UK may issue exchangeable gilts

The UK Treasury may issue bonds exchangeable into shares of Royal Bank of Scotland and Lloyds TSB, according to the asset manager responsible for the government's stakes in the two banks.

John Crompton is head of market investments at UK Financial Investments (UKFI), the government-owned company which manages a 70% stake in RBS and 43% in Lloyds TSB, as well as the mortgage lender Northern Rock and the legacy portfolio of lender Bradford & Bingley. UKFI's job is to manage the stakes for value and ultimately to dispose of them.

It is possible, once market conditions improve, that UKFI could see a takeover bid from another major bank - presumably an overseas one, to avoid competition concerns. But it will also be exploring more active options for disposing its stakes. As well as private placements with institutional investors and a flotation aimed at retail investors, UKFI could also use convertible government debt, he said.

"We would essentially package options over shares with debt issued by the government. The advantage of that is that we would sell them at a premium, and capture some value for the option we had sold, and we would have created what you might think of as a conduit, through which shares would pass from our ownership as the debt converted to the ownership of the debt investors," Crompton said.

The final decision on whether to go ahead with the scheme rests with the Treasury, which has never issued convertible debt before - though other European countries have done so. KfW, the German state-owned bank, issued a bond convertible into Deutsche Telekom shares in May this year, and the Hungarian government used a convertible bond issue as part of its privatisation of the state-owned pharmaceutical company Gedeon Richter.

Crompton also warned that divesting the government's stakes will be a slow process. UKFI's total holdings are worth more than £70 billion. The largest 'precedent transaction' in the UK, the privatisation of British Telecom in 1993, was worth $5.4 billion.

Successive sales would have to be spaced out, Crompton said, meaning a full divestment could take many years. He added that no transactions would go ahead until the UK financial markets had stabilised further, pointing out that the banks had still not completed their negotiations with the Treasury's Asset Protection Scheme, which protects banks against losses from their portfolios of toxic assets in return for agreements to increase household and business lending.

See also: Cooksey to manage UK government's stakes in banks 
Lloyds asset protection scheme talks stall as HBOS losses confirmed 
RBS signs up to UK's asset-protection scheme