Debts & Loans

Your profits and cash flow depend, to a significant degree, on the progress of the stockmarket. You have concentrated risk in a couple of sectors. You operate in an industry where performance can be volatile - even long-term winners have spent long periods near the bottom of the charts. Your main assets are a few individuals who are vulnerable to poaching.

How much debt should such a company carry?

When New Star Asset Management answered this question in March last year, the answer was £300m, or more than five times the previous year's free cash flow. If that sounds racy, almost nobody said so. The return to shareholders of £363m, thanks to a big bank loan, added to the legend of founder John Duffield. As a big shareholder, Duffield collected £45m while some New Star staff became multimillionaires.

But the return of cash, it is now clear, was the moment New Star made itself vulnerable. To service borrowings of £300m (or even today's reduced sum of £240m) with ease, New Star needed almost everything to go right. Almost nothing has. The stockmarket has slumped; the property and financial sectors, New Star specialisms, have been hit hardest; and individual fund managers, the new stars, have fallen to earth.

Charitable spirits will say Duffield was unlucky. In truth, last year's refinancing displayed a lack of respect for markets, which have always humbled those who place too much faith in their own brilliance. Fund management is an inherently cash-generative game: there was no need to perform fancy tricks with the balance sheet.

Yesterday's hullabaloo about whether trading in New Star's shares should have been suspended is a sideshow. A more conservatively funded business would not have found itself negotiating a debt-for-equity swap in the first place.

On the other side of the negotiating table, the banks, led by HBOS (them again), should ask themselves what they were smoking when they agreed to lend £350m for six years at 1.5% over Libor. There was not much profit in those arrangements, but a lot of risk.

If the debt-for-equity deal proceeds, the banks will have to find a way of motivating the fund managers, whose job will be to restore confidence in New Star and prevent the flow of investor redemptions becoming a flood. Lock-ins for underperforming millionaires? Yes, that's where the banks find themselves.
O'Leary flies a kite

You didn't like my last bid. How about one at half the price? Ryanair's offer to Aer Lingus looks cheeky - and very odd.

Chief executive Michael O'Leary has offered no meaningful concessions to charm his audience in Brussels. What's the European Union supposed to do? Simply say that a takeover that was judged anti-competitive 18 months ago is now competitive? The airline industry is in pain and in need of cost-cutting alliances and mergers, but the EU is highly likely still to regard the proposed dominance at Dublin as unacceptable.

And has the outlook for Aer Lingus altered so radically that its board can roll over in the face of a cut-price offer? That's unlikely, too. Yes, Aer Lingus may be facing two years of operating losses, but the management will be inclined to look at the falling oil price and dream of better days.

In the end, the Irish government, with 25% of the shares, holds the key, given that only it could hope realistically to alter thinking in Brussels. But can a government, even a cash-strapped one, ignore the wishes of management and (probably) staff? That doesn't sound like a vote-winner.

O'Leary may bag his prey one day - consolidation among airlines, as he says, is a fact of life. Even so, yesterday's offer looks like too little, too soon.

Hester's bonbon

Smart move, Mr Hester. There are brownie points for Royal Bank of Scotland in granting a six-month moratorium to home-owners struggling with their mortgages. The sensitive issue of repossessions ranks very high on the government's list of concerns - and relatively low among banks' concerns.

Bigger battles lie ahead for RBS and the other part-nationalised bank, Lloyds-HBOS. The most important scrap centres on interest rates. If the Bank of England cuts to 2%, as it may on Thursday, lenders will be under pressure to pass on the full benefit to borrowers.

If they are to do so profitably, rates for savers will have to be cut to the bone. At some point, though, the banks will encounter resistance from savers. Their instinct will be to use a portion of the rate cuts to preserve lending margins.

That's a tough line to sell to politicians. So it's very sensible to secure some positive headlines when you can.