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Rights and wrongs at Lloyds Banking
If you’ve ever wondered how the big-shot investment bankers “earn” their bonuses, the document launching Britain’s biggest rights issue will give you a clue. Lloyds Banking Group is issuing 36,505,088,579 new shares, to add to the 27,161,682,366 currently in issue.
The new shares will raise 13.5 billion pounds, of which 500 million pounds will disappear in the expenses of the offer. Much of this is paid to the banks which are guaranteeing that Lloyds gets its money, a reward for the risk they are taking that the shareholders will fail to take up their rights.
So just how big is this risk? Here’s one way to look at it. The rights price is 37 pence, and as long as the Lloyds share price remains above that, the risk is minimal. At 37 pence, engorged Lloyds, with 63,666,770,945 in issue, would be capitalised at 23.5 billion pounds, including the 13.5 billion pounds of new money. On Tuesday, the day the issue was priced, with Lloyds old shares at 91 pence, the business was valued at 23.5 billion pounds.
In other words, for the underwriters to pay up, the value of old Lloyds would have to slump from 23.5 billion pounds to 10 billion pounds – and all by December 11, the day on which the new money is due.
Investors ignore ratings at their peril
Rexam is delivering a nasty surprise to its shareholders, but the logic of its proposed rights issue is hard to fault.
If trading turns out to be as bad as the board expects, then the penalty payments for refinancing its existing debt will far outweigh the cost and dilution of the issue.
Broker Oriel Securities reckons the cost to Rexam if it loses its investment grade rating will be an extra 8 to 12 million pounds a year in interest payments.
Businesses everywhere are rediscovering the joys of equity, as the way to stave off the dreaded downgrade. So far this year, shareholders have put up $119 billion, according to Thomson Reuters data, with $28 billion more due.
Even cash-rich carmaker Volkswagen is reported to be considering issuing shares to bolster cash reserves and pre-empt any ratings downgrade relating to its merger with Porsche. Spanish utility Iberdrola and French construction groups Lafarge and Saint Gobain all took similar steps to bolster their ratings.
Unfortunately, credit ratings agencies are so jumpy about regulators and the risks of legal action by investors that companies can’t always bank on such moves working.
Saint Gobain launched a rights issue, but still S&P cut it to BBB from BBB+. Lafarge did worse. Fitch not only cut its rating to BBB-, it added a “negative outlook”.
One reason ratings have increased in importance is that as banks have turned off the taps, companies have turned to the bond markets, allowing the agencies like Moody’s Corp and McGraw-Hill’s S&P to cash in.
Experience has taught them caution, however, and the number of issues downgraded from investment grade to junk is on the rise. The threat of this — with the higher cost of borrowing and reduced market access it brings — is a powerful incentive to go to the shareholders. S&P has identified 75 issuers — with $255 billion of debt — in danger of losing their coveted investment grade.
The unhappy experience of Rexam shareholders is likely to repeated many times as the debt crisis unwinds, but at least it’s better than losing control of the business to its lenders.
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The Wall
