Amateurs approach the recent UK bank results at their peril. They are full of confusing complications. I last wrote about Lloyds in March when we got more detail about the government Asset Protection Scheme (APS), under which it was proposing to ensure Lloyds against 90% of its losses on £260 billion of risky assets. Lloyds was to bear the first £25 billion of losses and to pay a premium of 13.6 billion ordinary shares. On the basis that the shares were worth 115p a share (currently 102p) the government would start to lose if Lloyds lost more than 16% on the portfolio. However, the details of the scheme have still apparently not been signed off, so that may have changed.
On Wednesday, Lloyds came out with its Interims (results for the 6 months to 30 June 2009).
To recap, the acquisition of HBOS and the new equity from the government were agreed in 2008, but they were not implemented until 16 January 2009, within the period covered by the Interims. Analysts like to compare figures with the previous year. In the case of Interims, that means they want to compare 1H09 with 1H08. That is does not help much in this case, because Lloyds has essentially doubled in size with the acquisition of HBOS, so the interims include “proforma” figures. These are imaginary figures prepared as if HBOS had been acquired on 1 January 2008 (the first day of 1H08). The idea is to push most of the bad news into 2H08, so that it does not affect the comparison between 1H09 and 1H08. No one grasped at the time of the acquisition that a big chunk of the HBOS loans were bad, they would discover that towards the end of 2H08.
Personally, I find this kind of stuff unhelpful, so I have stuck to the “statutory” figures. Summarised, and rearranged a little, they are:
In many ways Lloyds remains an extremely simple business. It borrows around a trillion pounds, mainly from customers, and lends most of it out to other customers. The interest rate turn is enough to give it a profit after meeting its various expenses. Well, it wasn’t during 1H09, but it hopes it will be in future.
Impairment is one of the problems. That is bankspeak for bad debts. Accounting for bad debts is slightly intricate. Suppose you loan someone £1 million. Then you realize it was a mistake, they are probably not going to repay you. You look at your security (maybe a mortgage) and estimate that you might get back £0.3 million after costs. So you make a provision (or more pompously an impairment provision) of £0.7 million. The loan stays on the books at £1 million, but the total shown in the balance sheet is after deducting the provisions. The provision is charged as an expense in the year that you make it.
Now suppose that the following year you manage to collect £0.4 million on the loan by grabbing the building and auctioning it off. You have ended up with a loss of £0.6 million on the loan, but in the income statement you show a profit of £0.1 million, because you already took a loss of £0.7 million the previous year. The loan is removed from the books and neither it nor the £0.6 million provision appear in the balance sheet.
In the Annual Report, this is spelt out in some detail in the Notes to the Accounts. Note 20 for the Lloyds 2008 AR shows:
That did not include HBOS. Although HBOS was taken over by Lloyds, it still exists as a legal entity and still has to prepare accounts. You can find its 2008 Annual Report on the Lloyds site. It shows that during 2008, its impairment provision increased by £7.3 billion to £10.7 billion, and in addition it created a new £0.9 billion provision against the value of its investment securities.
The old Lloyds TSB, also still exists as a subsidiary and you can find its interim statement, with shows an impairment charge of £2.2 billion, so it looks as though the other £5.8 billion relates to HBOS.
These may seem like fairly big numbers, but remember the combined bank now has assets of about a trillion, of which £652 billion are loans to customers. So it is making about 1.4% interest turn (per year). It has also suffered a 1.2% bad debt loss over half a year. It is hard to assess that. Clearly, HBOS got careless with its lending and lent far too much to bad risks over a essentially the whole of its 8 years as an independent bank. So you can regard most of the loan losses coming through now as attributable to James Crosby, just as most of those in 2008 were. But probably not all. Some may be due to the recession. It is hard to tell.
Continuing down the Interim statement, Net fee income is probably about half current account charges and card fees, and half a miscellaneous collection of things like trust fees and insurance broking fees (guessing from the 2008 accounts which give more detail than the interims).
Net trading income seems to be mainly losses from trading equities. There were also big losses from this in 2008 at Lloyds, but historically they have been an important source of profit to Lloyds (2007 £3.1 billion, 2006 £6.3 billion, 2005 £9.3 billion, 2004 £5 billion – all full year numbers).
HBOS joint ventures seem to have been some HBOS property developments.
Other operating income is not explained. It is much higher than in previous years (2008 £0.5 billion, 2007 £1 billion, 2006 £0.8 billion, 2005 £1.1 billion, 2004 £0.9 billion – full year figures for Lloyds alone). It appears from the Lloyds TSB interim that £1.7 billion was the profit realized on the redemption of undated subordinated debt, which is certainly a one-off.
I have shown the total loss of £9 billion excluding all other operating income, which may be somewhat unfair. Maybe a billion or so is likely to be continuing.
I have excluded the “gain on acquisition” as a one-off. That is more clear-cut. Lloyds paid for HBOS with 7.8 billion of new shares. At a deemed price of £1.733 per share (which bore some sort of relation to the market price around the time the deal was agreed) that amounted to £13.5 billion.
The HBOS balance sheet at 31 December 2008 showed £13.5 billion of net assets (after making impairment charges of around £12 billion). So where is the gain? Well, government also subscribed £11.5 billion for new shares in HBOS just before Lloyds took it over on 16 January 2009. So leaving aside the small £0.3 billion difference, Lloyds got a windfall of £11.2 billion.
However, whilst that may be correct in accounting terms, it is clearly a one-off. One normally excludes obvious one-offs from a company’s income statement. So the new Lloyds made a half-year loss of around £9 billion. That must have been better than the market expected since it closed on Tuesday at about 84p, ended Wednesday up 10% at 92p, and spent most of Thursday and Friday over 100p. Or maybe people did not look that closely at the figures.
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