Lloyds Banking Group - Case Study Example

Table of Contents Introduction 2 Investigation on Rights Issue of Lloyds Banking Group 2 Elements Identified 4 Rights Issue 4 Deep Discounting Of Shares 5 Right of Existing Shareholders to Receive Compensation 5 Advantages and Disadvantages of Rights Issue 7 Long Term Sources of Finance 8 Conclusion 11 References 12 Introduction It was in the year 2009 when Lloyds Banking Group was formed following the acquisition of HBOS. It can be said that the Group is one of the largest and chief retail banks in the UK having a diversified and a large customer base. It is worth mentioning that the company is quoted both in New York Stock Exchange as well as London Stock Exchange (Lloyds banking Group. n.d.). Lloyds has strengths as well as products, which are from both the companies that include Lloyds TSB’s approach towards risk and HBOS’s leading bancassurance businesses. The company’s multiple brands provide service to the customers regarding pricing as well as positioning in order to cover and attract more of the market. The two main brands of the company in England are Lloyds TSB as well as Halifax while in Scotland the company’s main brand is Bank of Scotland. The company tries to keep its cost down and improve its services to customers as the company can deliver effectiveness through shared services (Lloyds Banking Group, n.d.). Investigation on Rights Issue of Lloyds Banking Group There are several means of raising capital in an organisation. One such means applied by Lloyds Banking Group has been right issue. The company sold its new shares at discount. It was found that the existing shareholders of the company were offered new shares in ratio to their holdings. The left out shares that were not sold were bought by other investors as well as investment banks underwriting the process that has promised to swab up the unwanted shares in order to ensure that Lloyds gets its money. The reason behind Lloyds raising the fund has been that the bank wanted to evade from being involved in the Government’s toxic Assets Protection Scheme (APS). The bank had 43pc owned by their taxpayers. Originally, in order to insure £260 billion in loans from the scheme, Lloyds Was expected to pay £15.6 billion and thus increasing the taxpayer stake to 62pc. Royal Bank of Scotland that took part in the APS ended up being 84pc which were owned by the Government after putting its risky loans for insurance. However, Lloyds has to pay the Government a fee of £2.5 billion in response for the protection that was by now offered by the taxpayers since the declaration of the scheme in 2009 (Telegraph, 2009) ‘The offer on the table for the shareholders’ was that Lloyds, for every current share owned offered 1.34 new shares at a deep discount of around 37p each. The most important consideration has been the cost associated to the average shareholders. The typical investors who owned 740 shares were provided the opportunity to retain their stake in the company by buying around 991 new shares at a price of £366.67 (Telegraph, 2009). It can be analysed that the fees that Lloyds had to pay was huge. The company planned to spend £500m on all its cost out of the £13.5billion raised by them (Daily Mail Reporter, 2009). It was further proposed that if the shareholders of Lloyds don’t do not take any measure at all then Lloyds is going to sell the shareholders allocation of shares on its behalf and send them the profit by cheque (MoneyHighStreet Staff, 2009). For the 2.8 million private shareholders the average holding was 740 shares, which denotes that if they assume their rights in full, they would have had to pay almost £370. Small investors were involved in right issue of Lloyds. Some were the institutions such as pension funds and investment firms along with the taxpayers. However, for those investors who didn’t take up the offer had to receive a cheque from the bank for the sale of their nil-paid rights. Moreover, the underwriters had guaranteed to buy the shares that was not subscribed for by investors and thus was decided to sell the rights in the market. The major advantage for investors in taking the offer was that the average buying price would fall sharply downwards and would allow them to sell them at a profit eventually (Connon, 2009). The potential risk associated with the rights issue of Lloyds is that it is banned from paying dividends until 2012 even if the country’s recession gets over. Therefore, it was anticipated that the next few years would be tough. Lloyds had set a deadline of 11 December 2009 for the investors to decide if they would be taking part in the issue activity or not (Wearden, 2009). Elements Identified Rights Issue Rights issue can be defined as the issue of the capital through a Letter of Offer to the existing shareholders which is made in the first instance to the existing shareholders of the company on a pro rata basis. It is to be noted that the number of right shares to be issued is generally decided by the issuing firm. For instance, the company that has 1 million outstanding shares may decide to issue 200,000 right shares. The rights entitlement of the existing shareholders depends upon the number of right shares that are proposed to be issued. In addition, it is worth mentioning that the rights are negotiable. The holder of the rights can sell them. However, rights can be exercised only during a fixed period that is usually for 30 to 60 days. The prices at which the shares are issued to the shareholders are generally at a discount to the existing share price that provides the investors an incentive for buying the new shares. However, if they don’t then their holding tends to dilute (Chandra, 2008). Deep Discounting Of Shares In order to cut the cost, companies can also go for deep discount right issue. This can be considered as one of the methods of raising the cash when the companies are in deep trouble. Moreover, the underwriters are not willing to take the risk of guaranteeing to buy the new shares since they fear that the price may collapse again. It is worth mentioning in this regards that the ‘deep discount rights issues’ may not be underwritten. They can be characterised as being uncommon, nonetheless. The new shares in this case may have to be issued at a deep discounting rate which can be as little as half the current market price (Waller, 2008). Right of Existing Shareholders to Receive Compensation It was found that Lloyds Banking Group conducted a successful placing as well as compensatory open offer. However, the compensatory open offer was no quicker than a right issue with no requirement of general meeting (IFR, 2011). Advantages and Disadvantages of Rights Issue It can be noted that the right issue provides various advantages to companies over secondary offerings of ordinary shares. There are few companies that appreciate the equitable method of offering the existing shareholders the opportunity to purchase the shares. It has also been found that there is little right issue which features an investment bank to coordinate the right issue and also assist the companies in acquiring interest in the rights. There is lower sales commission for this role in comparison to the underwriting commissions for share pricing. Moreover, the other advantages as provided by the right issue is that since the existing shareholders are targeted rather than the new one, so the roadshow expenses tends to be lower than those associated with a secondary offering of ordinary shares (Andrew Case, 2008). However, the most significant disadvantage of the right issue is that it requires the offering to be conducted with a Prospectus Directive-Complaint Prospectus that is approved by the FSA with companies having more than 100 shareholders who resides in any EU jurisdiction. This usually adds to the cost and the time that is generally needed to prepare the requisite documentation since the right issue circular needs to be abided by the same level of disclosure as in an AIM Admission (Andrew Case, 2008). Long Term Sources of Finance Firms may require money for the purpose of investment in the form of fixed assets and working capital which is needed for its day-to-day operation. There are various sources from which the firm can acquire funds. However, securing it from appropriate sources is of vital importance. The sources of funds can be classified into long term, medium term and short term sources of fund. The short term sources of funds may be required for a short period of time and includes the fund that needs to be liquidated within one accounting period. Trade credit, short term bank borrowing, overdrafts are few examples of short term sources of funds. The long term sources include sources where the repayment may take place after five years and more. Various long term sources of funds are preference shares, debentures, equity shares, long term institutional loans and others. Lloyds could have obtained funds from these sources as well. It is now important to discuss the potential advantages and disadvantages of each of the long term sources of funds. Preference Shares In this case the preference shareholders receive a fixed rate of dividends. The preference shareholders have preferential rights over the equity shareholders in relation to both payment of dividends and repayment of capital under certain circumstances. The potential advantages of the preference capital are that since the preference shareholders don’t carry voting rights, the preference shares avoid diluting the control of the existing shareholders. The disadvantage of the preference shares for Lloyds is that preference shares are less attractive than loan stock since they cannot be secured on the company assets. Debentures Debentures are one of the most common forms of long term capital. It is an instrument acknowledging the debt of the firm. Therefore, it can be said that the debenture holders are the creditors who receive interest for deposit of their money with the firm, irrespective of the profit and loss. The advantage of financing through debenture to Lloyds is that the firms need not sacrifice control on ownership and management of the firm. Moreover, it can be redeemed when the firm has surplus funds. The disadvantage of acquiring funds by means of debenture is that since the cost of stamp duty is high, cost of securing the debentures tends to be higher. Equity Shares Equity shares are the ownership capital of the firm. The equity shareholders are entitled to the surplus of the firm. Therefore, it can be revealed that from the point of view of both profitability and control, firm can enjoy advantage over providers of other sources. However, it is worth noticing that equity is the costliest sources of capital since dividends are paid out of after-tax profits. Lloyds had made use of one of the equity capital, i.e. right issues. Its potential advantages and disadvantages have been already noted in the paragraphs above. However, there are two equity share capital that the company could have used in order to acquire the funds to serve its purpose. They are new issue and bonus issue. The bonus shares are issued out of the capital reserves, general reserves or through balance in the profit and loss account. The most important point to note in this regards is that they cannot be issued instead of the cash dividends. The overall amount of the bonus shares which is issued out of the free reserves must not go beyond the total amount of ‘paid up equity capital of the firm’ (Banerjee, 1990). The new share issue is also useful means of acquiring the funds which Lloyds could have used to obtain the additional equity funds. However, the main consideration here is that an unquoted company that wishes to obtain a Stock Exchange quotation, a company that is already listed on the Stock Exchange may desire to issue few additional shares or an unquoted company that may wish to issue new shares, but without acquiring a Stock Exchange quotation (FAO, n.d.). Lloyds may also acquire the funds from institutional finance. The various institutions are Industrial Finance Corporation, Life Insurance Corporations, State Financial Corporation and others. In addition to the nationalised institutions, Lloyds may also approach foreign institutions in order to raise the funds. World Bank is a ‘specialised agency of the United Nations’. This bank can act as a significant source of long term loan to its member countries (FAO, n.d.). Conclusion Lloyds Banking Group in order to raise capital utilised a method of right issue. It was a part of the overall £23bn capital raising program. Lloyds wanted to reduce their dependence on the government by raising capital. Lloyds did sell their new shares at a discount amount and also offered the shareholders who were already part of Lloyds’ new shares at a ratio proportionate to their holding amount. It can be observed that right issue provides various advantages such as option of targeting existing shareholders which enables an organisation to do away with certain expenses. Lloyds could have also utilised preference shares and debentures options apart from using other equity shares such as bonus share and new issue to raise capital in their organisation. References Andrew Case, 2008. Right Issues: Is The Time Right? Deal Monitor. [Online] Available at: http://www.dechert.com/library/Rights%20Issues%20Is%20The%20Time%20Right.pdf [Accessed March 24, 2011]. Banerjee, B., 1990. Financial Policy and Management Accounting. PHI Learning Pvt. Connon, H., 2009. Money. Lloyds Rights Issue: Key Questions for Undecided Shareholders. [Online] Available at: http://www.guardian.co.uk/money/2009/dec/07/lloyds-bank-rights-issue [Accessed March 24, 2011]. Chandra, P., 2008. Financial Management. Tata McGraw-Hill Education. Daily Mail Reporter, 2009. Lloyds' Record £13.5billion Rights Issue. Mail Online. [Online] Available at: http://www.dailymail.co.uk/money/article-1224905/Lloyds-Banking-Group-unveils-UKs-biggest-rights-issue.html [Accessed March 24, 2011]. FAO, No Date. Chapter 7- Sources Of Finance. Ordinary Shares. [Online] Available at: http://www.fao.org/docrep/w4343e/w4343e08.htm [Accessed March 24, 2011]. IFR, 2011. The Need For Speed. IFR Equity Capital Markets. [Online] Available at: http://www.ifre.com/the-need-for-speed/574501.article [Accessed March 24, 2011]. Lloyds Banking Group, No Date. Customers. Group Profile. [Online] Available at: http://www.lloydsbankinggroup.com/customers.asp [Accessed March 24, 2011]. Lloyds Banking Group, No Date. Company Profile. About Us. [Online] Available at: http://www.lloydsbankinggroup.com/about_us/company_overview.asp [Accessed March 24, 2011]. MoneyHighStreet Staff 2009. Lloyds Banking Group Rights Issue Raise Share Price. Finance News. [Online] Available at: http://www.moneyhighstreet.com/finance-news/lloyds-banking-group-rights-issue-share-price/ [Accessed March 24, 2011]. Telegraph, 2009. Lloyds Rights Issue: What it Means For Shareholders. Investing. [Online] Available at: http://www.telegraph.co.uk/finance/personalfinance/investing/shares/6644079/Lloyds-rights-issue-what-it-means-for-shareholders.html [Accessed March 24, 2011]. Wearden, G., 2009. Business. Q&A: What The Lloyds Right Issue Means For You. [Online] Available at: http://www.guardian.co.uk/business/2009/nov/24/lloyds-rights-issue-questions-answers [Accessed March 24, 2011]. Waller, M., 2008. Q&A: What Is A Rights Issue? The Times. [Online] Available at: http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4080355.ece [Accessed March 24, 2011]. Read More