Moment of banking madness

Yesterday was an exciting day for RBS shareholders:

• Expected loss of £22-28bn, the largest in UK corporate history.
• Further shareholder dilution as the govt swaps its preference shares for equity at a price of ~32p, meaning that it will own about 70% of the company.
• A 70% fall in the shareprice to under 11p.

By the afternoon my bank shares constituted only about 1.2% of my portfolio, and a moment of madness spurred me to increase that to about 11%.

I think nationalization is a real possibility, but there is also a real possibility that banks have sufficient capital and no further dilution will occur. In the event of nationalization it's possible that ordinary shareholders might get some compensation, but I wouldn't count on it. So the downside is 0p for RBS, BARC, LLOY and HSBA.

On the other hand, if no further capital is required, then we can expect RBS, BARC, LLOY and HSBA to dominate UK banking and for all but LLOY to have a reasonably substantial global banking operation. Barclays claims to be capable of making about 40p per share even in difficult circumstances. RBS has previously made about £7bn per year, so perhaps £4bn is a reasonable expectation in the future, which is about 7.5p per share. The forecast for Lloyds is about 25p per share. HSBC is forecast to make about 85p in 2010.

Assuming a fair P/E ratio of 10 (although it could be a while before we see the markets agreeing), that gives an upside of:

• 75p for RBS
• 400p for Barclays
• 250p for Lloyds
• 850p for HSBC.

I therefore bought roughly equal shares of these 4. At my purchase price the upside represents 5.5 times for RBS, 4.6 for Barclays, 3.7 for Lloyds and 1.8 for HSBC. I don't expect to achieve this with all 4, but even 2 out of 4 would put me in profit.

This is clearly a bit of a punt, but if these 4 all go under (or even just RBS) sterling will be trashed and my non-sterling assets (IEEM, IDVY, IAPD and actual dollars) will more than offset any losses.

Update

After 1 day my purchases are already down: -35% for LLOY, -25% for RBS, -17% for BARC. HSBA is up 1%. Woohoo! Luckily today's $/£ exchange rate movement ($1.47 to $1.39) more than offset any losses. So far this year my portfolio is very slightly negative, down about 1%.