29 October 2009
Lloyds Banking Group has been given the go-ahead to proceed with a £13.5bn rights issue as part of a wider capital-raising. Given their knowledge of the extent of the challenges facing the bank, were the tripartite authorities (the FSA, Bank of England and H.M. Treasury) well-advised to sanction this cash call? Ian Fraser investigates.
How gullible are people in the City? It’s a moot point but one worth exploring given Eric Daniels’ apparent belief that investors can be persuaded to inject a further £13.5bn into Lloyds Banking Group’s shares through a rights issue as part of a planned £21bn monster capital raising, after which the bank would remain 43%-owned by the UK government.
The chain-smoking Lloyds boss, pictured above with his Blackberry (or is it an iPhone?), needs the money because of the dire state of Lloyds balance sheet, the need to recapitalise (again) and because he is so keen to avoid having to participate in the government’s Asset Protection Scheme. Much of this stems from his catastrophic decision to buy HBOS last September.
If the bank were to fully participate in GAPS, the government’s stake in LBG would rise from 43% to 62% — which would be equivalent to full nationalisation and would make Lloyds much more susceptible to being fully broken up by the European Union.
Yet one would have thought that savvy investors would, at the very least, be sceptical of Daniels’s proposals. However there may still be a few out there who are prepared to give him the benefit of the doubt. This post is mainly for their benefit.
If such investors were to allow themselves be soft-soaped by Lloyds’s disingenuous spin machine (its P.R. and investor relations departments), they risk sleepwalking into disaster. Here are 13 reasons why they should avoid this cash call like the plague.
- Since its disastrous acquisition of HBOS last September, Lloyds’ balance sheet has not only become dangerously toxic; it has also largely become a work of fiction. The labyrinthine series of joint ventures that former BoS Corporate boss Peter Cummings entered with property and other business tycoons, often with limited paperwork and due diligence, are almost certainly over-valued in the accounts. Some of the myriad of firms acquired or part-acquired by BoS in this way, such as Inverness-based builder Tulloch Homes (in which Cummings paid £27m for a 40% stake in April 2008), have only just filed their 2007 accounts. I know there have been some “mark downs”, but given poor visibility one wonders whether Lloyds is correctly valuing such stakes in its own accounts? The valuations put on the equity stakes the bank acquired through HBOS’s “pig on pork” integrated finance model may also be inflated through the widespread use of “mark to make-believe” accounting. I suspect that Lloyds’ current auditors, PWC, will be more rigourous and conservative than their predecessors KPMG when it comes to valuing such things.
- Bank insiders tell me that internally Lloyds is in a state of chaos. Owing to internal turmoil and because disgruntled insiders in Edinburgh and Halifax have been throwing the odd spanner in the financial works, the “superbank” is struggling to come up with anything resembling accurate financial data. My source suggested this was the case during the compilation of the H1 2009 results. More and more people are wondering whether, just like Enron before it, Lloyds’ accounts are riddled with inaccuracies and even fraud.
- Even seasoned banking integration experts are agog at the size of the challenge the “superbank” faces as it struggles to eke out synergy savings by integrating Lloyds and HBOS. Lloyds still hasn’t even fully integrated the TSB business it acquired in 1995 for heaven’s sake! UKFI has apparently told the “superbank” that its favoured route to making cost savings of £1.5bn a year — circa 30,000 sackings and the offshoring of jobs — are politically unacceptable. So the bank is trying to get a quick hit from merging IT platforms and systems between the Lloyds and HBOS legacy sides of its business. The task is so massive Lloyds has hired four leading IT consultancies — Accenture, Deloitte, Ernst & Young and IBM — as it struggles to integrate legacy systems. People with inside knowledge of the situation say their fees will amount to at least £1bn over the next three years. I am told this makes the £1.5bn cost savings target first mentioned in November 2008 “pure fantasy”.
- Eric Daniels has claimed that the impairments on Lloyds’ corporate loan portfolio peaked in the first half of 2009. However few analysts or investors believe this. Given the dire state of the BoS Corporate loan book — where reckless loan was piled on reckless loan during the go-go HBOS years — analysts and investors are right to be sceptical. Daniels may be in denial, but the toxic chickens will keep coming home to roost from Cummings’s radioactive legacy for many years to come, particularly from commercial property lending.
- Lloyds Banking Group is dependent on £165bn of loans and guarantees from the Bank of England and other central banks around the world — without which it would collapse tomorrow. In its rights issue prospectus the bank admitted it remains “heavily reliant” on government funding and admits it would face “materially higher refinancing risk” were this to be removed. The funding, sourced from the Bank of England’s special liquidity scheme (SLS) and credit guarantee scheme (CGS), mostly matures in 2011 and 2012. “A lot of things trouble us about LBG, in particular the funding structure,” says Credit Suisse analyst Jonathan Pierce.
- Several major court cases are pending in which former HBOS customers who were fleeced by the bank are expected to secure compensation stretching, possibly, into the billions. The chancellor of the High Court recently consented to cases against BoS relating to shared application mortgages (Sams) being dealt with on a class-action basis and the same concession can be expected to be applied to the other cases. The scores of business customers affected by the BoS Reading scandal are making some progress with their legal action. I also understand the alleged fraud is also finally being investigated by the FSA. Imagine if LBG were to be found guilty of fraud and some of its former executives were sent to jail. In such a scenario, would Lloyds shares have any value at all?
- It is possible that HBOS’s former board, led by chairman Lord Stevenson of Coddenham, chief executive Andy Hornby and finance director Mike Ellis, fraudulently misrepresented their bank’s financial position at the time of their June 2008 capital-raising. In particular, they seem to have “buried” any information about the £260bn of toxic assets accumulated by Cummings. See my Independent on Sunday article from November 8th, 2009. Lloyds admitted it could be liable in its November 4th rights issue prospectus.
- Lloyds Banking Group was always a deliberately oligopolistic construct which Gordon Brown only promoted to get himself out of a hole. However, the resulting superbank is clearly anti-competitive and probably a danger to its clients. Chancellor Alistair Darling has been seeking to post-rationalise his stance, finally agreeing with EC competition commissioner Neelie Kroes that a break-up is called for. The bank has been ordered to sell at least 600 branches (20% of its branch network), comprising 185 Lloyds TSB Scotland sites, 164 Cheltenham & Gloucester branches and 250 Lloyds TSB branches in England and Wales. Should these gestures prove insufficient, the Office of Fair Trading, Competition Commission and a future Conservative government could step in at a later date and demand further divestments. Doesn’t this mean the whole raison d’etre for the Lloyds / HBOS merger — including proposed cost savings of £1.5bn a year — evaporates?
- In 2004-08 the FSA had succumbed to “regulatory capture” and invariably sided with banks like HBOS and Lloyds TSB against the banks’ customers. This enabled the banks to sweep wrongdoing — including the alleged Vavasseur fraud and the apparent theft of customer assets at BoS Reading — under the carpet. In today’s tougher regulatory climate, the banks are going to find such cover-ups harder to pull off and they’re more likely to be prosecuted and forced to compensate the victims.
- Lloyds’ board remains dysfunctional and lacks credibility in the City — not least because of its failure to address the issues described above. The arrival of Sir Win Bischoff, the German-born banker who retained a self-destructive course while chairman of US bank Citigroup, including sanctioning an £8bn loan to Dubai in December 2008 (well after it was known the emirate was bust), has not improved things. Unlike RBS, Lloyds failed to sack the management team responsible for its catastrophic deal.
- The “superbank” will have to pay the UK government an estimated £2.5bn to extricate itself from the government asset protection scheme.
- If it does manage to carry out a rights issue, Lloyds will have to pay some £500m in underwriting and other fees to its investment bankers. The firms involved are Merrill Lynch, UBS, Citi, Goldman Sachs, HSBC, JP Morgan Cazenove, IMI, BarCap, Calyon, Commerzbank, ING, Normura, RBS Hoare Govett, Banco Santander, Macquarie, Natixis, RBC and Unictredit. How will lining these City boys’ pockets go down with the ‘red tops’ and the general public in the current climate? (By the way, why is the “superbank” using this many underwriters? Is it using taxpayers’ money to “buy” the support of investment banks/investors/sellside analysts?)
- There’s no certainty that the government of Irish Taoiseach Brian Cowen will permit the shockingly toxic loan portfolio assembled by Bank of Scotland (Ireland) to pollute the Irish government’s National Asset Management Agency (Nama). Why should Irish taxpayers be expected to pick up the tab for this poisonous legacy?
Given the above 13 points, I cannot see how sanctioning this proposed capital-raising can be in the regulator’s best interests — or how participating in it can possibly be in investors’ interests. Even on the strength of what the FSA already knows about the alleged BoS Reading fraud alone, let alone the other matters outlined here, wouldn’t the FSA be leaving itself wide open to being sued for negligence down the line if its green-lights this plan?