Lloyds sale of Verde hits huge obstacle

Lloyds bank sign

09:38: Now that the prospectus has been published for the forced sale of a big chunk of Lloyds, which goes by the name of Verde, serious doubts have emerged about whether Verde as currently constituted is actually sellable.

Here is what you need to know.

Under orders from the European Commission, Lloyds is selling 632 branches, equivalent to 22% of its branch network - and initial bids need to be received by mid July (which is a bit quicker than expected).

However, these branches deliver just 9% of Lloyds' profit - largely because what's being sold is in effect a low-margin mortgage bank, without the benefit of all the other higher margin loans and products that Lloyds also sells its millions of customers.

Now the relatively low profitability of the branches will have an impact on the price Lloyds eventually receives for Verde. But that is not the massive obstacle to a sale (because any new owner would presumably take steps to flog other things to the 3m to 5m customers that bank with those branches).

What makes a disposal close to impossible is that Lloyds has been instructed by the European Commission to sell £68bn of assets, largely mortgages, and customer deposits of nearer £35bn.

So there is what bankers call a funding gap of more than £30bn.

The point is that any buyer would have to pay Lloyds £68bn for the assets, but some £35bn of this would be covered by the £35bn of deposits that are being transferred to the successful bidder. The remaining £33bn has to be raised from investors in the form of regulatory capital and new debt.

Or to put it another way, any successful bidder would have to borrow at least £30bn.

Which would not be a massive problem if Lloyds were allowed to sell Verde to one of the UK's big banks. But Lloyds is prohibited from selling to them, because the whole point of the disposal is to promote competition.

The banks that will be allowed to bid are those that are small, such as Virgin Money or the shell company NBNK, or foreign, such as National Australia Bank.

Now it would be technically possible to borrow the £30bn - largely because the advisers to Lloyds on the Verde sale, Citigroup and JP Morgan, have promised to provide the necessary bridge finance.

But the bridge finance would be expensive, relative to the interest the owner would receive from Verde's mortgage lending.

Perhaps more importantly, borrowing that much on wholesale markets is neither a stable or prudent way to fund any bank - as the UK taxpayers found out to their cost when Northern Rock, Royal Bank of Scotland and HBOS all went to the brink of collapse after their access to wholesale funds dried up in 2007-8.

So any owner of Verde would over time wish to replace all or most of that £30bn of wholesale funding with retail funding.

However £30bn is a significant chunk of the entire retail deposit market.

Perhaps for me the most shocking statistic, in that context, is that at its peak - in the middle of 2007 - Northern Rock had £24bn of retail deposits, less than the retail deposits that any new owner of Verde would have to take from other banks in order to put Verde on a sound funding basis.

Lloyds already knows that this funding gap is a serious problem for the Verde sale, although there may be a fix.

I am told there is a clause in the European Commission's order to Lloyds on the disposal which allows Lloyds to go back to the Commission and renegotiate, if the package of assets mandated for disposal simply can't be sold.

Bankers say that what Lloyds needs to do is persuade the European Commission to reduce the package of mortgages and other assets being sold from £68bn to something a good deal nearer the £35bn of customer deposits on offer.

But trying to renegotiate in that way could be very dangerous for Lloyds.

The reason is that the Treasury is intimately involved in the negotiations with Lloyds and the European Commission on what Lloyds should sell to promote competition. And the Treasury is under intense pressure from the Independent Commission on Banking, which it set up, to force Lloyds to sell an even bigger business than it wants to do.

In that context, it would be almost impossible for the Treasury to acquiesce in a decision to shrink the business being sold by Lloyds. The politics for the chancellor of reducing the size of the sell-off would be terrible, given that the Treasury Select Committee has raised serious concerns about Lloyds' current market share.

So there is a serious risk that the Treasury would force Lloyds to close the funding gap by including even more customer deposits in the package of what is being sold - which Lloyds would hate.

Right now, the Verde disposal looks like the corporate finance equivalent of a huge looming car crash.

Update, 17:46: If all goes well, the Verde sale will complete in around two years. It will take as long as that, largely because the technological and legal challenge to carve out a banking business of this size is massive.

What is interesting is that Lloyds believes that if the successful bidder borrows £30bn to buy Verde, to close the funding gap, some £20bn of that will have been repaid within 18 months of the completion of the sale - just from Verde's customers paying off their mortgages and putting cash into their current accounts.

So Lloyds is trying to reassure bidders and the regulator that there isn't an insuperable funding problem here.

What's more, if no bidder is prepared to take on that financing risk, Lloyds has been given the option by the European Commission to reduce the volume of mortgages being sold - such that the funding gap 18 months after completion would be as low as £5bn.

We'll see if Lloyds' optimistic projections about how the funding gap can be closed will reassure bidders.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 77.

    I don't believe this article. If purchase of Verde's assets can not be financed at this price, the assets are clearly overvalued: bidders will surely bid at a level which they judge reasonable value. The consequence would be Lloyds -TSB booking the difference as a hefty loss. That really would be mark to market and may call into question Lloyds-TSB's solvency?

  • rate this

    Comment number 76.

    Whistling Neil
    4 Hours ago

    63 I suspect you may have overbid.


    Another bank mis selling scandal .....Im calling my lawyers before I sign

  • rate this

    Comment number 75.

    Lloyds buys basket case HBOS after competition authorities ALLOW them to, write off billions on bad loans, share price plummets, EU say that Lloyds have to sell 600 branches, Banking Commission state Lloyds may have to sell more. Govt appear to agree.
    Govt change the rules to suit.. should support Lloyds, ignore EU, as without Lloyds, HBOS would have cost taxpayer billions. No need for Verde.

  • rate this

    Comment number 74.

    @26 Wee-Scamp

    If Scotland had been independent 3 years ago then

    1. The rest of the UK would not have had to prop up two SCOTTISH banks
    2. Scotland would be even more of a basket-case than Ireland

    Just count youself lucky that the rest of us do not declare UDI on you.

    Should have done it years ago. No Blair, no Brown, no RBS, no BoS.

  • rate this

    Comment number 73.

    They should sell it to the Bike of Ireland. BOI will then offer 20p in the pound to each deposit holder or a very generous 40p worth of BOI shares to those speculators having more than £50,000 on deposit. This fair, essential and compulsory offer could be justified on the grounds of burden sharing.

  • rate this

    Comment number 72.

    We are doomed, anything that Crash had a hand in will haunt us for decades, and it is increasingly clear that the current PM is not he Heir of Blair, but the Heir of Crash - the fact that he can still rate higher than Crash's apprentices in the Nu Old Labour praty sums it up. One good thing, we have global warming, I can't afford my energy bills now, imagine if it got really cold in winter!!

  • rate this

    Comment number 71.

    European Commission??? Bow down to this incorruptible body of infallible experts they must be right.
    And of course mortgages are assets? right on, what class are these mortgages surely not subprime.
    Verde - doesn't this also mean a green incrustation, a corrosion?

  • rate this

    Comment number 70.

    The sooner the government get out of banking the better. Remove the need for banking licenses and the free market will determine which organisations people trust there currency with. All this posturing and "deal-making" by ministers is just making things worse and frankly it is getting embarrassing.

  • rate this

    Comment number 69.

    58. its not difficult to make money from mortgages, but it is tricky to quantify the level of risk of default, especially when property bubbles like ours are bursting all around the world. Of course the new Verde could rely on the IMF to bail them out (with a loan we have to pay back) if that happens, but I suspect that you have to know the right people to be a member of the club of never-lose.

  • rate this

    Comment number 68.

    Presumably an individual would have to give their consent to having their account transferred; so what would happen if the majority said no?

  • rate this

    Comment number 67.

    63 I suspect you may have overbid.

  • rate this

    Comment number 66.

    Remember the wizard way of raising cash in the '80s? Privatisation. Instead of that, how about stockmarket floatation? How about spinning off the Halifax? Perhaps enough will be raised for it to buy Verde. Job done. I like the vicious circle of this, the taxpayer gets to buy what he already owns, only this time he is in position to make something back!

  • rate this

    Comment number 65.

    @13 KitGreen

    I agree it would be better if fewer acquisitions were funded via debt, but I doubt many (if any) companies have £30bn just kicking around that they could stump up to buy Verde - and even if they did, Verde would remain under pressure to massively increase its retail deposits to deal with the funding gap - not easy to do if new owner wants a similar profit margin to other UK banks...

  • rate this

    Comment number 64.

    The BBC seem to be having a problem with their improvements

    Lessons will be learnt!

  • rate this

    Comment number 63.

    Why should there be an obstacle !Everyting can be sold at the right price.

    Its called capitalism

    Let me start the bidding at 25p Subject to contract of corse

  • rate this

    Comment number 62.

    When I first saw the name 'Verde' I immediately transcribed it to Merde and I am afraid that is exactly what it is! For both vendor and purchaser.

    I can see the court cases now my bank tried to sell my account without my permission - I demand compensation!

  • rate this

    Comment number 61.

    Anyway, who'd buy a used bank off these people. We've no lomger got "The more you pay, the more it's worth"!

  • rate this

    Comment number 60.

    Looks like a chance for BoE to go into retail banking and show how it should be done.

    Or UKGov (i.e. us) to buy it of itself (i.e. us) and give it to the Post Office (i.e. us) to run as a no risks simple banking bank (for us)?

  • rate this

    Comment number 59.

    "There will be plenty of potential buyers with new entrants such as foreign banks, start-ups and private equity firms joining existing players," quote off internet

    How many "start-ups" have £30bn in the bank? maybe under the more relaxed lending of a couple of years ago, but now! you'd be laughed out of the bank "£30bn, we can offer you £20bn, but i'll have to check with the manager first"

  • rate this

    Comment number 58.

    Wildsnoopster - Agree with your comments entirely.

    The comments here really show how ignorant most people are. Robert's blog is really showing how difficult it is to generate money from mortgages yet people here claim the Bank's are ripping us off.

    A case of having cake and eating it methinks!


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