Martin Flanagan: Lloyds faces a long haul to revival but it's a good start

Published on Friday 26 February 2010 20:31

LLOYDS Banking Group's annual results are a mixed bag. The bank made the heavy losses expected of it as HBOS's terminally gung-ho commercial real estate strategy remains a monkey on its new owner's shoulders in terms of billions of pounds of bad debts.

And UK-centric Lloyds is undoubtedly more dependent than any other British bank on the country not succumbing to a double-dip recession this year. The bank's Irish operations also remain problematic despite some scaling back there.

But bad debts and net interest margins at Lloyds seem to be going the right way in late 2009, 2010 and beyond; the likely synergistic benefits from the acquisition of HBOS have been bumped up sharply which will help the group's capital strength; and the strong market shares it has in mortgages, deposits and current accounts, allowed by the government as the quid pro quo for the group rescuing HBOS, remain a massive fillip-in-waiting, even if down the line.

At this stage, therefore, in terms of both where Lloyds and the UK economy are, it still feels as much an act of faith as any compelling business narrative as to whether investors should climb on board the 41 per cent taxpayer-owned group.

The same could be said at 84 per cent taxpayer-owned Royal Bank of Scotland. RBS's losses this week were 3.6 billion (sharply lower than the 24bn nuclear fallout unveiled in 2008) compared with losses at Lloyds narrowing to 6.3bn from 6.7bn.

Both RBS and Lloyds, under their chief executives Stephen Hester and Eric Daniels respectively, face formidable turnaround challenges over the next couple of years in particular, after which things should get appreciably easier.

Hester has the advantage of being untainted by RBS's previous excesses: he's the sheriff come in to clean up a bank that had become a bit too like Dodge City.

Daniels is associated with both running the previously highly-successful, conservative Lloyds; but also taking on the HBOS can of worms or golden pot at the end of the rainbow, according to one's view.

Having said that, in the court of public opinion, Hester will have the continuing bonus uproar to deal with given RBS's significant banking operation compared with Lloyds's traditionally much more modest investment banking arm.

Sharply-contrasting bonus pots in 2009 of circa 1.6bn and 200m at RBS and Lloyds respectively say it all in terms of public vulnerability on this issue – even if both banks' chief executives did right in recognising the public mood in this area rather than delivering any by-the-numbers "meeting the performance criteria of an independent remuneration committee" script.

Over an extended time, however, as deferred bonuses in shares and clawback options become part of the junior school curriculum, attention will undoubtedly focus more on whether Lloyds and RBS have rehabilitated themselves as businesses.

To adapt a sometime-sporting maxim, in business images are for show, delivery is for dough.

Lloyds showed enough yesterday to suggest the worst is over: that HBOS remains a big negative for now but no longer threatens to bring the whole edifice down, and that there are signs on bad debts and margins that it is out of the trading trough.

But we are not talking Lazarus-Lloyds. Any rebound will be gradual, not astral.

As with RBS, there are likely to be big bad debts at the bank in 2010 as well, and therefore losses too.

Dividends at both banks still seem a pretty distant prospect and those taxpayer-holdings still loom large in the minds of other would-be shareholders. You can hardly call these two banks star-crossed in any way because they both brought much of their banking problems, for different reasons, on themselves.

But even if they are only on the very first floor of the elevator to recovery, investors have to see at least some tangible signs of improved performance if they are to eventually buy back into the investment story.

Lloyds and RBS showed definite glimmers of that this week.

The worst does look past, but a long haul remains.