Are Lloyds shares cheap? Not as cheap as this funny money

August 19, 2009

Shares in Lloyds Banking Group are worth 150 pence apiece, according to the analysts from Royal Bank of Scotland, who think the shares offer “a compelling restructuring opportunity” around today’s 95 pence.

Lloyds, say the brokers, is going to recover sufficiently to pay a nominal dividend next year, and something quite substantial in 2011, thanks to margin expansion, cost control and normalising bad debts.

Well, maybe. Over in the distressed debt market, they are a lot less sure. Mind you, they are not very sure of anything, and anomalies abound. Brokers Collins Stewart, who have specialised in the backwaters of preference shares and PIBs, have one this very day. They are offering the snappily-titled HBOS Capital Funding 9.54 percent fixed-to-floating perpetual preferred securities at 65 pence.

The buyer gets a 14.68 percent return until 2018, when he either gets 100 pence, or the coupon is reset at Libor plus 6.75 percent, a rate deliberately designed to be punitive for the borrower, which is of course, HBOS’ parent, Lloyds.

That, at any rate, is the theory. Existing holders of these obscure instruments have little idea how to value them. As Collins Stewart point out,  similarly-ranked paper from Lloyds itself yields 11.28 percent. There’s the additional risk of Lloyds following Northern Rock’s example and electing not to pay the interest, since it’s clear that the bank is still short of capital.

The point, though, is that Lloyds cannot pay a dividend if interest on these higher-ranking securities is not up to date. If the RBS analysts are right, then the mouthful of HBOS stock above is cheap; it looks better value than the shares, at any rate.

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