There must have been a huge sigh of relief at the Gresham Street headquarters of Lloyds TSB on Wednesday morning: the stock price rose.
After falling 14.5 per cent on Monday and a further 6.6 per cent on Tuesday, the shares were 9.7p, or 6.4% higher, mid-morning at 161p.
The reason, of course, is reports suggesting the government might rethink the terms of its bailout plan, particularly the requirement that HBOS/Lloyds and RBS stop paying dividends until the £9bn of preference shares they plan to issue are repaid.
The prefs, which pay a fixed interest rate of 12 per cent, cannot be redeemed for five years.
The prospect of zero dividend payments for the foreseeable future, of course, has seen investors exit Lloyds and HBOS and has increased the likelihood that the government will end up with a 40 per cent stake in the superbank.
Shares in HBOS are still trading well below the subscription price for the £8.5bn equity placing, which has been underwritten by the Treasury. Indeed, Lloyds shares are also trading below their subscription price.
But what can the Treasury do to avoid this scenario and a similar situation at RBS, where it could end up controlling 60 per cent of the company if investors shun its £15bn cash call?
Suggestions range from replacing the prefs through asset sales, or by raising addition capital, or simply using retained earnings. Sadly none of these look possible at the moment, according to Alex Potter of Collins Stewart:
For both RBS and the combined Lloyds-HBoS, the amount of preference capital raised is broadly equal to a year of “recovered earnings”.
The issue, therefore, is when we see the next year of such earnings. Our current thinking is that arrears peak in a year’s time (or thereabouts) meaning that 2010 earnings will likely be better than 2009 earnings but only marginally so. This means that the preference capital is unlikely to be paid down through retained earnings until 2011 at the earliest. For these two banks, the equity dividend moratorium is unlikely to end before 2012
The government’s preference injection can also be repaid via simple refinancing from private sources as an alternative. However, we feel this will require a significantly more positive market than that seen at the moment and is therefore unlikely in the next year or so.
Update: Comment from Lloyds on the prefs:
“The prefs are callable at par after 5 years but we will potentially work with the government to refund and repay them earlier.”
So, it seems the terms of the bailout could well be changed. All of which would come as relief to Lloyds, which really needs to get its share price back above the placing price. For the record this is 173.3p – about 5% below where Lloyds shares are trading at now.
Update II: Pestowire has spoken. With some understatement the news service says:
There may have been some misunderstanding between the banks and the Treasury about the nature of the prohibition on dividend payments pending repayment of the preference stock they are selling to the state.
Apparently, according to well-placed sources, a sensible interpretation of the complex documentation drawn up for the banks’ capital-raising would say the following:
1) there is a strict ban on dividend payments for a year;
2) thereafter there would be discretion for the Treasury to permit dividend payments to start again at Royal Bank of Scotland and Lloyds (as enlarged by the planned takeover of HBOS); irrespective of whether all the prefs had been repaid.
The rest can be found here