Lloyds bond deal aims to save it from RBS's fate

As the Lloyds Banking Group formally took over HBOS yesterday, the new group's flag was unfurled – almost – at the Mound

THE newly formed Lloyds Banking Group strengthened its hand yesterday in its fight to avoid following Royal Bank of Scotland into government ownership, doing a deal with bond holders to boost its capital position.

After formally completing the takeover of HBOS yesterday morning, the bank's bond move allowed it to ignore the government's latest recapitalisation initiative which saw RBS set to become 70 per cent owned by the state.

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The government increased its ownership after RBS yesterday agreed to swap 5 billion worth of government preference shares – taken when it launched its 37bn recapitalisation plan October – for ordinary shares.

News of the deal came as RBS revealed it would book the biggest loss in UK corporate history, 28bn, and it's shares plummeted to a new all-time low.

Although RBS will now no longer has to pay the government 600 million per year, Lloyds – which has eschewed the idea of a similar swap – will pay 480m this year until the government's preference shares are paid off. Lloyds is currently 43.4 per cent owned by the taxpayer.

Yesterday Lloyds issued a guardedly positive update to the market in which it revealed it was "pleased with the strong response" it received from its bond holders who sold lower-risk tier two securities back to the bank and instead took new, more highly subordinated bonds.

Bond analysts said the deal was good for both Lloyds and its bond holders as the bank could bank the discount in the debt and use it to boost its tier one capital ratios, now up about 35 basis points to between 9 and 10 per cent. The capital may also be used to pay down the 4bn government preference shares.

Andrew Sutherland, head of credit at Standard Life Investments said: "The positive thing from Lloyds' point of view is they improve the quality of their capital because they get more subordinated capital. They also get a benefit because they can buy back upper tier two bonds well below par and book the capital profit. They can book that profit as tier one capital.

"You could speculate maybe they will use some of this to retire some of the government prefs (preference shares]."

Lloyds, now the UK's biggest mortgage lender, confirmed it intends to stick with its plan to repay the government's shares by the end of the year.

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However, Simon Willis, an analyst for NCB Stockbrokers, said the group may yet see the government's stake in the bank increased: "They are resisting for as long as they can, but I suspect in due course they will be majority government-owned due to rising bad debts on the back of a deterioration in the UK economy."

Keith Bowman at Hargreaves Landsdown said the bank's choice not to up the government's stake through the preference shares swap was a good one. "They are obviously confident enough to believe they will pay down the pref shares," he said.

Nevertheless, Bowman said the bank's fortunes would depend on the impact of the still rapidly deteriorating economy, particularly on HBOS which is expected to be hit particularly hard by the downturn. "It is in the fate of the gods in terms of how the economy fares in the very near term," he added.

"If life for HBOS becomes considerably more difficult then it may need reassessing, but Lloyds management for now are still confident it can be achieved."

Although a number of analysts advised investors to "hold" on the new Lloyds group shares, Bruce Packard at Evolution Securities remained grim in outlook. "We are heading into quite a dark recession and maybe people should be paying down their mortgages and paying off their credit cards rather than buying bank shares," he said.

The markets did not acknowledge any good news from Lloyds. Shares last night closed 34 per cent down at 65p. RBS fared much worse closing down 67 per cent at 11.6p, having earlier slumped to 10p.

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