Saturday, February 14, 2009


UK Financial Investments Ltd. (UKFI) already owns 100% of Bradford & Bingley and Northern Rock, and 68% of Royal Bank of Scotland (RBS) and 43% of Lloyds Banking Group (LBG), the merged Lloyds TSB and Halifax Bank of Scotland (HBOS). The total commercial banking assets this represents exceeds about $4 trillions and is therefore the biggest financial services group in the world! By virtue of being a government agency, UKFI and those parts of its conglomerate that are nationalised - all this by law now stands outside of regulatory supervision of the FSA and other national financial regulators in Europe including C-ebs at the EU level. Now the opportunity has arisen, following the LBG interim trading statement, to complete the entity neatly by increasing the government share of LBG to more than 50%.
If this is what Eric Daniels, CEO of LBG, wants to have happen, then fine. He told the Treasury Select Committee that except for the takeover of HBOS his bank would not have been in need of a government shareholding (liquidity infusions via the Bank of England is another matter). If it is not what he wants to happen, then I suggest heads should role for the cack-handed way in which the interim trading statement was drafted and announced. As argued in the my blogs in the figures have been misrepresented giving a false impression of the underlying profitability and soundness of HBOS.
Speculation is mounting in the UK media that the Government may be preparing to increase its stake in LBG, after Chancellor Alistair Darling declined to rule out the option of nationalisation, having previouslysaid it is undesirable. The group stunned the City by warning of £10 billion in annual losses at HBOS, which it rescued with direct Government backing, involvement and approval when Lehman Bothers collpased on 15 September 2008. The takeover completed on 16 January 2009. LBG may have thought that results for the period preceding the takeover completion would not have had a dramatic effect on its shares and other bank shares. If so, that was a foolish assumption, not least now that short-selling is again unconstrained.
UKFI owns 43% of LBG after the government pumped £17bn into the two banks, and was left with paper losses of more than £2.5bn at a low point yesterday when Lloyds' shares had fallen 40%.
The Chancellor, Alistai Darling has defended the Government decision to broker the merger of Lloyds and HBOS and offer financial backing, saying that failure to do so would have brought down HBOS and potentially collapsed the whole UK banking system.
Speaking from the G7 finance ministers summit in Rome, he said the immediate priority was to identify banks' bad assets and "put them out of the system", warning that without this step normal lending to businesses and individuals cannot resume. The official reason for the merger was funding (liquidity risk) which means inability to fund the gap between loans and deposits. This lies more essentially at the heart of the problems of the banks - wholesale funding so that the banks will not have to dramatically call in loans and reduce their loanbooks by up to 30% at worst. The funding gap in UK banks is about £800bn to be reinanced over 3 years and £185bn has been supplied by the Bank of England's SLS in 2008, and another £200bn or so will follow in 2009. So, arguably, this is all being taken care of via the Bank of England.
Asked on two occasions during an interview with BBC2's Newsnight whether he could rule out nationalisation of LBG, Mr Darling did not do so. Instead, he responded: "I said in January there is a range of options that we will be deploying, a range of levers that can be pulled to help all banks, because I have made it very, very clear that the integrity of the banking system is very, very important. What we are focusing on at the moment is making sure that we can identify these bad assets and then deal with that problem. That's our focus at the moment and that will continue not just here but it will continue across the world as well."
Liberal Democrat Treasury spokesman Vince Cable, who has become an always available ever-ready gloomy crtic of the government, said: "It looks increasingly as if Lloyds is being dragged under by the dead weight of HBOS, a financial disaster created by Andy Hornby and his predecessor, Sir James Crosby. Obviously we need to digest the detail, but it looks increasingly as if Lloyds HBOS will now go into majority public ownership, followed inevitably by nationalisation." Ken Clarke, for the Conservatives, is in catch-up mode and finds himself echoing the Cable.
Eric Daniels who undoubtedly felt he had the trust of the government and therefore may have believed they would take his opinion on the matter, may now find that he has no more freedom for manoeuvre than he gave HBOS and his bank is now firmly in political hands and what happens to it will be determined by the Treasury.
The Conservatives have been most anxious that the Government's control should be arm's length and temporary.
This was transparently not so in facilitating the Lloyds TSB, HBOS takeover/merger. Eric had insisted on no reference to the Competition Commission. The Government complied, but found that this was roundly resented. There was a lot of popular and even institutional tacit support for the action by the Merger Action Group before the Competition Appeals Tribunal to make the case for referral to the Competition Commission as recommended by the OFT. Eric wanted the freedom to determine himself what parts of HBOS to keep and what to sell. Now all of that commercial latitude may be taken away and will be decided by the Treasury's UKFI board. How it operates and decides matters is not subject to FSA approval or Companies Act or Code of Conduct.
The remaining private shareholders are along for the ride, very much on the tiger's back. Some of the major institutional investors may have envisaged no more share value dilution and opportunities to cherry-pick in the HBOS carcass. One law that will not apply, however, is that if LBG is nationalised whatever is sold out of HBOS parts or Lloyds TSB parts will be subject to full EU competitive tender and the decisions will be by UKFI board, not the LBG board. The commercial freedom to exploit the merger that Eric Daniels so ravenously desired will be lost to him!

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