How to turn Lloyds back into a stallion

Rosamund Urwin
16 Oct 2009

The black horse bank is desperate to avoid a whipping from Brussels. Limping along after its disastrous takeover of stricken rival HBOS last year, Lloyds Banking Group now has the demands of European competition watchdogs to contend with.

As a condition of accepting state aid, regulators want 43% taxpayer-owned Lloyds to reduce its hold on the current account and mortgages markets by shedding a large number of customers. Neelie Kroes, the EU Competition Commissioner, is proposing Lloyds — which controls about 30% of these markets — sell up to 1000 branches.

This week, Kroes extended her term to the end of the year, giving Lloyds an extra two months to negotiate. So what will she eventually demand? And, with its balance sheet still laden with dodgy assets, what is chief executive Eric Daniels planning to return Lloyds to health? These are the key issues:

DEALING WITH EUROPE
Nightmare scenario: sell off Halifax

This is the disaster scenario Lloyds is desperate to avoid: Halifax was the welcome inheritance to the poisoned chalice of Bank of Scotland.

Regulators warn that Lloyds could be forced to sell off Britain's biggest mortgage lender, a ruling which would render the HBOS takeover pointless and for which Daniels would pay with his head. But analysts don't think Europe will manage to claim such a hefty price, with one noting: “Lloyds was heavily leant on to buy HBOS. It is ludicrous that a year later the EU could destroy any benefit of the deal.” Even if the takeover isn't unpicked, however, the integration of HBOS has been held back as Lloyds awaits the ruling. A preferable option — though still far from ideal for Lloyds — would be to sell Bank of Scotland's personal banking business.

Dream scenario: bye-bye, Cheltenham & Gloucester

In a dramatic U-turn, Lloyds shelved plans to shut the entire Cheltenham & Gloucester network in August. While its 930 staff were thrilled not to join the dole queue, the move wasn't caused by a sudden sensitivity to their plight.

Analysts believe that Lloyds is hanging on to C&G as a bargaining chip with Brussels, offering its closure in place of less appealing sell-offs. However, C&G can only offer part of the solution: the 164 branches are likely to be too few to satisfy Kroes. Moreover, the big concern for European regulators isn't so much mortgages — where the market remains very fragmented in the UK — as Lloyds' dominance in personal accounts, which ditching C&G would do little to help. One analyst summed it up: “Halifax is too much, C&G is not enough, but what's the compromise?”

BOOSTING THE BALANCE SHEET

Raise £25 billion to escape the Government's insurance scheme

Lloyds needs £25 billion to avoid the Government's asset protection scheme completely, to stop the taxpayer's stake in the bank rising and limit Brussels' remedies for state-aid. The bank has a three-pronged plan to reach this hefty target: asset sales, a cash call and a debt for equity swap. But a total bypass of the scheme now looks unlikely. Sources close to the negotiations say that the Government requires Lloyds to come up with a deal that is “considerably better” for the taxpayer than the APS to get its longed-for escape. Moreover, while terms were never finalised, Lloyds has already benefited from the stabilising effects of the toxic assets insurance scheme. Exiting could leave Lloyds facing a £1 billion break fee.

Plan 1: put non-core assets under the hammer

Lloyds is looking to raise around £10 billion from its trips to auction. Life assurers Scottish Widows and Clerical Medical are the star assets up for grabs, although fears remain that it won't get a good price.

Buyers are also likely to be sought for its 60% stake in wealth manager St James' Place, worth £800 million, while Lloyds this morning sold its Halifax Estate Agencies business. In August, Bank of New York Mellon snapped up half of Insight, HBOS's asset management arm, for £235 million.

Plan 2: go cap in hand to investors

Lloyds's advisers are working on what would be one of the biggest rights issues in UK corporate history, planning to raise £11 billion. But the potential cash call has already hit a snag. The Government is unwilling to underwrite the issue. As Lloyds' biggest investor, its refusal would hamper plans to raise enough cash to keep out of APS. Even Government participation in the rights issue is not an absolute given, although it is unlikely Chancellor Alistair Darling would refuse. The cash-raising plan could also involve a debt for equity swap, raising around £3-£4 billion.

But there are no easy options.