Jeremy Warner: Dividend concession revitalises Lloyds merger with HBOS

Outlook: Sir Victor Blank can congratulatehimself on the revised terms
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After much Downing Street lobbying, Lloyds TSB appears to have secured the right to resume dividend payments next year – that is, provided it manages to find a way of refinancing or otherwise paying off the preference capital it is receiving as part of the Government's banking bailout.

Nothing has been agreed formally, for preference capital has to be held a minimum of five years to acquire the "permanence" that allows it to be counted for solvency purposes, but the clear understanding is that Lloyds TSB, or Lloyds Banking Group as we must learn to call it after it has merged with HBOS, will be allowed the wriggle room it needs to put itself back on a par with Barclays in the early resumption of dividend payouts.

For many investors, Lloyds TSB has long been viewed as more of an income stock than anything else. In itself, the merger with HBOS prom-ised significantly to damage this stand-ing, but the Government's enforced recapitalisation programme seemed completely to kibosh it. No dividends could be paid until the preference stock is redeemed, which for the reasons just stated, might have been a minimum of five years. Shareholders were not happy, not happy at all.

Lloyds TSB's chairman, Sir Victor Blank, thought he was doing the Prime Minister a favour in agreeing to acquire the beleaguered HBOS, but he then found himself in the uncomfortable position of being penalised for his services. If he hadn't been saddled with HBOS, he could probably have gone the Barclays route, and raised his new capital from private investors. But the merger with HBOS tied his hands.

One of the hallmarks of the present crisis is a constant roller-coaster of reversing fortunes. Just a couple of weeks back, Barclays was looking clever for having turned down the Government's money. By doing so, it seemed to have won the commercial freedom to do what it liked, on dividends, bonuses, strategy, credit allocation and board composition.

Now it doesn't look quite so far-sighted after all. Barclays has had to pay through the nose for the new capital it is receiving from the Gulf. It has also infuriated its own shareholders by denying them pre-emption rights. Ah, but at least we'll be able to pay a dividend next year, John Varley, chief executive of Barclays, might reply. What's more, we've retained the commercial freedom to expand further into investment banking and pay the bonuses necessary to achieve this ambition. Round at Lloyds Banking Group, there is little or no interest in expanding in investment banking, and the obligations imposed by the Government, such as they are, amount to no more than it would have done in any case. The dividend breakthrough removes the final fly in the ointment of UK government money. More encouraging still, if the present phase of improved sentiment in markets continues, it may not be necessary to call on the full £17bn of state support.

Shares in Lloyds TSB are now some distance ahead of the Government's placement price, providing an incentive to shareholders to take up their rights, and even the HBOS share price isn't far off. The Government may, therefore, end up a significantly smaller stakeholder than the 43 per cent implied by the terms of the recapitalisation. As a consequence, the dilution may not be as bad.

Just a few weeks back, Sir Victor found himself awkwardly trying to explain why he was sacrificing an attractive dividend yield for a three-year punt on a busted mortgage bank. It looked as if he had been had. The Government had led him to believe he had no alternative but to accept the taxpayers' pound. Barclays had, meanwhile, been allowed to sail off untainted by the stigma of part nationalisation.

Yesterday's dividend concession helps correct the grievance. Barclays and Lloyds Banking Group (LBG) are two very different business models. It probably won't harm LBG, an almost exclusively UK retail, commercial and mortgage bank, to be part-Government owned. For Barclays, with its international and investment banking pretensions, any amount of UK Government ownership was anathema, even if it is reasonable to ask why being part-owned by three overseas governments is any better.

The mistake that Barclays made was its failure to offer the attractively priced "reserve capital instruments" by way of pre-emption rights. The row has been made worse by the fact that some institutions believe they were misled in pre-marketing, because they hadn't realised that valuable warrants were being attached to the new capital. Warrants were only added during negotiations with the Gulf states, when they were offered up as a way of clinching the deal. Beggars can't be choosers, but it would have saved an awful lot of grief had Barclays asked its own shareholders first.

As for Lloyds Banking Group, the quality of assets at HBOS is continuing to deteriorate at alarming speed. The main surprise in yesterday's numbers was an additional £1.25bn provision against property and other forms of commercial lending. Sir Victor has good reason to congratulate himself on the revised terms he's negotiated with the Government, but there is no disguising the scale of the challenge faced in paying off the preference stock before the end of next year.

The easiest way to do it would be to dispose of assets, but this is hardly a sellers' market right now, and as Barclays has discovered, raising preference capital on better terms than the UK Government is far from easy in these markets.