Lloyds is £10bn down but not out

Published on Saturday 28 February 2009 13:21

ERIC Daniels, otherwise known as the "quiet American", maintained his usual calm demeanour as he and the other board members of Lloyds Banking Group assembled to answer questions on their first set of results.

Last Friday, the so-called "super bank" formed by Lloyds TSB's controversial takeover of the beleaguered HBOS, issued a dismal set of figures showing a 10bn loss for 2008. The gloomier-than-expected news caused its share price to plummet by 20.5% to 59.6p on the day.

Daniels and his chairman Sir Victor Blank would have been prepared for a grilling on whether they now regretted rushing into the deal, brokered by the Treasury. It was HBOS's strong appetite for risk, particularly Bank of Scotland Corporate's involvement in residential and commercial property, that led to the loss. Without the acquisition, Lloyds TSB would have made a profit of 807m.

Daniels would also have been well aware of how differently this day was panning out than in previous years. Until getting into bed with HBOS, Lloyds had been regarded as a well-managed and profitable but "boring" bank because of its reluctance to get involved in certain areas of business, most notably sub-prime lending. Clearly, it is now generating more attention – for all the wrong reasons. A Sky TV cameraman had positioned himself outside Lloyds' headquarters on Grenville Street in the heart of the City in the early hours of Friday morning. He was still in his post at lunchtime when journalists were crowding into the building to see what directors had to say about the future prospects for the new bank.

While the board insists it has no regrets on the HBOS deal, its failure to reach a deal with the Treasury on the Government's asset protection scheme (APS) seems beyond its control. Lloyds, which is currently 43% state-owned, had hoped to announce that it was putting 250bn of riskier assets into the scheme to allow it to focus on increasing its lending and returning the business to profitability. The bulk of these assets are expected to come from the HBOS corporate lending book.

Alex Potter, analyst with Collins Stewart, warned that if Lloyds does not end up taking part in the scheme, it would become 74% owned by the Government. This would outrage shareholders in Lloyds who are already questioning the wisdom of Daniels and Blank in pressing ahead with the HBOS deal.

So how confident are the executives that it will finally get access to the APS? Would a breakdown in talks prove to be the final nail in the coffin for the board, which is already under pressure?

Blank decided to cut to the chase and address the fact it had failed to reach an agreement with the Government before being put on the spot by the media last Friday. He said: "We announced this morning that we were in discussion with the Government regarding its APS. There's no certainty about the outcome of this."

While Lloyds will issue a further statement in "due course", Blank made it clear he wants Lloyds to be part of the scheme. "We at Lloyds Banking Group want to do more lending and this scheme in principal releases capital to allow more lending to take place. It's a sensible scheme and we want to support its objective."

He admitted the Treasury's prolonged meetings with Royal Bank of Scotland earlier in the week were a factor in the delay in reaching an agreement. Last Thursday, RBS announced it was placing 325bn of assets into the scheme. "The whole Treasury team were up for three nights with RBS. They are absolutely and completely knackered," he said.

While the APS is clearly a major worry for Lloyds, analysts expect the situation to be resolved to avoid the prospect of the bank becoming majority-controlled by the Government. Mike Trippet, from Oriel Securities, said: "My hunch is that the delay is not down to a disagreement in terms. It's a massively time and labour-intensive process going through all of the assets and I think they just ran out of time."

There were also concerns over the pension and remuneration deals agreed with senior HBOS executives, including Peter Cummings, the former head of BoS Corporate who left the day the deal was done with Lloyds. He is understood to have a pension pot of 5.9m. UK Financial Instruments, which looks after taxpayers' interests in part-nationalised banks, has asked Lloyds to examine such payoffs.

On Friday, Blank claimed that salary and pension arrangements for HBOS directors were all in place long before Lloyds took over. He explained they would become public when HBOS's final annual report is published in March.

Despite such setbacks, Lloyds insists that it has HBOS's problems under control and the deal represents good medium-term value to shareholders. Blank said the board is in unanimous agreement that the business will be a success regardless of the "tough outlook" for the economy.

Daniels admitted HBOS had not had a good year and that impairment charges for its corporate business had totalled 6.7bn, up from 0.6bn the previous year. He said its businesses, including insurance and retail banking, are valuable assets. "The deal fundamentally repositions us and we're getting very important franchises. The results show bad losses but those losses over time will diminish. We're in the good part of the UK financial services market. We make real loans to real people and real companies."

Lloyds has been through HBOS's books with a fine-tooth comb and separated out assets that it regards as too risky, such as commercial property and sub-prime and self-certification mortgages. These will be managed by a new business support unit containing 240 employees who have around 4,000 years of experience between them. Lloyds plans to triple the numbers employed in the unit this year to develop a bank of experts in specialist high-risk areas.

Daniels still aims to cut costs in the new group by 1.5bn in 2011, but refuses to say how much of this will come from job cuts. "Clearly, there will be some staffing reductions resulting from the broad range of programmes we will initiate, but we anticipate that we can accommodate the majority of any reductions through natural staff turnover or limited voluntary redundancy programmes."

Although he claims to hold no regrets about the deal, Daniels admitted he would have welcomed more time to scrutinise HBOS's books. "In an ideal world I would have liked to have done more due diligence. But in an ideal world, would I like to have more free beer, of course I would."

Lloyds has yet to make decisions on what brands may be merged to make cost savings and what areas of the UK could be most affected by any consolidation.

Archie Kane, the head of Lloyds' insurance business and the executive director overseeing the combined Scottish operations, said Edinburgh is well placed in the new group. "Edinburgh is a key site. We have based the insurance division in Edinburgh and will be running it from there."