What does today's news mean for shareholders of Lloyds and RBS?
And so, the deed is done. Heavily leaked and trailed over the weekend, a flurry of announcements at 7am this morning saw the tectonic plates of British banking once more strain, shift and settle into awkward new positions.
Lloyds Banking Group (LSE: LLOY) escapes the clutches of the expensive Government Asset Protection Scheme, but pays a heavy price. Forced disposals, a £13.5 billion rights issue coupled to a £7.5 billion debt-for-equity offer, and a £2.5 billion fee paid to the government in respect of protection under GAPS thus far enjoyed -- and that's just a taster.
Royal Bank of Scotland (LSE: RBS) stays in the asset protection scheme, and gets still more government funding, but pays a price that's every bit as onerous if not more so. More forced disposals, annual payments to the government, and -- as at Lloyds -- tough restraints on bonuses, dividends and coupon payments.
The Treasury and outgoing European Competition Commissioner Neelie Kroes have driven a tough bargain, and the best gloss that each bank's board can put on the outcome is that it's better than it might have been -- and probably would have been otherwise.
In short, Lloyds escapes the asset protection scheme, while RBS continues to be propped up by the government. At the time of writing, Lloyds shares were down by less that the overall fall in the FTSE, while RBS shares had crashed by 10%.
What does it mean for investors?
The press -- perhaps predictably -- have been playing up the consumer and competition angles. More competition offers the prospect of a better deal for consumers, and even better, those beastly fat cat bankers get to kiss goodbye to their vast bonuses -- bonuses paid in cash, anyway.
Investors' concerns will be more prosaic:
- What does it all mean for the two banks' business models?
- What does it mean for dividends and coupon payments?
- What are the advantages -- or disadvantages -- in participating in Lloyds' debt-for-equity swaps and rights issues?
The simple answer to all three questions is that the picture is still unclear. As usual, though, there's already a huge amount of informed comment on the Fool's discussion boards. If you've been trading preference shares, check out the very detailed (and numerous) posts in this thread, for example.
Goodbye to all that
Both banks are having to part with significant chunks of their operations. For Lloyds investors, it's particularly galling to see some of the jewels in the HBOS crown -- the very reason for the rescue -- snatched away.
RBS is disposing of 318 branches UK‑wide, equivalent to 14% of its UK retail network. It's a blow that chief executive Stephen Hester describes as "more material than we expected." Out go the bank's Natwest branches north of the border, and its former Williams & Glyn's branches in England and Wales. Insurance and card payment operations are to be sold off as well.
The net result is to reduce RBS's UK market share by 2 percentage points in retail banking, 5 percentage points in SME banking and 5 percentage points in the mid‑corporate market. Bad? Yes. Catastrophic? No.
For its part, Lloyds must dispose of around 600 branches, plus the Intelligent Finance Internet-based operation. Out goes the Cheltenham & Gloucester operation and the TSB brand -- the former having been saved from closure just weeks back, probably in anticipation of just such as move. Out, too, go the bank's Lloyds TSB branches in Scotland (although it keeps its HBOS branches). The timetable calls for these to be disposed of within four years. An asset reduction programme also sees the bank shed £181 billion of lending.
According to Lloyds, it will be saying goodbye to a retail banking business with a 4.6% current account market share, and around 19% of the bank's mortgage balances.
Dividends and coupons
As a condition for receiving state aid, both banks are constrained from paying dividends for a further two years. There will be no dividends until February 2012 at the earliest.
In the case of Lloyds, that's a little longer than optimists might have been expecting, but a lot depends on the banks' return to profitability. While dividends would be nice, if the profits aren't there, there's not much that investors can do about it.
And when will those profits be there?
An interim management statement, also released this morning, says that Lloyds expects to make a loss in 2009. However, embedded in the rights issue prospectus is the comment that "The Board now has increased confidence in the Group's ability to deliver a strongly improving business performance in 2010 and 2011." So a dividend in 2012 should at least be affordable, if all goes well.
In the case of RBS, the logic is equally cut and dried -- and, to investors, unwelcome, I fear. There's a lot of state aid to be paid back before dividends appear on the agenda, it's safe to assume.
Both banks' announcements -- and the Treasury's own, separate announcement -- also constrain the paying of coupons on 'hybrid capital instruments' such as preference shares and 'B' shares, unless legally obligated. It's still unclear on which specific shares coupon payments are payable, and there may be legal challenges.
Even so, many investors are weighing up the odds of selling up, waiting for payments to be resumed, or (in the case of Lloyds) accepting the offer of a conversion to ordinary shares -- although the price at which this will take place at has yet to be determined.
Rights issue
Which -- in the case of Lloyds investors at least -- takes us to the rights issue and its associated exchange offers. Again, the rights price isn't yet known, and won't be until the 24 November.
But one thing is certain: as with the Lloyds rights issue earlier this year, investors will be galled to find themselves once more putting their hands in their pockets to fund an opportunistic acquisition that hasn't turned out as expected. And today's forced disposals make the benefits stemming from the HBOS takeover even less compelling.
Will it prove popular with investors? The government is committed to taking up its rights, as are the board of directors. But for ordinary investors, much will depend on the eventual price, and on how investor sentiment (and the broader market) fares over the next three weeks.
The good news is that the offer is fully-underwritten, so the bank will gets its additional capital. The sting in the tail will be if those underwriting facilities turn out to be required. As investors in oil giant BP (LSE: BP) learned to their cost, over twenty years ago, a massive overhang of shares left with underwriters depresses the price for months -- or years -- afterwards.
More on the markets:
Malcolm holds shares in Lloyds Banking Group.
