Sept. 18 (Bloomberg) -- Lloyds TSB Group Plc agreed to buy HBOS Plc for 10.4 billion pounds ($18.9 billion) as the government tried to keep Britain's largest mortgage lender from succumbing to the worsening global credit crisis.

Lloyds TSB, the U.K.'s biggest provider of checking accounts, fell 15 percent today in London after saying it will buy HBOS in a stock swap. HBOS investors will receive 0.83 Lloyds TSB shares for each HBOS share, valuing them at 197.1 pence, a 34 percent premium to yesterday's close. Lloyds TSB Chief Executive Officer Eric Daniels, who will run the combined bank, plans to sell assets to help fund the deal, he told reporters today.

HBOS had lost almost half its market value this week on concern it was cut off from funding for its loans, the same predicament that led to last year's government bailout of Northern Rock Plc. CEO Andy Hornby decided to give up HBOS's independence just days after the U.S. subprime crash forced Lehman Brothers Holdings Inc. into bankruptcy and led to the government takeover of American International Group Inc., the biggest U.S. insurer.

``We don't see the current turmoil as temporary,'' Hornby, 41, told reporters today. ``We believe the dislocation in the markets will be with us for some time.''

Lloyds TSB fell 42.25 pence to 237.5 pence in London, valuing the bank at 13.7 billion pounds. HBOS rose 17 percent to 172.6 pence, 15 percent less than Lloyds TSB's bid at today's close.

``There is a lot of risk with this deal,'' said Simon Maughan, a London-based analyst at MF Global Securities Ltd. who has a ``buy'' rating on the stock. ``Maybe people are also thinking HBOS's assets are worse than they thought.''

Worst U.K. Housing Market

Fitch Ratings and Standard & Poor's said today they may cut Lloyds TSB and HBOS's long-term debt ratings. Fitch said HBOS has ``high exposure to the deteriorating U.K. property market.''

HBOS struggled to raise money this year as the worst U.K. housing market since the early 1990s led to writedowns and loan losses that depleted capital. The government imposed restrictions on short selling in June to help HBOS, which gets about half its funds in capital markets, raise 4 billion pounds in a share sale.

Three months later, the Financial Services Authority agreed to waive antitrust restrictions and allow the combination of HBOS and Lloyds TSB ``on public interest grounds to ensure the stability of the U.K. financial system,'' the regulator said in a separate statement.

``The alternative was very bleak indeed,'' U.K. Chancellor of the Exchequer Alistair Darling told the BBC's Radio 4 in an interview today. ``It was a necessity. We were ready to facilitate this merger.''

`Shotgun Marriage'

Lloyds TSB and HBOS together will have a 28 percent share of Britain's mortgage market and more than 3,300 branches. Both companies earn more than 70 percent of their revenue from the U.K. Lloyds TSB Chairman Victor Blank said the bank promised the government it will keep up lending to British homeowners after the combination is completed early next year.

``There should be no impression that this is a shotgun marriage,'' Daniels, 57, told reporters today. ``Very clearly we are concerned about funding and liquidity. Who wouldn't be? We'll be managing our balance sheet and liquidity with extreme care.''

The combined bank will be based in London and will cut an undetermined number of jobs as the company integrates facilities and sells unspecified assets Lloyds TSB's Victor Blank will be chairman. The combined company will add 1 billion pounds in pretax earnings by 2011, the company said.

``This is the right transaction for HBOS and its shareholders,'' HBOS Chairman Dennis Stevenson said in the statement. ``Against the backdrop of the very high levels of volatility our industry is experiencing, the combined group will be one of the strongest players.''

Back to 1695

HBOS, which employs about 72,000 people in the U.K., was created in 2001 in the 9.7 billion-pound merger of Yorkshire-based mortgage lender Halifax Plc and Edinburgh-based Bank of Scotland, whose roots date back to 1695. Lloyds TSB employs about 58,000.

Lloyds TSB weighed a bid for Northern Rock 1ast year, before the lender needed emergency funding from the Bank of England following the first run on a British bank in more than a century.

``The last thing they want is a Northern Rock re-run,'' said Julian Chillingworth, chief investment officer at Rathbone Brothers Plc, which owns shares of HBOS and Lloyds TSB, before the deal was announced.

Fitch put Lloyds TSB's AA+ credit rating and HBOS's AA credit rating on ``rating watch negative.'' Fitch's London-based cited ``integration risks in undertaking such a substantial transaction at a time of extraordinary financial market turbulence.''

While the HBOS takeover is ``highly attractive in terms of market position,'' it could lead to ``increased financial risks'' for the bank in the short to medium term, S&P said.

`Stressed Environment'

The combined group's short-term liquid reserves of about 80 billion pounds allow the bank to ``approach the most stressed environment with comfort,'' Truett Tate, Lloyds TSB's head of wholesale funds, told reporters. Its core tier 1 capital ratio, a measure of financial strength, will be 5.9 percent, Lloyds said.

``Funding will be key,'' said Derek Chambers, a London-based analyst at Standard & Poor's Equity Research Ltd. ``The plans to grow new business look ambitious and the cost savings look modest,'' said Chambers.

After the takeover, Lloyds TSB will pay a second-half dividend in stock and reduce the payout to investors to 40 percent of earnings in 2009, Daniels said.

``They will need to save lots of cash, which is why the cash payout will be substantially lower for Lloyds' investors,'' said Chambers, who has a ``strong buy'' rating on the stock.

Merrill Lynch & Co., Citigroup Inc. and Lazard advised Lloyds TSB, while HBOS was advised by Morgan Stanley and by Dresdner Kleinwort.

To contact the reporters on this story: Jon Menon in London at jmenon1@bloomberg.net; Ben Livesey in London at blivesey@bloomberg.net

Last Updated: September 18, 2008 13:12 EDT