Investment Extra: Merger of weaklings must work

By Ian Lyall for MailOnline
Updated: 13:21 EST, 3 October 2008

It has been a wildly volatile ride for the more than 2million investors in Halifax Bank of Scotland in the wake of Bradford & Bingley's nationalisation at the start of this week.

A jittery market was spooked by the former building society's collapse, and it looked certain Lloyds TSB's £12.7billion rescue of HBOS would implode as a result.

This hasn't happened. But ever since B&B's implosion there has been rampant speculation the Lloyds takeover will have to be repriced.

According to the whispers in the market, HBOS investors could be forced to accept just 60 shares for every 100 they own instead of 83 under the terms of the current agreement.


lloyds

Looking rosy: Analysts expect the Lloyds-HBOS merger to go through

Let me emphasise this was, and is, only a rumour  -  and the outlook for the merger gets rosier with every passing day, particularly following the quite astonishing rebound we have seen in the banking sector over recent days.

Even so, some of you must be wondering why the current HBOS share price doesn't fully reflect the terms of the current deal.

Last night the stock closed at 200.5p  -  40.2p below the Lloyds offer price.

This seems to suggest the City doesn't have much faith in this merger of weaklings.

However this is mis-reading the situation slightly. Most analysts expect the transaction to go through. The discount reflects the financial wipe-out that will happen if it fails  -  however remote that possibility.

There are a number of reasons why this marriage of convenience must succeed.

Nationalising HBOS would swamp the economy with an estimated £450billion of loans and irreparably damage national finances.

And it would deal a massive blow to confidence in the British financial system.

This is why Prime Minister Gordon Brown was so adamant earlier this week that the union will take place.

Look at the personalities involved and you realise there is a huge impetus from both sides to ensure it works out.

Defeat at the hands of the market would be a personal disaster for Sir Victor Blank, the Lloyds chairman with close links to Labour.

While for Lord Dennis Stevenson, his opposite number at HBOS, the collapse of the lender would be an horrendous epitaph to an otherwise outstanding business career.

The big City shareholders, meanwhile, have no interest in scuppering the rescue.

In fact, it is the large shared investor base that will ultimately ensure the acquisition is done hitch-free.

Both M&G and Standard Life have gone on the record in support, which while not unprecedented, does underline the City's desperation to see the tie-up completed as soon as possible. That said, nobody is really jumping up and down with glee about the prospects for the merged entity.

Credit Suisse, in a research note earlier this week, points out that an enlarged Lloyds/HBOS will have a capital deficit of around £10billion.

Meanwhile, there are still persistent worries over the soon-to-be-formed Bank of Britain's reliance on the money markets, which won't disappear.

Add to this a heavy commercial focus on the recession-bound UK and you have quite a toxic cocktail.

On the face of it HBOS is a cheap way to buy into Lloyds  -  but only if you believe the company's prospects are sound.

Taking a three-to-five year view, today's prices will seem bargain basement. In between there will be a lot of volatility.