SECRET DOSSIER

In a comment to recent blog, I refer to a trigger used to leverage government support for Lloyds TSB's (LTSB) takeover of HBOS. Echoes of another 'dossier' now become a blighted word in any context '- a secret dossier', now in hands of lawyers for the Government and the tribunal judges only!
The story of the takeover has changed. First we were told that Victor Blank buttonholed Gordon Brown having seen the opportunity to takeover HBOS and got GB's support. Now, the story is that HBOS approached LTSB to say they were in deep urgent trouble! This could in my view only have been a Northern Rock problem fear following the collapse of Lehman Brothers and the fear that wholesale funding for the banks will dry up absolutely! - that problem of being unable to book refunding from other banks for the quarters ahead (HBOS as we know has to roll-over £132+bn in the next year and probably £50bn this quarter). If so, some banks, including major UK banks, may now regret not having been more active in making use of the Bank of England SLS window before 15 September. So LTSB was approached and loaned HBOS £10bn, the secret Victor Blank cheque engagement ring for what has become a shotgun wedding. In the 'secret dossier' there would have been an analysis of the liquidity problem (by HBOS, or by HBOS & LTSB, or by LTSB alone?) and this would be from several sources including bank of England, FSA, HM Treasury and the banks themselves, including possibly accounts information shareholders are not yet informed of about funding or systemic stability issues, or may never be informed about? At the 3rd December tribunal hearing of the Competition Appeal Tribunal (CAT) the presiding judges decided that only the lawyers are allowed to see this, not the MAG principals. And in the court case (which was accepted as a valid appeal to be heard on Monday 8 Dec)only high-level summaries would be permitted. The 'secret dossier' is deemed to be highly confidential. It may conceivably include the terms of the £10bn loan, and these may contain conditions pertaining to the HBOS board agreeing to the LTSB takeover etc.? This is speculation. But, such conditions, if they exist, may be subject to interpretation as anti-competitive practise of 'tying'! Undoubtedly, market conditions were extraordinary and it can be argued that demanded extraordinary responses? At the time (17 Sept.) after "emergency discussions" personally overseen by Gordon Brown a merger deal was agreed between LTSB and HBOS. It came after HBOS shares plummeted for a third day, at one stage in one day dropping 70% under short-selling pressure. The Government's bailout was not yet on offer (not until mid-October). The HBOS Board probably felt it was exactly in the Northern Rock category of liquidity risk and that an appeal for emergency help from BoE and/or HMT might again trigger a similar bank-run! But, history does not repeat itself a year apart, yet the Board may have feared precisely that? As any who look will know, HBOS accounts are not showing poor performance or excessive impairments compared to others, even though writedowns for 2008 (at 3Q interims) doubled from about £2.5bn to just over £5bn between 30 June and 31 October. Nonetheless, perhaps judging by share price performance in the belief that the markets know best, HBOS has been dubbed an especially troubled bank. Commentators have said this is a 'shotgun marriage'. If so, the shotgun may be the £10bn loan and the cartridges in it are the conditions attaching to the loan. The nature of these would be designed to ensure that HBOS does not entertain other potential suitors and explains why the HBOS Board has been so adament that there is no other choice and the brusqueness with which it rubbished the letter from the 'two knights'. This is merely speculation, not established fact. The existence of the 'secret dossier' is fact. That this dossier was shown to the Government (and if them, why not also to major institutional shareholders?) would go some way to explain its attitude that this merger is a done deal that has to be pushed through including by-passing the Competition Commission (and in advance of the shareholder vote) and believed to be unavoidably necessary to financial stability in terms of HBOS's solvency (in short term cash-flow terms i.e. liquidity risk). Any alternative buyer would have to immediately replace the LTSB loan, possibly merely as a condition to see the books and to discuss with the HBOS Board, as well as find the full net asset purchase price, and to do so without reference required to the CC. Therefore, such a buyer would have to be foreign or a much smaller UK bank than LTSB? Any other alternative would have to be Government, or another bank or syndicate of banks, prepared to lend £10bn on market terms without special conditions except possibly stock warrants (or prefernce shares) when the total stock market value of the bank is only 60% of the value of the loan. Government subsequently committed (at a current m2m loss for £11.5bn to HBOS including £2-3bn preference shares). This all hung like a Damocles sword over what HBOS could do now to efficiently refinance or roll-over its wholesale market funding once it had Government backing and should thereby be able to negotiate funding with more market confidence, unless the LTSB loan conditions (assuming these exist) cut off that option? What is clear, however, is that HBOS liquidity risk creditworthiness in the market gained by Government support, on the one hand, was taken away by Chancellor Darling's statement, on the other hand, just before the LTSB shareholders voted on 18th November saying that if the LTSB takeover of HBOS was voted down by shareholders then the Government's coninued support could not be relied upon automatically; it would have to be re-applied for (in a context of the Government's conditions being verbal and not written). The BBC's Robert Peston noted that the chancellor (MP for South Edinburgh) "raised strong doubts about whether the Treasury would provide vital new capital to an independent HBOS and he has also made it clear that the cost to HBOS of such capital (were it to be provided) would be almost prohibitively expensive", which is ironically the problem that HBOS faced at the outset leading to its loss of independence. Peston continued, "most HBOS shareholders would take the view that voting to block the takeover against the revealed wishes of the Treasury would be an instance of turkeys clamouring for an early Xmas. There is evidence that many (perhaps most) investment institutions support the deal. That can be deduced from the overwhelming support for the takeover shown today in a vote of Lloyds TSB's shareholders. The reason it's possible to extrapolate from that vote is that there is an overlap of more than 50% between the institutions owning HBOS and Lloyds TSB". He finished with, "So I think it is reasonable to predict that this takeover will now take place. And it's also reasonable to predict that as and when Lloyds TSB reduces the headcount of the combined banks by 20,000 or more - as it must do because of the overlap between the operations of these two large organisations - some members of the government will not feel totally euphoric in getting what they wished for". The regret may be felt not only by some MPs but also by the Labour Party in Scotland, who while on the one hand have categorised all this as evidence for why an independent Scotland would (like tiny Iceland) prove to be unviable in a crisis, may find that the cost includes longer term exclusion from majority power at Holyrood than the party might otherwise have expected.
Burt and Matthewson, the 'two knights', who until this point had led a last minute campaign against the deal, now recognised that their appeal for HBOS to show more negotiating flexibility on behalf of shareholders and to seek alternative routes to maintaining independence was now futile.Thus, it follows, that despite the Government's primary concern to restore UK financial stability, HBOS (one of the UK's domestic big 3 and big 5 banks) it is prepared to risk this objective by its determination to corral HBOS into the LTSB takeover/merger. Whether or not there is any political game-playing affoot, the moral hazard risk here is that both banks, should they or their shareholders (some, or many, of whom are common to both banks) have thought to back off from the deal they too must now feel they have no other choice but go ahead anyway. Hence, no other banks (UK or foreign) can intervene or offer alternatives, no matter how angry they are about the projected new Lloyds Banking Group gaining a super-dominant position of 30-40% of the domestic banking market and 38 million account holders (that the OFT believes is an anti-competitive market share in important asset classes and regions). Other banks could spoil the party by offering £10bn+ loans to HBOS, but why do that? The other domestic big banks will seek to refer the new super-bank to the Competition Commission after the takeover and press the bank to sell-off business units and assets to them above some market share threshold to be determined by the Competition Commission. LTSB has said it intends to writedown HBOS's assets (book value) and to seek buyers for some of HBOS's business holdings. In the meantime, after CAT, if CAT does not grant the appeal by MAG, the EC's Competition Law may also be appealed to. At the EU level there is concern about the integrity of the Single Market, about area, region and cross-border market shares and any potential for, or actual, anti-competitive practises. What is equally concerning to EU authorities is how liquidity risk can lead to bypassing or overriding of Competition Law process, even if an ex ante referral becomes instead an ex post referral. This is a concern too at EU level concerning fiscal and financial responses in respect of what common framework to apply to each state's bank capitalisation support measures. At the heart of this are two factors, systemic risk (national financial sector stability) and liquidity risk (credit crunch in interbank loans and deposits). The UK, for example, has just announced it will require banks to buy new Government bond issues to an amount equating to about 10% of assets (to total loans i.e. more than the total of their 'own capital' and more than the total of their economic capital reserves) including foreign government bonds but only in proportion to the international mix of their assets. One common feature agreed as part of the common framework is that capitalisation support for banks should be as temporary as possible. In the UK the Government's share will be replaced in 2009 by Government bond holdings. Will this resolve any still peristing liquidity risk problems?
Therefore, from the above, the CAT case by MAG may hinge on whether the Government is condoning anti-competitive practises and moral hazards:
- by giving in to possible anti-competitive conditions attaching to interbank loans during the credit crunch e.g. any special conditions attaching to the LTSB £10bn loan to HBOS that would severely restrict HBOS's freedom to search for better alternaties for its shareholders, customers and employees etc.
- by bypassing ex-ante reference to the CC and Government taking on the legal role of the CC onto itself merely on the basis of a 'secret dossier' etc.
- by failing to examine alternatives fully (if the HBOS board is constrained from doing so itself?) including full analysis of HBOS's liquidity risks and systemic importance by the Bank of England, which is the authority responsible for financial sector stability, not just the opinion of the FSA, which is responsible for individual bank's financial resilience, and possibly for not obtaining the views of the other major UK banks, and for not referring this to the CC, especially after the OFT's negative report, and
- by failing to balance long term effects with short term expediency measures and challenge its own assumption about net benefit in the public interest. The MAG case only secondarily touches on the above. Its principal case is that the Secretary of State after obtaining a discretionary power to bypass the CC via an order in Parliament and only after the merger was agreed between the banks then illegally applied this new power retrospectively. In pitching its case, however, the MAG legal team may seek to uncover whether 'anti-competitive' conditions were attached to the £10bn loan by LTSB to HBOS as well as whether the 'secret dossier' or any other advisory reports obtained by Government were technically sufficient to influence its actions including the obvious arm-twisting by the Chancellor just before the LTSB shareholder general meeting and vote.