Page last updated at 17:13 GMT, Thursday, 12 November 2009

Decision time for Lloyds shareholders

Money Talk
By Justin Urquhart Stewart
Seven Investment Management

Justin Urquhart Stewart
Justin Urquhart Stewart is from Seven Investment Management

Lloyds Banking Group now finds itself with the largest shareholder base in the UK, at 2.8 million.

All of these shareholders are finding a 240-page document landing on their doormats outlining the biggest rights issue in history.

Why? First let me put the position of the bank into context. Over the past 12 months the share price has fallen from a peak of £8.20 in April 1998 to a nadir of 25p in January 2009.

This reflected the horrendous losses and liabilities that became apparent throughout the year. As a result, the company announced last week that for the second time in a year that it would have to go back to its shareholders for more help.

Its shareholders now, of course, include the government which has a 43% holding.

Toxic assets

The bank has decided to raise more money to allow it to avoid the government's Asset Protection Scheme (APS) which is the insurance plan for banks' toxic assets.

If you are willing to take at least a five-year view then it is likely that the bank will recover and the shares will rise and eventually even start paying a dividend

However, the cost of being in such a scheme is expensive, as Royal Bank of Scotland is already finding out.

Lloyds therefore is now looking to raise £13.5bn from shareholders in a rights issue and a further £7.5bn by converting other debt into equity, a total of at least £21bn even though its current market capital is just £22bn!

Over the next few weeks shareholders will be receiving some weighty documents detailing the conditions of the rights issue and their alternatives. As yet we do not know the price of the shares which, as an incentive, will be at a significant discount to the current price.

We expect the rights issue to be launched on 24 November, two days before a shareholder meeting at the NEC in Birmingham to vote on the share issue.

At that point they will announce the price, and they have given us some guidance that it will not be less than 15p but could rise to 40p. After that shareholders will have to get their decision in by 11 December.

So what are shareholders' options? They will have three alternatives.

Firstly, they can take up their rights and pay for the shares.

Secondly, they can "sell their rights" where they will be paid the difference between the rights issue price and the share price at the time it goes ahead.

There is also a third option known as "tail swallowing" where shareholders can sell a proportion of their rights in order to pay the rest of the rights they are entitled to.

Shareholders will have until 11 December to make up their minds.

Problem solved

A problem for some of Lloyds' small investors who own preference shares has now been resolved since the deal was first announced.

Lloyds
Lloyds Banking Group has 2.8 million small shareholders

At first, those who owned £1,000 worth or more of the preference shares could not take part in the fund raising exercise, if their stockbroker used only the Crest paperless share registration system.

Lloyds had organised the deal so that it could only be accessed by investors whose brokers used either the alternative Euroclear or Clearstream systems.

The potentially disenfranchised people were faced with either being locked out, or having to change their stockbroker to take part.

Dealing via Crest is now allowed, so that problem has gone.

So those investors can choose, if they wish, to accept some of the newly issued ordinary shares or another bit of investment paper, similar to a bond, called an Enhanced Capital Note (ECN) .

However, investors who own fewer than £1,000 worth of preference shares still cannot opt for either of the new bits of paper.

They will simply be offered cash instead, but at a premium to the market value of the preference shares.

All this is entirely voluntary, though, and any investor can simply choose to hang on to their current investments if they wish.

So what should they do?

The good news is that the bank is effectively backed by the government, which has said it will be taking up its rights in the issue - about £4bn. The bank is therefore unlikely to go bust, but full nationalisation is still not out of the question.

The bad news is that the bank will have a huge amount of bad loans to write off over the next few years and is quite likely wipe out any profit for some time. There will be no dividend for at least two years, something which Lloyds was renowned for in years past.

The future

However, within the financial mess of the group, there is at its core an efficient domestic banking business which is profitable and will very likely improve over the next few years as the UK economy does.

Nevertheless, any recovery is likely to be slow and languid and thus the banking industry will reflect this weakness.

Additionally, it was announced last week that under the direction of the EU competition requirements, Lloyds will have to shrink its current account business by 4.6% and also reduce its mortgage business.

This will be achieved through an overhaul of the retail banking business including the disposal of branches of Cheltenham & Gloucester, Lloyds TSB in Scotland and certain Lloyds TSB branches south of the border. This is to be done within the next four years.

So the outlook is not particularly appealing. If however you are willing to take at least a five-year view then it is likely that the bank will recover and the shares will rise and eventually even start paying a dividend.

Lloyds' adverts used to say "for the journey" - maybe, but it will be a rough one.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.



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