The broker advised investors to "sell" Lloyds, arguing that the proposed acquisition of HBOS, which was up 17.87 per cent, or 30.4p, at 200.5p, will materially stretch the bank's capital ratios.
"We remove the capital benefit of the insurance subsidiaries from our core Tier 1 [capital estimate] and believe that there could be a further £2bn post-tax impairment on HBOS treasury assets. This would result in a core Tier 1 ratio of 4.7 per cent for the combined entity, which implies a £6bn capital shortfall," the broker said. "If we were to assume that this shortfall was addressed through a 45 per cent discounted rights issue, this would equate to an additional 3,910 million shares being issued."
Traders said the assessment had been overshadowed by hopes that the US House of Representatives would take its cue from the Senate and approve the bailout plan. "That's driving the sector," said one market source, who added that, given the considerable political and regulatory pressure, the merger with HBOS was likely to go ahead. "It would surprise a lot of people if it doesn't go through – we have heard that it might not be good for Lloyds. But there is no indication that they think so," he added.
Overall, confidence ahead of the House vote aided the FTSE 100, which gained 109.91 points to 4,980.25. The FTSE 250 was also firm, gaining 30.6 points to 7,995.54.
On the FTSE 100, London Stock Exchange was down 24.5p at 833.5p after Credit Suisse revised its recommendation on the stock to "underperform" from "neutral", anticipating further market share losses and pricing cuts in the face of rising competition.
"Although we believe that price formation still happens on the LSE, we believe that the launch of two other trading platforms in recent weeks [Project Turquoise and NASDAQ] should result in further market share losses for the LSE," the broker said, reducing its earnings forecast for 2010 by 1-2 per cent.
The mining sector fared better last night, firming up thanks to a lift in metals prices. Vedanta Resources, at second place on the FTSE 100, was up 11.73 per cent, or 107p, at 1019p while Antofagasta, at fifth place, climbed to 380.25p, up 8.95 per cent, or 31.25p.
Marks & Spencer advanced to 239.5p, up 12.25p, as analysts revised ratings in light of the retailer's second-quarter update. UBS reduced its target price for the stock to 235p from 275p, maintaining a "neutral" rating, while Cazenove upgraded its recommendation to "outperform" from "in-line". JP Morgan also changed its stance to "neutral" from "underweight", noting that "M&S now appears to be taking action to improve cash flow and to keep its debt more under control".
On the FTSE 250, the directories group Yell advanced to 100p, up 11.11 per cent, or 10p, after Morgan Stanley said that, in keeping with recent market rumours, the company should "finalise re-negotiating banking in the next 1 to 2 weeks". "Our base case is that the deal is completed despite being complicated by 300 holders," the broker said, noting that, if completed, a deal "will reduce near-term risk of default and enable greater operational flexibility". "It would also represent an excellent outcome relative to other ongoing re-negotiations in the UK," it added.
On the downside, Derwent London traded lower, losing 6.87 per cent, or 69p, to 935p, after Morgan Stanley initiated coverage with an "underweight" rating and a 610p target price. The broker expects Derwent's shares to "significantly underperform" the wider property sector over the next 15 months as West End office rents fall off recent highs.
Elsewhere, Taylor Wimpey, up 0.25p at 34.75p, said that its lenders had agreed in principle to a new refinancing agreement, but that a deal may be delayed as it was broadening the discussion to include applicable Eurobond holders.
The announcement was accompanied by more talk of a possible 50 basis-point reduction in UK interest rates next week and, as a result, Barratt Developments was up 5.68 per cent, or 6.25p, at 116.25p and Persimmon climbed to 399.5p, up 1.59 per cent, or 6.25p.
Among smaller companies, Regal Petroleum soared, up 50.6 per cent, or 42p, at 125p, following talk that Lukoil, the Russian oil giant, was preparing a bid for the company. The speculation suggested that an approach may be forthcoming in the next few weeks.
The rumours followed reports, later denied by the company, that the energy giant Royal Dutch Shell had made a $1.2bn takeover approached. Traders pointed out that the reports were odds with a recent share purchase declaration by the chief executive David Greer, who bought 10,000 shares at 91p apiece on Wednesday.
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