Lloyds avoids asset protection, RBS revises terms
9:53a ET November 3, 2009 (MarketWatch)
LONDON (MarketWatch) -- U.K. lender Lloyds Banking Group on Tuesday said it will avoid participating in the government's asset-protection program and will instead raise at least 21 billion pounds ($34.4 billion) of capital, while Royal Bank of Scotland agreed to take the insurance under revised terms.
The new plans will see the U.K. government inject a further 31.2 billion pounds into the two banks and will take the taxpayers' economic holding in RBS to 84.4%.
Both banks also outlined likely sales that will be needed to satisfy European Union regulators, including the disposal of branch networks as well as RBS' insurance business. See full story.
The agreements followed months of speculation about whether either bank could avoid taking the government insurance as market conditions have gradually improved.
Both Lloyds and RBS also made further commitments on lending and pay, including that they wouldn't pay discretionary cash bonuses for 2009 to any employee earning above 39,000 pounds a year.
Shares in Lloyds rose 1% Tuesday, outperforming compared to most other European banks.
RBS shares dropped around 10% as broader European markets fell sharply. Also see Europe Markets.
"However much today's news was expected, the prospect of hefty divestments [at RBS] and 84% taxpayer ownership is a bleak one, particularly when there is limited potential upside for shareholders in the future," said Paul Mumford, senior fund manager at Cavendish Asset Management.
"With the mammoth Lloyds, there is at least a compelling long-term case for huge earnings potential and a leading domestic market position once recovery is more firmly underway," he added.
Lloyds said it will raise 13.5 billion pounds in a fully underwritten sale of shares to existing investors -- the biggest-ever rights issue in the U.K.
It will also launch an exchange offer to swap existing bonds for new convertible bonds that will turn into ordinary shares if the capital ratio falls too low. The exchange deal will add at least 7.5 billion pounds of contingent core Tier 1 capital, the bank said.
The U.K. Treasury will fully participate in the rights issue, and with a 43% stake in the bank that means the government will buy around 5.7 billion pounds of new shares.
Lloyds said the capital raising will help protect it against rising bad-debt charges and is a more attractive alternative than the asset-protection scheme, under which the bank didn't expect to make any claims based on its current performance.
"These proposals provide a significantly more attractive, market-based alternative to participating in GAPS and offer superior economic value to shareholders," said Lloyds Chairman Winfried Bischoff.
"We believe that this represents a significant step towards meeting our, and the government's, objective that the group operates as a wholly privately-owned, self supporting commercial enterprise," he added.
Lloyds will pay a 2.5 billion fee to HM Treasury for the implicit protection the group has had since the government offered the insurance deal.
Macquarie analyst Dave Johnston said the new plan seems to be more efficient than the asset-protection scheme. He said under the original proposal Lloyds could have ended up over-capitalized, with a core Tier 1 ratio of over 15% by the end of 2011.
"Under the current scheme, and with Lloyds currently delivering within expectations, this is no longer the case," he added.
Credit Suisse analyst Jonathan Pierce said the bank is being forced to sell more assets than originally expected by the European Commission. But he added the new bonds will have a relatively low interest rate, saving the bank around 200 million pounds a year compared to expectations.
RBS fees cut
Under the revised terms of its asset-protection deal with the government, RBS will reduce the overall pool of insured assets to 282 billion pounds from 325 billion pounds. See sidebar on banks with protected assets
The first loss -- or the losses RBS has to absorb before the government starts paying out -- was increased to 60 billion pounds from 42.2 billion pounds. But the fee was also significantly reduced.
RBS will now pay 700 million pounds a year for the first three years, followed by 500 million pounds a year after that, compared to the previous plan for an initial upfront fee of 6.5 billion pounds. The announcement came after RBS said it will also cut a further 3,700 jobs in its branch network.
As well as the lower fees, RBS will no longer be forced to give up certain tax losses and allowances, which had been valued at between 9 billion pounds and 11 billion pounds.
Credit Suisse's Pierce said the new fee is "tiny" compared to the original plan, though he also noted that the government is standing by with another 8 billion pounds if it is needed.
RBS said it doesn't expect to need the extra capital, but Pierce said it could suggest that existing calculations on the bank's capital are too optimistic.
Exit sought
RBS Chief Executive Stephen Hester told analysts the bank hopes to exit the asset-protection scheme within its five-year recovery plan, which currently has just over four years left to run.
"Effectively this policy is now more of a catastrophe insurance policy, where we wouldn't expect to have to make claims under our base case scenario," said Finance Director Bruce van Saun.
The Treasury will subscribe for the full 25.5 billion pounds of B shares that were announced in February, taking the government's economic interest in RBS to 84.4%, while its ordinary shareholding remains at 70.3%.
