Business | Features
Lloyds chief banks on yes vote
Stress levels were running high for Daniels ahead of putting the detailed plans for the bank's £22.5b record capital-raising venture to shareholders
- Financial Times
- Published: 00:00 November 30, 2009
- Image Credit: Ramachandra Babu, Gulf News
This spring, with equity markets plunging and bank results deep in the red, was probably not the best time for a banker to try giving up smoking — especially when that banker was Eric Daniels, chief executive of Lloyds Banking Group.
But the stress that Daniels felt then, as he grappled with his acquisition of the troubled HBOS and its vast portfolio of rapidly souring lending, was nothing compared with what he was about to go through. He has spent the past six months fighting a battle on four fronts — with the government (his biggest shareholder), with regulators, with the European Commission and with his own investors, as he has sought record amounts of fresh funding to put Lloyds back on track.
Sure enough, a few weeks ago, he buckled. Colleagues relate with amusement how their boss could be seen scurrying around the office, delving into drawers in which he had hidden stashes of cigarettes.
"Was there anything you wanted, Eric?" asked a bemused Tim Tookey, the bank's finance director, after Daniels burst into a meeting with financial advisers, rifled through a filing cabinet and headed for the door without uttering a word. The chief simply held up the packet of Marlboro Reds and smiled wryly.
The anecdote is revealing as much for the smile as for the craving for stress relief. By last month, it was clear that Daniels' plan to raise £13.5 billion (Dh81.6 billion) in the world's biggest ever rights issue, combined with a further £7.5 billion — now raised to £9 billion through a complex restructuring of bond finance — was on the verge of coming together.
The fund-raising is designed to allow Lloyds to contain the UK government's ownership at 43 per cent, following a bail-out late last year that was a consequence of Lloyds' rescue of the rival HBOS at the state's behest. In particular, the new capital should allow the bank to avoid the stigma, cost and increased state ownership entailed by the government-sponsored Asset Protection Scheme, an insurance vehicle that would have cost £15 billion in premiums but gave regulators confidence the bank was safe.
Thursday saw the last showdown for the Lloyds CEO as he put the detailed plans for the bank's £22.5 billion capital raising to shareholders and set Lloyds up to stand on its own feet again. Shareholders voted yes in a tense meeting.
Only a few months ago, many commentators were writing Daniels off. Already the government body charged with managing its bank shareholdings — UK Financial Investments — had dispatched Sir Victor Blank as Lloyds' chairman and overseen the installation of Sir Win Bischoff, who used to chair Citigroup.
In the autumn of 2008 — within days of the Lehman Brothers collapse that sent the world's financial markets into turmoil — Gordon Brown, prime minister, had famously buttonholed Sir Victor at a cocktail party and launched the idea of a Lloyds-HBOS deal. By the spring of 2009, that deal had been done but markets had hit a nadir, wiping 90 per cent off the value of Lloyds' shares.
Surely a chief executive who had taken over HBOS, had admitted to parliament that due diligence on the deal might in normal circumstances have taken "three or five times more" time than the 5,000 person-hours committed to it, and had gone on to find that HBOS had racked up losses of £10 billion for 2008, double the expected tally, could not cling on to his job.
Insurance structure
Within weeks, his ignominy was compounded as his bank was herded by the government into the APS insurance structure, agreeing a fee, payable in stock, that would have seen the government's economic interest in the bank rise to a painfully high 60 per cent.
"Eric was under a huge amount of pressure in March," says one banker who has advised Lloyds and Daniels for years. "The government was quite vicious. He felt that they had just extorted £15 billion as a fee for a scheme that had no genuine economic benefit."
But Lloyds' chief executive was in no mood to throw in the towel. Asked to describe Daniels, "determined" is the adjective on the lips of everyone who knows him well. American-born to a Chinese mother and German father, he is as gritty at the core as he is placid and polite on the outside. (Fishing in his native Montana is his favourite hobby.)
Angela Knight, chief executive of the British Bankers' Association, says: "He is one of the best retail bankers around. He's the sort of person you'd call if you've got a war on." And Lloyds was certainly under siege.
Some still see smoking as not his only weakness, however. One top City analyst says anyone capable of upending Lloyds' low-risk strategy and pitching it into several years of loss-making cannot be trusted to run the show. "Is he up to the job of running the bank? Clearly not."
Yet although he booked £13.4 billion of loan loss impairments for the first half, Daniels made clear he was confident that bad debts had peaked — a crucial signal to the market that there was hope for Lloyds amid the carnage of the HBOS deal and there was an economic argument for trying to escape from the APS scheme and its vast insurance premium.
In June, as Daniels saw the first bright spots in the bank's second-quarter performance and the glimmers of broader economic improvement, he started to hatch a plan for a massive fund-raising that might act as an alternative backstop.
He began assembling his close advisers — Alex Wilmot-Sitwell and his team from UBS, Matthew Greenburgh and colleagues from Bank of America Merrill Lynch.
"One day Eric rang up and said: ‘I think I've found a way to get out of APS'," recalls one banker. Just hours later, Daniels was at the Connaught outlet in Mayfair, sipping his habitual drink and talking his advisers through his idea.
"Eric's conviction in the face of a lot of opposition was that this was the way to protect investors' interests," says another City grandee who later advised on the deal. "A lot of people shared that sentiment but were not convinced it was do-able."
Ever since, he has been battling to get his "Plan B" past an array of doubters and opponents. The toughest tussle has been with the government — principally Lord Myners, the City minister, and Hector Sants, head of the Financial Services Authority, both of whom remained unconvinced for months that Lloyds could raise sufficient funds with sufficient certainty. The government was also wrestling with the financial and political impact of backing a new fund-raising.
On another front, Daniels was embroiled with Neelie Kroes, the European Union's tough-talking competition commissioner, as the bank struggled to minimise the state aid penalties to be imposed for taking the government's £10 billion of bail-out money (now being topped up to nearly £16 billion via the rights issue).
All the while, Daniels — a man who in six years in the job has never been close to his shareholders, let alone charmed them — was having to counter investor scepticism, rooted in the abrupt transformation of Lloyds from a safe and boring bank into a high-risk lender following the HBOS deal.
Though the potential long-term benefits are clear— with an unparalleled market share, even after concessions to the EU are met, of about 25 per cent — there are near-term risks, with at least two loss-making years ahead, according to some analysts.
It was against that background that Daniels forced himself out of his comfort zone of dealing with the bank's internal workings and out on an ambitious roadshow to try to convince both bondholders and shareholders that his capital-raising plan made economic sense.
By late August, when he held a board meeting to present his strategy to exit APS, it appeared Plan B was going to work. Investors had been buoyed by Daniels' optimism that the worst of the bad debts were over.
UBS and Merrill had the skeleton of a plan in place, which would combine a rights issue, to raise fresh equity, with a conversion of existing debt into higher-ranking securities.
Shrinkage
The FSA reluctantly backed the plan, albeit with the proviso that the total sum raised should be higher than originally planned — in a spirit of caution, it said Lloyds would have to fill a hole of about £25 billion through a combination of shrinkage and at least £20.5 billion of fresh capital.
In spite of the higher bar, Daniels and his advisers were confident they could raise the money. It remained for the government to give the deal the green light. But Alistair Darling, the chancellor, sat on his hands for weeks, nervous of the political capital that the opposition Conservatives and Liberal Democrats would make out of a plan that would involve injecting nearly £6 billion more cash into a risky bank, while at the same time removing a comforting safety net from underneath it.
Darling was keen on a compromise solution — a modest capital raising combined with a reduction of Lloyds' original participation in the APS scheme, which would have seen the government underwrite about £130 billion of toxic assets instead of the planned £260 billion, with the premium reduced accordingly. Investors hated the idea.
Not only was the APS punitively expensive; barring financial meltdown, its terms meant that it was extremely unlikely ever to pay out.
Signs of progress came towards the end of last month. First came the punishment, as Lord Myners — after months of meetings with Daniels that were variously described as "volatile" and "bullying" — extracted a hefty price for the implied benefit of the APS scheme. Though the APS was technically not yet in place, the government imposed a £2.5 billion charge for the seven months it had been in planning.
Then, on October 28, Darling gave Lloyds the go-ahead to begin officially testing the water for the rights issue in a so-called pre-marketing campaign. By 9am the following day, Daniels was spied in the City meeting his biggest investors.
"It was Eric's force of will that convinced the government the cost of partial APS would have killed the equity story [for shareholders]," says one banker. "They realised they would look stupid for standing in the way of it."
Thursday's vote, widely expected to endorse the capital raising, signals a remarkable turnround from the spring and summer when commentators were dismissing Lloyds' prospects and predicting that Daniels' days as chief executive were numbered.
His fans say the bank is set fair, on the verge of proving that its take-over of HBOS was an inspired move, and that Daniels is the man to oversee the creation of the biggest force in British high-street banking.
Step down
Some investors suggest that given the self-inflicted trouble from which he has had to extract Lloyds, he should step down before the end of next year. The consensus, though, seems to be that at the very least, the against-the-odds fund-raising that Daniels has piloted has won him time to disprove the sceptics.
"If we hadn't got this done, he would have gone," says one close adviser. "Without doubt, he has been given a stay of execution. But Eric has said some pretty bullish things, particularly about impairments. Now he has to knuckle down and deliver."
Probably not the time, then, to try giving up the Marlboros again.
Lloyds' £22.5 billion capital raising breaks a string of records. It is the biggest ever fund-raising, according to bankers, incorporating the biggest equity capital raising via the biggest rights issue (£13.5 billion) anywhere in the world.
One other element of the deal is unprecedented — switching existing bondholders into "contingent convertible", or CoCo, instruments, which will raise another £9 billion of potentially top-notch capital.
Lloyds' CoCos begin life as debt, paying a regular set interest to investors, but will turn into equity if Lloyds' losses worsen to such a degree that they eat into capital and cut the core tier-one ratio — the key measure of capital strength — to less than 5 per cent from its current level of 8.6.
It is a clever, complex structure, which bankers admit is probably more about regulatory box-ticking than practical use. If the group's capital ratios collapse to such an extent that the bonds look like they will be converted into equity, the chances are that the bank will already be in crisis, with both profits and share price tumbling. At such a time converting a slug of CoCos into equity, and diluting existing investors, could be disastrous.
However, Lloyds' shareholders seem to like the concept, on balance, because it means bondholders share some of the burden of refinancing. Most bondholders like the idea too because, unlike with existing debt, European Commission state aid rules do not prevent the payment of interest on the new instruments.
More broadly, CoCos are seen as fitting for the times — governments, regulators and investors all want banks to hold more robust capital buffers. Lloyds' issuing of the instruments is expected to be copied by banks around the world that need to strengthen their capital.
Already nationwide, the UK's biggest building society, has signalled that it is in discussion with regulators about adapting the model for use in the mutual sector.
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