HBOS - Another One Bites The Dust

HBOS walks warily down the street,
With its price pulled way down low
Aint no sound but the sound of its balance sheet,
Short Traders ready to go
Are you ready, are you ready for this
Are you hanging on the edge of your seat?
Out of the doorway Lloyds Bank rips
To the sound of the beat

Another one bites the dust
Another one bites the dust
And another one gone, and another one gone
Another one bites the dust
Hey, I’m gonna get you too
Another one bites the dust

(With apologies to Queen!)

I wake up on another morning where another bank is gone. Britain's Lloyds TSB sealed a 12.2 billion pound ($21.7 billion) deal to buy HBOS to create a dominant mortgage and savings bank, encouraged by the government amid fears turmoil in financial markets would claim another UK victim.

Lloyds will offer 0.83 of its shares for each HBOS share, valuing them at 232 pence based on Wednesday's closing price of 279.75p, a 58 percent premium over HBOS's last price of 147.1p.

HBOS shares were up 25 percent at 184p while Lloyds shares dipped 3 percent to 268p, trimming the value of the deal to 222p per HBOS share.

The bank said it expects the deal to boost annual earnings by over 1 billion pounds a year by 2011 through cost savings and boost its earnings per share by over 20 percent a year. Lloyds CEO Eric Daniels will remain as chief executive of the enlarged group and Victor Blank will stay as chairman.

The UK government said it intends to smooth regulatory approval of the takeover -- despite the enlarged group having a 28 percent share of mortgages -- to ensure the stability of the UK financial system.

Alistair Darling, UK finance minister, said he fully supported and welcomed the deal. But Daniels denied it was a government-brokered rescue of its rival, and said the banks have been in talks for several weeks.

"There shouldn't be any impression this is a shotgun marriage or a forced marriage, this is something that's been looked at for a good long while.

"Our most recent set of conversations have taken place over the last several weeks," Eric Daniels, chief executive, told reporters on a conference call.

All I know is someone is making a fortune

Lloyds said the combination will strengthen its ability to serve UK customers in current difficult markets.

It follows a plunge in HBOS's share price in the last six days amid fears about its funding position.

What interests us is what will come out about this deal when the short positions in the bank over the past weeks are analysed. The one thing we know for sure here is that someone has made a killing on the short side.

This will no doubt bring up the debate on short selling once again and I would suspect we will get some politician, who doesn't really understand the markets, calling anyone who was short 'Satan'.

The US SEC have recently made a call on short sellers by stiffening the rules. The SEC adopted two regulations forcing traders and brokers to close out short sales on all stocks, amid concern investors are driving down prices by flooding markets with sell orders. A third rule makes it a securities fraud when sellers deceive brokers about delivering borrowed shares to buyers.

I am not so sure about having everyone close short positions, shorting is a legitimate market tool and is creating, perhaps a false market, but the naked short rule is a good one.

Naked shorts are where people have not borrowed the shares in the market to cover their short positions. Basically if you have a brokerage account and you sell short on a 10 day settlement, for example, without shares on your account, then you will have to 'cover' your position in the market. Imagine now that thousands of traders did this on HBOS (I am not saying they did).

There could be a position (and it has been well documented in high profile cases in the US) where there are more shares being shorted than actually exist in the market. The price, therefore, is only going one way.. down the pan. But if a huge volume of the shares are naked, then it is a false price.

If you do this now in the US it is securities fraud. Personally, I think this is the most sensible thing a regulator has done for years, it almost make up for getting rid of the 'up-tick' rule that probably would have stopped a lot of this shenanigans.

My fear, however, is that Mr. Alastair Darling is now under pressure to do something about short selling in the UK. And with all due respect to Mr Darling, he has not got a great record when it comes to making decisions under pressure (non-dom tax and capital gains tax to name two).

I do sympathise, however, because it is a tough call to know what to do. The government recently stopped short selling around rights issues, and we suspect this will now be extended. A knee-jerk reaction would be to stop short selling on bank shares, however, to create a protective shell around banks on that basis may be a mistake, it depends on the view point you take.

The FSA have said that short selling is a 'legitimate tool', which I agree with, however I would like to see naked shorting stopped, it disturbs the natural order.

When the dust settle on all this I would suspect that there will be some hedge fund managers cashing in their chips and moving to somewhere they can keep a low profile, because the recriminations will be huge.

John Paulson making a 500%+ on one of his fund shorting the sub-prime market was received with applause for his heroics. The average guy in the street did not understand how this was done but had no particular problem with it. Any hedge fund manager who starts telling of the billions they have made shorting bank shares will not get the same reception. The perception will be that taxpayers are the ones who have bailed out the greedy hedge funds, and that would almost certainly put an end to the party.

I would suggest that the billions being made from shorting banks be kept very quiet indeed or you may find that the government and regulators start using the words like 'fraud', market abuse', 'market manipulation' and the Kryptonite words for hedgies 'windfall' and 'tax'.

Source: HF Markets Online Trading