BREAKINGVIEWS-Lloyds weighed down by familiar bugbears

Thu Jul 26, 2012 12:24pm BST

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

By George Hay

LONDON, July 26 (Reuters Breakingviews) - Chief Executive Antonio Horta-Osorio will one day be able to present a shiny new Lloyds Banking Group (LLOY.L), shorn of duff non-core assets and boasting a dominant position in a recovering UK economy. A 439 million pound first-half loss is evidence that not all of the engines required to get him there are working.

Horta-Osorio gets a tick for his deleveraging plan. Of 200 billion pounds of non-core asset reduction targeted in 2008, subsequently upped to 230 billion pounds, just 48 billion pounds remain. Lloyds’ outsized wholesale funding requirement has been slashed by almost a third to 213 billion pounds and lengthened in maturity. And the bank is adequately managing the awkward transition to funding all this in the market, instead of with government help: its net interest margin expectations are unchanged.

But Lloyds is very much a UK bank and the domestic economy is going south. A 0.7 percent contraction in the second quarter was its third of negative growth. That is hitting the top line in Lloyds’ cherished core operations, which was down 5 percent compared to the six months to December. The bank has not changed its assumptions of flat GDP this year and recovery next year, and a 42 percent year-on-year drop in impairments suggests things might be better than government statistics suggest. But if the economy is as fragile as the headline numbers say, bad debts will spike.

The last thing Horta-Osorio needs is leftfield threats to the bottom line. Despite a 3.2 billion pound provision to cover compensation claims for insurance mis-selling, Lloyds had to fork out another 1.1 billion pounds in the first half. And although the bank has yet to set aside any funds to cover losses from probes into Libor, it admitted today that it has already been subpoenaed.

Horta-Osorio has one trump card: the Bank of England’s Funding for Lending scheme. Using BoE repos to secure cheaper funding could slash Lloyds’ financing costs to big corporates almost in half, according to a person familiar with the situation. A virtuous circle would see increased credit to businesses stimulating economic growth, and helping Lloyds too. On the other hand, if the slump persists, more of these loans could go bad. But that’s the danger, and the opportunity, of Lloyds’ umbilical link to the UK.

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CONTEXT NEWS

- Lloyds Banking Group on July 26 reported a loss before tax of 439 million pounds in the six months to June 30, compared to a 2.3 billion pound loss in the same period in 2011.

- The loss was driven by an extra 700 million pound provision in the second quarter to cover expected compensation claims connected to the mis-selling of mortgage insurance. Overall, the bank has now set aside almost 4.4 billion pounds to deal with so-called payment protection insurance claims.

- Lloyds’ net interest margin fell to 1.93 percent, down 19 basis points compared to the first half of 2011, but in line with anticipated shrinkages caused by higher wholesale costs. The bank’s overall impairment charge was 3.2 billion pounds, down 42 percent on the figure recorded in the first half of 2011.

- The bank has not changed its forecast of flat UK GDP in 2012, with a progressive recovery in 2013. Assuming this occurs, it expects the 2012 impairment charge to be less than previously thought. Lloyds said non-core assets had now reduced to 118 billion pounds, ahead of expectations. It also reported deposit growth of 6 percent and a 4 percent increase in net lending to small- and medium-sized businesses.

- The bank now expects non-core assets to reduce below 70 billion pounds by the end of 2014, when they will be folded back into the main group and cease to be non-core. Lloyds shares initially fell 1.9 percent on the morning of July 26 but recovered to 29.5 pence, up 0.9 percent.

- Reuters: British bank Lloyds gets Libor subpoenas [ID:nL6E8IQ29S] - For previous columns by the author, Reuters customers can click on [HAY/]

(Editing by Chris Hughes and David Evans)

((george.hay@thomsonreuters.com)) Keywords: BREAKINGVIEWS LLOYDS/

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