Lloyds, RBS agree to massive shake-up

By Clara Ferreira-Marques and Steve Slater

LONDON (Reuters) - Britain's two largest retail lenders are to get another 31 billion pounds from the government and have agreed to sell hundreds of branches and key businesses to appease EU competition concerns over state aid.

The deal announced on Tuesday paves the way for Britain to begin reducing its holdings in Royal Bank of Scotland and Lloyds Banking Group, a potentially critical source of funds as the country struggles with a ballooning budget deficit.

RBS and Lloyds ended months of uncertainty, with Lloyds announcing that it would drop out of a government insurance scheme for bad debts by raising 13.5 billion pounds ($22.08 billion) in the world's largest ever rights issue, as part of a 21 billion-pound capital raising plan.

The move leaves RBS, 70 percent state-owned, as the only bank joining the government's Asset Protection Scheme but under more flexible terms than expected earlier this year, which RBS said will allow it to leave the scheme within four years.

Both banks, however, also agreed to disposals to meet EU state aid rules, with RBS particularly hit, selling chunks of its retail bank under the revived brand Williams & Glyn, its RBS Insurance arm and shrinking its investment bank.

"We do feel bruised by what we've had to go through," RBS's chief executive Stephen Hester said on a conference call.

"Our job (of turning around RBS) has been made more difficult by some of the aspects of the EU settlement, but nevertheless we believe it is a doable job," he added.

Shares in RBS were down 4.8 percent at 1100 GMT at 36.8p, well below the average price of 50.5p paid by the government for its stake in the bank. Lloyds, whose takeover of beleaguered rival HBOS was backed by the state, was up 1.3 percent at 86.2p, also below the government's entry price of 122.6p.

"The news is potentially good for both UK consumers and rival banking groups, although more debatable for both Lloyds and RBS shareholders," Keith Bowman, an analyst at Hargreaves Lansdown Stockbrokers.

The UK government, which will inject 25.5 billion pounds into RBS and pay Lloyds a net 5.7 billion pounds as a shareholder in the rights issue, said the disposals would shake up competition in retail banking, bringing "at least three new banks" to Britain's high streets over the next four years.

Lloyds and RBS will between them have to sell off businesses equating to 10 percent of the UK retail banking market. Only new entrants or "small players" in the market will be allowed to bid, raising the key question of which buyers will step up.

Lloyds, which avoided harsher penalties by staying out of the APS, said it would sell 600 of its retail branches, with disposals including Lloyds TSB Scotland, Cheltenham & Gloucester branches, as well as its Intelligent Finance and the TSB brand.

To address EU concerns, it will also face a dividend ban for two years and a prohibition on acquisitions for up to four years.

RBS -- whose sanctions including punitive sales imposed as late as this week -- will be forced to sell NatWest branches in Scotland, RBS-branded branches in England and Wales, along with RBS Insurance, Britain's largest car insurer. It will also sell Global Merchant Services and RBS Sempra Commodities.

RBS said it expected buyer interest and was considering an initial public offering for RBS Insurance, which it initially put on the block in 2008, but pulled earlier this year.