Analysts urge caution on banks despite bailout

BANGALORE (Reuters) - Analysts on Monday urged investors to stay cautious on UK banks, as it warned that the government's second bank bailout was no magic fix and that this would put equity shareholders at risk of further dilution.

"Any euphoria from the plethora of government bank support programmes announced today (Monday) will prove short-lived," analyst Sandy Chen at Panmure Gordon warned.

Additional losses from deleveraging and deflation will likely consume these funds leaving equity shareholders at risk of further dilution, Chen added in a note to clients entitled "Another bailout, another rally? Not for long."

On Monday, Britain threw its troubled banks their second multi-billion-pound lifeline in three months and gave the Bank of England a green light to increase money supply if necessary as interest rates approach zero.

Banks will now be allowed to insure themselves against losses on their riskiest assets. The government will also offer guarantees on their debt and set up a 50-billion-pound fund to buy up high-quality securities to get cash flowing freely again.

"The obvious question is: will all this money turn things around?" Chen questioned, adding that there is a high risk that it will not.

Chen cited concerns that the loan guarantee/insurance programmes could cost the government far more than expected and that banks could be dragged through a "creeping nationalisation" that would severely dilute existing shareholders.

Analysts also warned that the government may resort to full scale nationalisation if current measures are not enough.

"We would suggest that if the latest set of measures proves insufficient, particularly in restoring what the authorities regard as adequate credit flow, then the authorities are likely to feel that they have little alternative to full nationalisation," Nomura analysts Robert Law and Raul Sinha said.

To finally remove downside risk to solvency, the three domestic UK banks alone could require equity injections of 80 billion pounds, Nomura analysts estimated.

"We further believe that support on this scale is unlikely without very significant dilution to existing shareholders and/or full scale nationalisation," they added.

Nomura analysts maintained their bearish view on the sector, while Panmure's Chen kept his "severely negative" stance on UK banks, with "sell" ratings on Royal Bank of Scotland and Barclays.

On Monday, the FTSE 350 banks index, which touched its new lifetime low of 2489.22 points, pared some of its losses and was down about 18 percent at 2510.21 points by 1516 GMT. Through Friday, the index has fallen 20 percent since the beginning of the year.

(Editing by Anil D'Silva)