Is it a coincidence that, just as Sir Win Bischoff prepares to assume chairmanship of Lloyds, we are being treated to some high-level — and positive — leaks regarding the part-government-owned banking group?
To wit, Thursday’s story in the Times:
Lloyds is considering creating a new form of capital that it could offer to shareholders in an attempt to cut its use of the Government’s insurance scheme for toxic assets.
It is discussing a new form of capital instrument to which investors could subscribe and which would convert into ordinary shares.
The attraction for investors would be that this instrument would pay interest. The advantage for Lloyds would be that, if its balance sheet weakens, the instruments would automatically convert into loss-absorbing core Tier 1
What’s more, it would certainly be in the interest of Bischoff — still smarting, perhaps, from his experience at Citi — to be seen leading the bank out of the government’s asset protection scheme, or APS, and into a (well-received) capital raising.
At the same time, we suspect the new chairman, who assumes his position on Sept. 15, will also be looking closely at CEO Eric Daniels, as well as the wider Lloyds board. Indeed — a possible cull of the bank’s directors has already been the subject of another Times leak. The board, which includes such ‘veteran bankers’ as Guardian CEO Carolyn McCall and United Utilities CEO Philip Green — has been the subject of some scrutiny in the past.
Under the initial terms of the APS deal, released in March,the government will absorb 90 per cent of Lloyds losses after the first £25bn. The trade-off is that Lloyds has to pay a participation fee, make additional lending commitments and promises on renumeration, and endure further dilution of its shares, as well as involvement by the European Commission.
In fact, Fitch cut its ratings on Lloyds suboordinated bonds last week, on the assumption that the EC, keen to ensure that bondholders share in the pain of government bank bailouts, may force Lloyds to stop paying coupons on its hybrid debt. Reducing Lloyds’ participating in the APS then, or ending it altogether, would reduce the likelihood of the bank being pressured to take that step.
Nevertheless, the market remains somewhat sceptical that Lloyds can carry this particular plan off.
Here for instance, are RBS analysts Tom Jenkins and Christy Hajiloizou:
There is a long way to go here, but just theoretically if Lloyds does not use the APS scheme (remember UKFI has said it will not use its 43% voting rights to decide) and if it can demonstrate a massive capital raise then the threat of EC intervention into switching off hybrid coupons is diminished but not removed. Feedback from the equity community is that non-usage of the APS is a non-starter, that raising a huge sum like GBP20bn is a non-starter, so the issue becomes how to either partially renegotiate APS or reduce the quantum and fund it without issuing B shares to the govt – and that could be plausible. Either way, right now is not the time to be backing up the truck on Lloyds hybrids on the hope of a benevolent EC… we may be marginally closer to that eventuality but it’s still not on the horizon yet.
And KBW’s Mark Phin and John Holmes:
However, there are some practical realities [to exiting the APS]. Firstly, it seems to us there would be little incentive for the government to agree to a significant change in terms to the benefit of Lloyds. Secondly, establishing a true cost/benefit analysis of the APS is not possible because we don’t know how Lloyds would have fared without it over the last six months or so, e.g., funding costs, FSA stress test assessment, etc. Thirdly, we doubt there is sufficient market demand for a c£15bn equity issue, particularly given the current shareholder structure. Fourthly, there is a risk that credit quality deteriorates beyond current expectations, which in turn, could threaten credit availability, a key objective of the APS in the first place. Fifthly, the risk of Lloyds being wrong in its impairment outlook is transferred from the government to shareholders.
More realistic perhaps is a smaller equity issue combined with a reduction in the level of insured assets. This is possible, but bearing in mind that the loss content per £ of assets will have risen since the original agreement, we think it would be wrong to believe that the government will allow the fee to come down pro-rata with the assets. All in all, our base case is that Lloyds will enter the APS on broadly the same terms as those already disclosed.
And Oriel Securities’ Mike Trippitt:
The operating outlook is beginning to improve for Lloyds Banking Group and we forecast a strong trading surplus performance for 2010 underpinned by favourable revenue and cost trends. However, a base case core tier 1 ratio of sub 5% in 2011 suggests life without GAPS or an alternative capital raising is not tenable. Whilst Lloyds Banking Group will be a relative industry winner in the longer term, between now and then investors face the prospect of dilution from the GAPS scheme or increasingly likely, from a dilutive equity placing, or a hybrid of the two. We suspect the shares will underperform the sector during the intervening period and there may well be opportunities to buy into the long term recovery story at lower levels.
If the new Lloyds chairman is keen to swiftly and dramatically make his mark at the bank, he certainly has a Bischoff a job cut out for him (ahem).
Related links:
Lloyds, out of the frying pan and out of the APS? – FT Alphaville
Hybrid security (or not) – FT Alphaville
Laughing Lloyds – FT Alphaville
Lex on Lloyds Banking Group – FT