Consumers the losers in Lloyds’ escape

November 3, 2009

Lloyds Banking Group has pulled off a stunning escape. By wriggling free from the UK government’s toxic asset insurance scheme it has almost certainly avoided being broken up. The bank, its shareholders, and the government can all claim to be getting a good deal. The real losers, however, are British consumers, who will pay the price for the creation of a superbank with more than a quarter of the UK market.

For Lloyds, the escape makes sense. Had it stayed in the government’s asset protection scheme (GAPS) it would have been forced to pay a 15.6 billion pound fee to participate in a plan that is increasingly looking like a bureaucratic headache. The European Commission’s price for this level of state support would probably have required Lloyds to spin off HBOS, the mortgage lender it absorbed less than a year ago. This, in turn, would have undermined the investment case for Lloyds.

This explains why shareholders are happy to support a 13.5 billion pound rights issue – the largest ever in the UK – even though the bank has not yet finalised the issue price. Of that, the government is putting in 5.9 billion pounds to maintain its shareholding at 43.5 percent. However, the cost to the state is reduced by the 2.5 billion pound fee that Lloyds has to pay for the implicit support it has already received. And at least ministers can claim taxpayers are no longer on the hook for Lloyds’ future losses.

Holders of Lloyds’ hybrid debt are also expected to play their part by swapping their existing instruments for 7.5 billion pounds of contingent capital notes, which automatically convert into ordinary shares if Lloyds’ core Tier one capital ratio falls below 5 percent. The Commission’s demand that Lloyds not pay interest on the existing debt for two years should encourage most holders to convert. Even if they don’t, the issue is underwritten, so Lloyds is certain to get its money.

But not everyone is better off. Key to Lloyds’ prospects is its ability to squeeze 1.5 billion pounds a year in costs out of the enlarged bank by the end of 2011 at a cost of tens of thousands of jobs. Even after it appeases regulators by offloading at least 600 branches – some of which it would probably have sold anyway – Lloyds will still control one in every four current accounts in Britain, a level of dominance unthinkable a few years ago.

Ministers now claim they are encouraging competition. But it was their decision to allow Lloyds to merge with HBOS last autumn, and their subsequent failure to reverse the deal, that has provided the bank with the escape hatch through which it has now squeezed.

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