Lloyds Buys HBOS: Good Deal or Bad?

by: Dah Hui Lau

It is fascinating to see HBOS be acquired by Lloyds (NYSE:LYG), which is only half its size! In my humble opinion, the British government might have played a key role in this deal to avoid another Northern Rock (OTC:NHRKF)-like nationalization. However, I'm not sure whether this is a smart move or not.

  • Lloyds has total assets of £367.8 billion and net tangible equity of £8.54 billion. Leverage of 43 to 1.
  • HBOS has total assets of £681.4 billion and net tangible equity of £18.32 billion. Leverage of 37 to 1.

These two institutions are as leveraged as one can be. How much can a much-leveraged, yet smaller bank help a larger one, i.e. can Lloyds "rescue" HBOS?

Interestingly, when Lehman (LEH) filed for Chapter 11, it had a leverage of 32 to 1. And, Bear Stearns (NYSE:BSC) had a leverage of 33 to 1 when it was bailed out by JPMorgan Chase (NYSE:JPM). Even Morgan Stanley (NYSE:MS) with 25 to 1 leverage is potentially merging or selling to Wachovia (NASDAQ:WB) or another willing buyer.

The Lloyds-HBOS deal doesn't look like a good deal to me. It might solve a temporary liquidity crisis for HBOS, but if residential mortgage defaults start climbing, which I believe they will, then, Mr. Gordon Brown, might have to think about bailing out Lloyds-HBOS at some later date ...

If HBOS needed a bailout, it would need a larger, better capitalized bank, i.e HSBC (HBC). Of course, the government is worried about monopoly, etc., etc. Unless government wants to nationalize HBOS, it really should have let bigger banks like HBSC step in. Bear Stearns was successfully taken over by JPMorgan Chase as JPMorgan is significantly bigger and has a "fortress balance sheet".

Any thoughts?

Disclosure: No position in any of the above mentioned banks

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