Lloyds: The Key Issues

Lloyds Banking Group - The Key Issues for Shareholders

This note attempts to explain some of the issues that have arisen for the current Lloyds Banking Group shareholders (including those specific to former LloydsTSB and HBOS shareholders). Note that there are probably about 3 million shareholders in the company overall, most of whom will be private individuals each with relatively few shares that they acquired from former demutualisations. However there are also large holdings by some individuals as well as substantial institutional holdings as one would expect in this FTSE100 company.

The issues of concern to shareholders tend to differ depending on whether they were originally HBOS shareholders or LloydsTSB shareholders, so they have been split into the following two categories and into a third general category.

1. HBOS shareholders
   
   1. The concerns here probably relate mainly to how the company managed to get into such difficulties that it eventually had to be “rescued” by LloydsTSB. In reality, it was clearly heading for administration or outright nationalisation at the time of the merger. Indeed many people feel that the Government encouraged the merger specifically to avoid the embarrassment of having to nationalise it.

      In essence what happened was that the company followed a path of rapid expansion of both its retail housing mortgage book and its commercial property book in an aggressive if not reckless manner, mainly financed by 'money market funds' and hence was heading for the same liquidity crisis that Northern Rock and Bradford & Bingley (who used the same business model) faced.

      The risks associated with this strategy were apparently advised to the board (as explained by Mr Moore in his evidence to the Treasury Select Committee but he was ignored). There is also good evidence about the high risks and poor structure of the deals undertaken in the commercial property sector (several people have advised us that they were seen as a 'soft touch' and property developers would go to them when nobody else would touch a deal). Were the directors of HBOS imprudent, did they ignore well-founded warnings, and could they be seen as irresponsible and negligent in their stewardship of the company? Likewise did they fail "to establish, implement and maintain adequate risk management policies and procedures” as required by the FSMA Act.

   2. HBOS also undertook at large rights issue some time before the merger with LloydsTSB and it might be questioned whether the prospectus disclosed fully all the potential liabilities. Also there is the issue of whether the accounts were properly audited and reported.
   3. There is also the issue of whether regulation by the FSA of HBOS was adequate. Why did they not prevent the excessive risk profile of the company and how much was known by the regulatory authorities about the impending problems?
2. LloydsTSB shareholders
   
   1. Many LloydsTSB shareholders believed the merger was a mistake – indeed although 96% of LloydsTSB shareholders voted in favour of it, perhaps based on the directors recommendation, we believe that most of the people voting for it also owned HBOS shares (true of many institutions and even private shareholders). Were the LloydsTSB directors influenced by both the Government and their institutional shareholders who held HBOS)?

      In reality LloydsTSB was a well diversified and low risk bank paying a high dividend yield that would not have needed Government finance if they had not taken over HBOS (the latter was admitted by Eric Daniels). The risk profile of the group changed enormously because of the HBOS acquisition which was concentrated in the property sector. Dividends were axed, and the Government immediately gained control of 43% of the enlarged company. Subsequently (and it could easily have been anticipated), the percentage of Government interest could rise as high as 77% with the latest proposals which have arisen from the need to further protect against the defaults in the HBOS loan book. In practice the Government has gained control of this company at minimal cost, and the LloydsTSB shareholders have had the value of their equity eroded in the name of protecting the wider stability of the financial sector.

   2. Was the merger offer document misleading for example in relation to the stated potential liabilities of HBOS, the comments about Government funding that might be required, etc? The liabilities have subsequently turned out to be higher than forecast if you read the recent Lloyds announcements, but it seems from the comments of Lord Turner that the FSA realised that they might be so. Was that information adequately disclosed?
   3. Also was reasonable and sufficient due diligence done? Daniels comments to the Treasury Committee suggested otherwise, although the company seems to dispute that.
3. All shareholders
   
   1. The latest “Asset Protection Scheme” which involves the Government insuring the poor quality assets (most of which have come from HBOS) also looks highly questionable. This seems to be more in the interests of the Government, and the general economy, by enabling the company to increase its lending, than it is in the interests of shareholders. Again further dilution of the original equity shareholders is taking place, and larger Government control and ownership.
   2. There has been a suggestion made that the Treasury and the Government have manipulated affairs, including 'leaking' of information, such that it has enabled them to gain control of these companies at a nominal cost. For example, the original need for the 'recapitalisation' and merger of these companies arose from the changes to the FSA imposed 'core capital' ratios that required them to raise enormous amounts of money to strengthen their balance sheet at very short notice. Only one company (Barclays) even attempted to do this and at very great expense, whereas the other main UK banks had to fall back on the Government. This could be seen as manipulation by the Government to gain control of these companies at the expense of the former shareholders