February 17, 2009 / 4:57 PM / 9 years ago

Lloyds investors fear dark hole for Black Horse

By Steve Slater - Analysis

LONDON (Reuters) - Lloyds Banking Group’s takeover of HBOS one month ago has left investors fearing they may not get to reap the long-term benefits of the marriage after a shock jump in bad debts has raised the specter of full nationalization.

The government-brokered deal was hurried through to help save UK mortgage titan HBOS but the first 30 days for the enlarged group have been a baptism of fire, with the loss of a much-coveted top credit rating.

The UK economy has deteriorated sharply and allegations from a whistleblower that previous HBOS management ignored risk warnings have fueled the public backlash against bonuses for staff at part-nationalized banks.

“The positive medium-term outlook for Lloyds has not been disputed; it is just whether or not it will make it there that investors seem worried about,” said Sandy Chen, analyst at Panmure.

The bank’s warning that HBOS will make a 2008 loss of 10 billion pounds ($14.1 billion) after a jump in corporate bad debts and asset writedowns stoked concern the government will need to ride in again and take a majority stake or even nationalize Britain’s dominant retail bank.

“The risk is the equity shareholder could end up with absolutely zero at the end of this. The risk of that has certainly increased in the last few days,” said Colin Morton at Rensburg Fund Management, who said he sold his portfolio’s small holding in Lloyds after Friday’s warning.

“There doesn’t seem to be very much management visibility or control over what’s going on,” he said.

Britain already owns 43 percent of Lloyds after injecting 17 billion pounds as part of October’s sector rescue plan.

Politicians have sought to cool the speculation, saying they were not currently considering taking a bigger stake but would act if necessary.

One option is to convert 4 billion pounds of government preference shares into equity, which would cut out 480 million pounds annual interest for Lloyds but take Britain’s stake to near 60 percent.


Lloyds said its core tier 1 capital ratio is likely to have been between 6 and 6.5 percent at the end of December, within previous guidance of 6 to 7 percent, as the impact of December’s losses were countered by gains on the value of HBOS’s own debt.

That compares with 6.7 percent for Barclays and 6.9 to 7.4 percent at Royal Bank of Scotland and a European average of near 7 percent.

Tom Rayner, analyst at Citi, forecast Lloyds could show a cumulative 2008-10 loss of 14 billion pounds and could need to raise 11.2 billion pounds of equity to top up its capital, potentially seeing the government hold a 76 percent stake.

Credit rating agency Moody’s cut its long-term rating on Lloyds by three notches Monday.

The bank, renowned for its “black horse” symbol, had held an AAA rating since 2000 and was the only major listed European bank with the top rating, giving it access to cheap funding. Now its rating is on a par with Barclays and RBS.

The cuts reflected “the high level of troubled and higher risk exposures within HBOS” and integrating its partner “during a major market downturn may prove problematic and will be a substantial challenge for the management team,” Moody’s said.

Britain’s economy has deteriorated sharply in recent weeks and could contract by an annual rate of 4 percent in the first half of this year or even worse.

That could be grave for Lloyds, which has inherited a huge residential mortgage book, including potential trouble spots such as self-certification mortgages.

Corporate loans are an even more acute worry as big bets on property and private-equity style deals have soured. HBOS’s corporate loan book was 117 billion pounds at the end of June.

Lloyds Chief Executive Eric Daniels admitted last week that he would have liked to have had three to five times more due diligence on the rushed HBOS deal and the scale of the warning two days later has shaken confidence in management.

Previously praised for steering a conservative strategy based on cheap funding, strong capital and a low risk appetite, Daniels and his Chairman Victor Blank need to show the enlarged group will not be holed by HBOS’s problems.

The arrival of Britain’s asset protection scheme is likely to be key for them to achieve that.

The Treasury is hammering out details of the plan that should allow Lloyds to put billions of pounds of assets into a vehicle that will cap losses above a set level, such as 10 percent. Details on how much of the loss banks will have to take before the insurance kicks in are expected to be unveiled by the end of the month.

Editing by Elaine Hardcastle

Our Standards:The Thomson Reuters Trust Principles.
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