The main Battle of the Branches has begun

It started in 2008 when the UK Government, the European Commission and Lloyds Banking Group (LBG) agreed to a divestiture as one of the remedies to the distortion of competition caused by government support to LBG during the financial crisis. LBG committed to divest the TSB brand with a retail banking business of at least 600 branches located in England and Wales, and at least 4.6% of the UK personal current account (PCA) market and 19.2% of LBG’s retail mortgage assets. The group also made commitments on the average quality and profitability of the divestiture and its branches. It must demonstrate that it has approached potential buyers by 30 November 2011. The sale must be completed no later than 30 November 2013. The buyer of the divestiture may not have more than 14% of the PCA market in the UK after the purchase. Add the Independent Commission on Banking (ICB) set up by the Treasury wants Lloyds to be ordered to sell "assets and liabilities" in addition to those that the European Commission is already obliging Lloyds to sell, to reduce its substantial market share in personal banking. If implemented, this would force Lloyds to sell more branches on top of the 600 it is already auctioning. The chief executive of Lloyds, Antonio Horta-Orsorio - with the full backing of Lloyds' board - is implacably opposed to selling "even one extra branch" on top of the 600 branches Lloyds is already being forced to sell. Lloyds Banking Group announced last week the executive management team that will lead the divestment programme of retail and commercial assets (“Project Verde”). A valuation of £3bn is expected according to media.

The Contenders

With the big brands (Barclays, HSBC/Midland, Natwest) already out of the race due to their market share, and of course LBG being the very seller and RBS the other bank that was already forced to sell 318 branches in a race in which Clydesdale and Virgin Money famously lost against Santander, there are only small entities or new entities left to play. Media has identified NBNK, NAB, Virgin Money, BBVA (in possible collaboration with NAB) and Nationwide (which last week ruled itself out of the auction) as the potential buyers.

NBNK

NBNK Investments plc is a company established in 2010 to take advantage of the opportunity which exists in the UK banking and savings market. The company has been founded by Lord Levene and a group of senior business figures, supported by a number of institutional shareholders. The Company’s proposition is to build (primarily through acquisition) a new and substantial UK bank. It will focus on the UK market only, initially just in the retail banking and small and medium enterprise (SME) areas but, over time, it intends to expand into wealth management. The Company intends to focus on acquisitions as the principal means of commencing and scaling its operations in UK domestic banking and, over time, retail wealth management.  The Company intends to focus on the acquisition of a large, established, high quality banking business to be funded by further substantial fundraisings. The articles of association of the Company do not contain any borrowing limits. Due diligence of proposed acquisitions will be undertaken by the Directors assisted by members of the executive management team, consultants engaged by the Company and the Company’s legal, financial and other professional advisers. On 4 November 2010 Gary Hoffman left Northern Rock to become CEO at NBNK Investments on 1 May 2011.

NAB National Australia Bank (Clydesdale and Yorkshire Banks)

As reported by Robert Peston last week NAB would be given "advanced" status. The FSA would therefore allow NAB to put a risk-weighted value on Lloyds' assets of around £11bn and hold 10% equity capital in relation to those assets. So it would have to raise nearer £1bn in equity capital - a fraction of what NBNK or Virgin would have to raise. Or to put it another way, the takeover of Verde would be massively cheaper for NAB than for the likes of NBNK or Virgin.

But Ian Fraser at the Herald Scotland reported that Clydesdale Bank appears to have lost its leading position as bank sources conceded that attempts to negotiate looser reporting standards with the FSA would take around two years to conclude. Sources said the FSA’s unwillingness to allow Clydesdale and Yorkshire Banks “advanced internal ratings-based” approach (AIRB), the status enjoyed by parent National Australia Bank on its home turf, will hamper the bank’s bid for the branch network that Lloyds is required by the European Commission to sell.  Under the Basel II regulatory framework, bidders granted AIRB status would be able to calculate the default risk attached to the Lloyds’ loan-books free from regulatory oversight. With AIRB, Clydesdale would have only had to raise £1 billion of equity capital to buy the assets in Lloyds disposal. Without the exemption, Clydesdale would need to raise £4bn of fresh capital to buy the assets. One banking industry source said: “Without AIRB, it’s going to be a struggle for Clydesdale to make the numbers work. Another problem is that the Verde businesses come with a £25bn wholesale funding gap.”

NAB London is authorised to use AIRB but NAB London operates as a branch of NAB (Australia) and is therefore regulated and supervised by APRA under global cross-border agreements amongst the supervisory authorities. If there would be a failure of buying the Lloyds branches and if Melbourne has lost patience with Clydesdale, the NAB boss Cameron Clyne may even consider divesting Clydesdale and Yorkshire banks.

Virgin Money

Virgin Money was knocked out of the race to buy the network of retail branches being sold by Royal Bank of Scotland after submitting a £1.5bn proposal that aimed to preserve jobs and save branches rather than simply offer the highest price. Virgin Money, the banking arm of Richard Branson’s business, was one of the four remaining bidders for the 318-strong branch portfolio, along with the Spanish banks, Santander and BBVA and National Australia Bank. People close to the sales process said the rejection of Virgin could be a sign that the priority is generating the best possible return for taxpayers. Virgin recently won the backing of the US billionaire investor, Wilbur Ross, who paid around £100m for a 21 per cent stake in the bank.

Virgin Money's CEO Jayne-Anne Gadhia's motto is "never give up". Just as well, perhaps, as the Virgin Money boss is accustomed to setbacks – but does not stop to think about them for too long. The imposing and gregarious Midlands-born banker tried and failed to buy Northern Rock before it was nationalised in February 2008 and then missed out on 318 Royal Bank of Scotland branches last year. She is now ready to do it all again, this time with simultaneous offers for 600 Lloyds Banking Group branches plus Northern Rock. As she prepares to embark on a roadshow to find £3bn of funding to enter first-stage bids for both Northern Rock and Lloyds, Gadhia is confident that Virgin Money's compound annual growth rate of 36% will be enough to arouse interest. Potential backers have already calling at the Edinburgh office, tucked on a quiet side street, to express an interest in standing alongside the US investor Wilbur Ross, who has already committed £500m to any bids.

The group headed by Sir Richard Branson held talks with Lloyds’ chief executive Antonio Horta-Osario on Tuesday last week and has made no secret of its plan to expand within the UK’s financial services sector. A formal bid for the 600 branches on sale is now expected from Virgin Money in July, with Sir Richard telling the Financial Times: “This can happen quickly and smoothly.” “We are a serious bidder and can give the government what it wants through competition,” Sir Richard said.