Government will own almost half of new Lloyds

Investors likely to shun Lloyds TSB and HBOS shares ahead of the merger

Lloyds TSB and Halifax Bank of Scotland face part-nationalisation next week after their share prices ended the year far adrift of the offer prices for their combined £13bn equity raisings.

The banks are due to combine as Lloyds Banking Group on 16 January in a Government-brokered takeover by Lloyds TSB of HBOS, the country's biggest mortgage lender. The expected failure of the share offers will leave the state owning up to 43.5 per cent of the combined bank, and investing a total of £17bn, including £4bn of preference stock.

Lloyds shares closed at 126p yesterday, way below the 173.3p price for the new stock. HBOS shares ended 2008 at 69p, compared with the 113p offer price. Institutional shareholders will have to decide early next week to take up their shares, requiring massive price rises for the offers to be successful.

The Government is underwriting the banks' offers to ordinary shareholders – £4.5bn for Lloyds and £8.5bn for HBOS – under the terms of the industry recapitalisation plan agreed in October. Existing investors have until 9 January to subscribe for new shares but have no incentive to do so at current prices.

Equity offers either get near-maximum take-up, because investors are able to buy new shares at a discount to the existing share price, or virtually none if the shares can be bought cheaper in the market.

The Government's investment will leave it owning large stakes in the two biggest lenders to British companies and consumers, after buying 58 per cent of Royal Bank of Scotland last month as part of a £20bn capital injection.

Lloyds' and HBOS's share prices have been hit by deepening gloom about prospects for the UK economy after a raft of bad news on the housingmarket, unemployment and the retail sector. HBOS shocked investors last month with a trading statement that revealed surging bad debts from the bank's residential and commercial property loan books.

Investors are also unwilling to invest in a bank that will not be able to pay a dividend until it can buy back the Government's preference shares. Lloyds claimed last month that it would be able to repurchase the preference stock later this year and resume payouts to shareholders, but with the economy slowing sharply investors fear the Government will be unwilling to allow this.

The Government waived competition rules in September to allow Lloyds to mount a rescue takeover of HBOS, which came close to collapse as it struggled to raise funding in wholesale markets. The deal will create a UK superbank whose dominance of the market would never have been allowed had the authorities not feared a collapse of the banking system.

The deal has faced a series of hurdles, including a renegotiation of the price in favour of Lloyds' shareholders and a legal challenge on competition grounds by Scottish interests opposed to the takeover. Trustees of HBOS's pension fund are meeting tomorrow to decide whether to try to block the deal in the Scottish courts unless Lloyds puts safeguards in place to protect the interests of the scheme's members.