shed pounds

As a Weight Watchers group gathered for a routine weigh-in, the dieters got an idea of
how far they still had to go: The floor underneath them collapsed, a Swedish newspaper
reports.

"We suddenly heard a huge thud; we almost thought it was an earthquake and
everything flew up in the air," one of about 20 group members said to the Smalandsposten newspaper. "The floor collapsed in one corner of the room and along
the walls."

After the initial collapse on Wednesday evening, the floor started to cave in other parts
of the room, and the stench of sewage crept into the clinic, which is in Vaxjo, a city in
south central Sweden. No one was injured, and the cause of the collapse is still under
investigation.

The group is looking, not unsurprisingly for an alternate location for future meetings. I
think it is frankly one of the best incentives to lose weight - I hope they find a building
with the right load (or is it lardy) factor to support them.

Have a good week.

Justin A Urquart Stewart
Director
Seven Investment Management Limited

For previous editions of our Weekly Update, please click here

This article represents a personal and light-hearted view from Director, Justin Urquhart Stewart of Seven Investment Management Limited, and is based on current financial news and events around the world. Its content should not be used for investment purposes and you should contact an independent financial adviser before making any investment or financial decision. Seven Investment Management Limited is authorised and regulated by the Financial Services Authority. Member of the London Stock Exchange. Head office: 23 Austin Friars, London EC2N 2QP. Telephone 020 7760 8777. Registered in England and Wales number 4092911. Registered office: 3 More London Riverside, London SE1 2AQ.