UK pound sterling

What you're hearing is the sound of UK taxpayers vomiting.

Her Majesty's Treasury has just confirmed new "financial stability agreements" (AKA: BAILOUT) with RBS and Lloyds to the tune of $51 BILLION (31.3 billion pounds).

Shares in UK financials have been tanking recently on expectations of divestitures and dilutions. RBS is off 2% today. Lloyds is actually a bit higher.

The full announcement is here:

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Implementation of Financial Stability Measures for Lloyds Banking Group and Royal Bank of Scotland

The Government is today announcing the conclusion of discussions with Lloyds Banking Group (Lloyds) and Royal Bank of Scotland (RBS) regarding their participation in the Government’s Asset Protection Scheme (APS).

As a result of improved market conditions and following extensive due diligence announced in February, the Government can today announce that:

Lloyds will not participate in the APS and instead will raise additional private sector capital and pay a fee to the taxpayer for the implicit protection provided to date. This will reduce the risk borne by the taxpayer, improving value for money;

RBS will participate in the APS under revised terms that improve incentives and deliver better risk-sharing with the private sector.

The likely costs to the taxpayer and the risks on the impact on the public finances have been reduced. Both banks will still be required to meet tough conditions on pay and lending set out below.

To promote greater competition in UK banking, and meet EU State Aid rules, the banks will also be required to make divestments of significant parts of their businesses over the next four years.

Background

The APS was announced in January to remove uncertainty about the value of banks’ past investments and allow banks to rebuild and restructure their operations to increase lending in the economy. All major UK banks were eligible to apply.

At the time the world’s financial system was facing a worsening crisis of confidence about the underlying value of bank assets. This was undermining financial stability and preventing the UK banking system from providing loans and mortgages.

In-Principle Agreements with Lloyds and RBS

RBS and Lloyds agreed in principle in February and March respectively to participate in the APS and in return to pay a fee to the taxpayer. They also entered into legally binding commitments to increase lending in the economy.

At the time the APS was announced, both RBS and Lloyds had insufficient capital to withstand the downside risks to their balance sheets. They were unable to raise this capital through the private sector, and needed to call on the capital protection afforded by the APS.

These agreements have given both banks implicit protection for their balance sheets, allowing them to begin the process of rebuilding and restructuring the healthier core of their businesses and to increase lending.

As announced at the time, final agreements with both banks would be subject to:

HM Treasury undertaking a thorough due diligence of the assets that RBS and Lloyds proposed to put into the APS;

Ensuring the terms were consistent with EU State aid requirements;

Rigorous stress-testing on both banks by the FSA, in line with the stress-testing framework it announced in May.

Together, these steps have given greater clarity about the scale and timing of likely losses and the impact those could have on Lloyds and RBS.

Following the completion of negotiations with the banks, the Government is now reporting to Parliament at the earliest opportunity the revised terms of agreement with RBS, and its decision with respect to Lloyds’ exit from the scheme.

Improved market conditions

Since the APS was announced, market conditions have improved markedly – largely as a result of the action the Government has taken, both domestically and globally in coordination with our partners in the G20 and European Union.

The announcement of the APS has helped to restore confidence in the banking system and banks are now able to secure capital support from the private sector in a way that was not possible six months ago.

Lloyds Banking Group

Under the March APS agreement with Lloyds, the Government would have been called on to cover 90% of losses for the £260 billion in assets covered under the scheme after the first loss had been exceeded. Today’s agreement removes this significant contingent liability to the taxpayer.

As a result of the confidence provided by the APS, and improved market conditions, Lloyds can now raise sufficient capital through the market to meet the FSA’s capital requirements without the need for additional support from the APS.

Lloyds has announced plans to raise £21bn through a combination of a £13.5bn rights issue, and £7.5bn by swapping existing debt for contingent capital. This option represents better value for money for taxpayers, as the private sector will now provide the majority of the capital required to protect Lloyds from the downside risks to its balance sheet.

Lloyds will also pay the Government a fee of £2.5bn in return for the implicit protection already provided by the taxpayer since the announcement earlier in the year. The Government will take up its rights as a shareholder in Lloyds to participate in the planned capital raising, investing £5.7bn net of an underwriting fee.

This will see the Government’s shareholding in Lloyds remain at 43% and therefore maintain the return for the taxpayer when the Government’s shares are eventually sold.

RBS

The Government’s final agreement with RBS on its participation in the APS reflects the due diligence it has undertaken, FSA stress tests and the requirements of the European Commission’s State Aid guidelines. All material commercial issues have now been agreed with RBS. Full legal documents are being finalised and will be signed shortly. These arrangements remain subject to final approvals, including by the European Commission.

The final agreement involves:

A larger first loss to RBS than agreed in February – the first loss to be borne by RBS has increased from £42bn to £60bn;

A smaller pool of insured assets – reduced from £325bn to £282bn based on their balance sheet at end 2008;

A capital injection by the Government of £25.5bn –– equal to the £25.5bn total capital commitment announced in February, which comprised £13bn in upfront capital, £6bn of capital to be drawn at the option of RBS and £6.5bn in a fee taken as capital;

A fee to the Government to be paid annually at £0.7bn for the first three years, followed by £0.5bn a year for the life of the scheme – compared to the up-front fee of £6.5bn paid in shares agreed in February;

Removing the undertaking, agreed by RBS in February, to forego for up to five years certain tax losses and allowances. This was estimated at a value of £9-11bn in RBS’ most recent accounts.

As a result the Government’s economic interest in RBS will rise to 84%, consistent with the agreement in February, but the Government’s ordinary shareholding will not exceed 75%.

To reflect the £18 billion increase in the first-loss borne by the company, the Government will no longer require RBS to give up its tax losses and allowances. And to protect against a worst-case scenario the Government will provide a contingent capital commitment of up to £8 billion. This would be drawn down in two tranches and only in exceptional circumstances where RBS’s Core Tier 1 capital ratio fell below 5%. In return RBS will pay a fee of 4% a year for the contingent capital. The FSA has confirmed that, with these measures, RBS complies with its stress testing framework.

The Government has also agreed that RBS will pay a minimum exit fee when it leaves the APS. The minimum fee will be the largest of either:

£2.5bn, or

10% of the actual regulatory capital relief received by RBS while it was in the APS

This fee will be less any fees already paid. Exit would need to be approved by the FSA.

Additional Commitments by the Banks

The Government’s priority in its negotiations with both banks has been to support financial stability, provide value for money for the taxpayer and ensure that the benefits of healthier banks translate into increased lending in the economy.

In return for taxpayer support provided, both banks have agreed:

That existing commitments to increase lending to businesses and homeowners by a total of £39bn for both banks will remain in place;

A commitment to ensure charging for current accounts and overdrafts is transparent and fair and that customers are not overcharged;

A ‘Customer Charter’ for lending to small and medium enterprises to reinforce their commitment to meeting all reasonable applications for finance from viable businesses;

Not to pay discretionary cash bonuses in relation to 2009 performance to any staff earning above £39,000;

In addition executive members of both boards have agreed to defer all bonuses payments due for 2009 until 2012, to ensure that their remuneration is better aligned with the long-term performance of their banks;

These build on their existing commitments to implement the G20 remuneration principles, the FSA Remuneration Code and any relevant provisions accepted by the Government from the Walker Review.

Competition Requirements

The Government has reached agreement in principle with Commissioner Kroes after constructive and helpful discussions on a package of restructuring and other measures, which we are confident will address the concerns of the European Commission. The package is now subject to agreement by the College of Commissioners.

To promote greater competition in the UK banking sector, and as part of the State aid requirements of the European Commission, the Government has agreed restructuring plans for RBS and Lloyds that include the divestment of a significant proportion of their retail and corporate banking assets over the next four years.

To ensure these divestments increase diversity and competition in the UK banking market, the assets can only be sold to small or new players in the market. The divestments from each bank will represent a viable stand-alone entity, together representing nearly 10% of the UK retail banking market.

Reduced risks to the taxpayer

As a result of all of these factors, the likely costs to the taxpayer and the risks on the impact on the public finances have been markedly reduced:

The total contingent liabilities the public finances are exposed to have reduced by over £300bn as a result of Lloyds not participating and RBS reducing the value of assets covered by the scheme.

The remaining risks are better shared with private sector shareholders – for Lloyds, the private sector will provide £15bn of capital and for RBS, the first loss on the remaining £282bn of contingent liabilities has increased to £60bn.

The Government estimated in the Budget that the impact of the financial sector interventions would be between £20-50bn and prudently included £50bn in the public finance projections. We expect, subject to wider factors, to revise these figures downwards in the Pre-Budget report, alongside the Government's fiscal and economic forecasts.

However, the purchase of shares would, all other factors being held constant, increase the central government net cash requirement (CGNCR) for 2009-10 by around £13 billion relative to that announced at Budget 2009. The CGNCR for 2009/10 will be updated in the Pre-Budget Report, to account for all changes since the Budget including, for example, the net receipt from the redemption of Lloyds preference shares in June 2009.

Next steps and Timetable for Reporting

The Government has reached agreement on the substantive elements of the deals with both Lloyds and RBS and is now announcing these at the earliest possible opportunity.

Full legal documentation on RBS’ participation in the APS is being finalised following this agreement and will be published shortly. Lloyds has signed an exit agreement and this has been provided to Parliament separately today.

Following European Commission approval, which we expect over the next few weeks, the Government will publish: