London, England -- Lloyds Banking Group and Royal Bank of Scotland on Tuesday announced that they were raising £54.5 billion ($88 billion) in moves agreed with the UK government and the European Commission.
After months of speculation, Lloyds confirmed that it was raising £13.5B ($22B) through a fully-underwritten rights issue and would swap at least £7.5B ($12.2B) of existing debt into a form of bond financing that can convert to equity.
The bank, which is 43 percent owned by UK taxpayers, also announced that it would have to sell a chunk of its retail banking business to satisfy state aid rules, including its Cheltenham & Gloucester and Intelligent Finance arms, as well as the TSB brand.
The UK state's economic interest in RBS, meanwhile, will increase to 84 percent after it injects a further £25.5B ($41.5B) into the business through a purchase of B shares. The government has also provided a commitment to buy up to £8B ($13B) more shares in exceptional circumstances.
RBS said it would also sell businesses to satisfy state aid rules, including its insurance arm -- which owns the Direct Line, Churchill and Green Flag brands -- and its interest in the RBS Sempra Commodities business.
It added that it viewed the RBS Insurance business as a potential candidate for an initial public offering of shares.
The capital raising moves will allow Lloyds to break free from the government's toxic asset insurance scheme while also reducing RBS's involvement.
As one of the conditions for the additional state support, both banks agreed not to pay discretionary cash bonuses in relation to 2009 performance to any staff earning above £39,000 ($63,500). In addition, executive members of both boards have agreed to defer all bonuses payments due for 2009 until 2012.
Lloyds said it would also be prohibited from "making certain acquisitions" for a period of three to four years. Among the conditions imposed on RBS is a requirement that its investment banking arm be ranked no higher than fifth in certain league tables related to debt market activities.
Shares in RBS fell 1.2 percent to 38.2p (62.2 cents) in morning trading, while Lloyds rose nearly four percent to 88.3p ($1.44).
The UK Treasury said the moves carried out by the two banks would reduce the risk to public finances by cutting the value of the assets insured under the toxic asset scheme by more than £300B ($489B).
The scheme would have insured 90 percent of any losses incurred by Lloyds on £260B ($424B) of assets, such as property loans. Under the original terms of the scheme the bank would have paid a £15.6B ($25.4B) fee for the cover but will now pay an exit fee of £2.5B ($4.1B) instead.
The value of RBS assets covered by the scheme has fallen from £325B ($530B) to £282B ($460B) on a like-for-like basis, while the "first loss" on these assets that would have to be swallowed by the bank rather than the taxpayer has grown from £42M ($68M) to £60M ($98M).
RBS will pay an annual fee to the government of £700M ($1.14M) for the first three years, falling to £500M ($815M) for the subsequent life of the scheme.
After subtracting an underwriting fee that it is due to receive for supporting the Lloyds rights issue, the government will contribute £5.7B ($9.3B) of the £13.5B ($22B) that the bank is raising.
Lloyds said the mandatory disposals would not stop it from realising the cost synergies of more than £1.5B ($2.44B) per year it expected to reap by 2011 as a consequence of its acquisition of HBOS, a deal that massively increased its exposure to bad loans.
The businesses earmarked for sale account for 4.6 percent of the UK market for current accounts and about 19 percent of the group's mortgage balances.
As part of the rights issue prospectus issued by Lloyds, the bank also released a trading update in which it repeated its belief that loan impairments for the overall group had peaked in the first half of the year.
RBS has been more downbeat about 2009 trading than Lloyds and it maintained this tone on Tuesday, saying its internal projections had not materially changed since August, when it said its poor results might not substantially improve until 2011.
However, it added: "We perceive the risk of a further stressed scenario receding."
© The Financial Times Limited 2009
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