We are maintaining our Hold on Lloyds TSB Group Plc (LYG). The company has agreed to buy HBOS Plc (HBOS), a UK bank with ?681 billion in total assets, in an all-stock deal worth about ?12 billion, expected to be completed in late 2008/early 2009.

We are reducing our 2008 EPADS estimate to $2.90 from $3.00, due to recent share issuance and US$ appreciation, and our 2009 estimate to $3.95 from $4.00, including the HBOS acquisition. While the deal makes Lloyds the #1 bank in the UK in terms of market share and over ?1 billion in pretax cost synergies are seen, risks include major loan concentrations, increased reliance on wholesale funding, and potential capital shortfalls.

The latter could be alleviated by the UK government's recapitalization program should Lloyds participate. In the first half, Lloyds had net earnings of ?705 million before nonrecurring items, down 52%. Excluding volatility and market dislocations, Lloyds had pretax profits of ?2,158 million, up 11%. The final 2008 dividend will be paid in shares to conserve capital.

At its current price, Lloyds trades at 4.6X the 2008 consensus estimate and 4.0X the 2009 consensus estimate. Our $15 price target implies a forward P/E of about 3 ?X based on our 2009 diluted EPADS estimate of $3.95.