Lloyds Rights Issue: Just one small point, Darling

I see that this week’s Guardian Money letters page includes the clarification that, as I’ve also pointed out, the Lloyds rights issue does amount to “about 50p for each current share”.

The Guardian also publishes a letter (sorry, the online version of their letters page has no internal links, so you’ll have to scroll down), noting how the Equitable Life “was operating a Ponzi scheme under the very noses of the regulators”. I couldn’t have, and, in fact, didn’t put it better myself.

Hey, here’s an idea. If Guardian Money doesn’t really know what it’s talking about, why don’t they simply list issues in the news, inviting correspondence for publication the next weekend? It’d save on journo costs. I doubt the other papers are any better – I’m picking on the Guardian because that’s the paper I take, so really, guys, this is all a vote of confidence!

Anyway, about this 50p.

Late last Thursday, I think it was, I thought I’d check the exact amount due in the rights issue per current Lloyds share held. And I found that the shares are being sold a little cheaper to the Treasury.

The reason I checked is that there are (at least) two slight complicating factors in the Prospectus.

First, I noticed that:

“Ordinary Shareholders in the United States or any other Restricted Jurisdiction will, in any event, not be able to participate in the Rights Issue.” (section 3.2, p.32).

If such shares didn’t qualify for rights (which is not what’s stated, though is not excluded by the statement), then obviously the rest of us would have to put in a bit more to raise the £13.5bn. But one would imagine the rights would end up being sold in the market, which is what p.77 of the Prospectus seems to say (Section 15: “What should I do if I live outside the UK?”). So shareholders in Restricted Jurisdictions shouldn’t be a problem.

Second, there are a small number of Limited Voting (LV) shares – 79 million, compared to over 27bn – in fact ~27,162 million – Ordinary Shares. These LV shares also have an entitlement to rights. What I don’t know, though, is how much these LV shares are worth. If each is worth much more than an Ordinary Share, and, more to the point, if the holder of each contributes significantly more than 50p to the rights issue, then the rest of us would have to put in a bit less than 50p.

On the other hand, the Prospectus clearly states that they will issue up to 90 billion Ordinary Shares. The lowest price the new shares could be issued for is 15p, and 90bn * 15p is precisely £13.5bn.

So it seems the £13.5bn is indeed being divided equally amongst the 27bn shares – 27,161,682,366 to be exact – so shareholders will have to put in 49.70p, to 2 decimal places.

Nevertheless, I thought of another way of checking the 50p figure. I realised it was possible to work out how much the Treasury is paying for new shares in the Rights Issue. Their press release on the topic notes they’ll be “investing £5.7bn net of an underwriting fee”.

According to the Prospectus (p.104), the taxpayer currently owns 43.43% of Lloyds’ Ordinary Shares (the Treasury press release gives 43%, which is disappointingly imprecise).

43.43% of the shares comes to 11.8bn – 11,796,318,652 to be as precise as we can.

£5.7bn divided by the number of shares the Treasury holds, comes to 48.32p, not 49.7p.

My first thought was that, since the proportion of shares owned by the Treasury was rounded to 43%, perhaps the £5.7bn is a rounded figure too. But even if the real figure was £5.7999999bn, that would only be 49.17p a share, significantly less than our 49.70p.

In fact, as the holder of 43.43% of the shares, the Treasury should be putting in £5.86305bn, not “£5.7bn”.

Then I paid attention to the words after the figure £5.7bn in the press release: “net of an underwriting fee” [my stress].

Yes, what appears to be happening is that the Treasury is underwriting its own share purchase!

And, sure enough, the Prospectus has this to say (p.216):

“7.2 HMT Undertaking to Subscribe

Under the HMT Undertaking to Subscribe, subject to certain terms and conditions, including that the Resolutions relating to the Rights Issue and the HMT Transactions are passed, HM Treasury has irrevocably undertaken to procure that the Solicitor for the Affairs of Her Majesty’s Treasury (as nominee for HM Treasury) (i) votes in favour of all of the Resolutions in accordance with the recommendation of the Board (except for Resolution 4, as set out in the notice of General Meeting, regarding the HMT Transaction) and (ii) takes up its rights to subscribe for all of the New Shares to which it is entitled under the Rights Issue, at or prior to 11.00 a.m. on 11 December 2009, each at the Issue Price. Conditional upon (ii) above, the approval of Resolution 4 by the Ordinary Shareholders and the receipt by the Company of the aggregate subscription proceeds payable by HM Treasury (the ‘‘HMT Subscription Proceeds’’), the Company has agreed to pay to HM Treasury (or to such other person as HM Treasury may direct) the HMT Commitment Commission, being a fee equal to: (A) the Base Fee multiplied by the aggregate number of New Shares for which it has subscribed, plus (B) the Per Share Discretionary Fee multiplied by the aggregate number of New Shares for which HM Treasury has subscribed, in consideration, amongst other things, for the undertakings given by HM Treasury in the HMT Undertaking to Subscribe. The HMT Undertaking to Subscribe contains certain representations and warranties and indemnity provisions in favour of HM Treasury which are the same as those given in favour of the Banks (and certain other indemnified persons) under the Rights Issue Underwriting Agreement.” [my stress].

Remember that £13.5bn? Well, as I had to allow for in calculating the “TERP”, only £13bn of it goes to Lloyds.

If we calculate how much the government is paying on a basis of the total rights issue being £13bn and not £13.5bn then 43.43% is £5.6459 which is much closer to £5.7bn. Not all of the £500m will be the underwriting fee. If the Treasury is putting in exactly £5.7bn (and owns exactly 43.43% of the shares), then that implies the issue will raise £13.12bn (rounded) including arrangement fees, but net of underwriting costs. The latter therefore come to around £388m. Shocking.

My understanding is that in fact this little perk is not special to this rights issue, nor to HM Treasury. Large shareholders are routinely underwriting their own subscriptions to share issues.

Now, all this really represents is an early commitment to subscribe to the issue.

Let’s just consider how much this is worth. The issue will be at a ~40% discount to the TERP, as discussed last time. As we saw, the TERP will be around 55p, and the new shares issued at ~33p.

Is there any real chance of the share price falling below 33p before the completion of the rights issue?

Not really. Cyclone Lehman has passed through the markets and all is now calm. Lloyds raised £4bn at 38p a share back in April, when the recession and its own position looked much worse than it does now.

More to the point, would I have taken the same deal as HMT to save my share of the £388m? Yes, I would.

Before Darling got his feet under the desk at Number 11, there was a principle that shareholders were protected by “pre-emption rights”, that is, existing shareholders had to be offered the same deal offered to new shareholders. Similarly, the interests of minority shareholders are supposed to be protected from the big guys. Now, an ignorant media (and Vince Cable) eggs on the government to act exclusively in the interests of “the taxpayer”. In fact, companies must be run in the interests of all shareholders. That’s why they are legal entities. In using its stakes in the banks to impose stealth taxes on the organisations, the Treasury is dangerously close to indulging in the same sort of behaviour that put Conrad Black behind bars.

Mr Darling, might I perhaps have the temerity to suggest that, rather than whinging about bankers’ bonuses, a better strategy would be to examine some of the ways in which business insiders make massive amounts of easy money at the expense of, very often, the private shareholder, among others? And underwriting rights issues isn’t even the worst offence. Start by looking at the bankruptcy process – e.g. Telewest, Cobra Beer, Jessops and Woolworths and list the winners and losers…

There is a massive conflict of interest if large shareholders receive underwriting fees for rights issues. I have no idea whether £388m is an objectively reasonable figure or not. But I do know two things:
1. The holders of large blocks of shares who also act as underwriters – including the Treasury in this case – have no incentive to question the underwriting fee.
2. I wasn’t offered the chance to underwrite my own share purchase – i.e. commit a few weeks early – which I would quite happily have done. I’d have liked a “Commitment Commission” too, Mr Darling.

Small shareholders can work out how much the under-writing will cost them: it’s £(~388m * no. of current shares)/total number of shares i.e. ~27bn, a bit over 1.4p per share or ~£14 per 1,000 shares. Adds up, doesn’t it?

No wonder investment bankers are rolling in money when the Treasury – far from ensuring fair play – is happy to be complicit in yet another systematic mugging of Joe shareholder.

And what’s more, it’s not difficult to think of better ways of carrying out rights issues.