Lloyds reflects on its self-inflicted woes

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Five months into his role as chief executive of Lloyds Banking Group, António Horta-Osório appeared in sombre mood as he presented a gloomy set of first-half results.

His initial exuberance at taking the top spot at Britain’s biggest high-street lender has been dulled by the grim reality of a worsening economy and the struggle to increase revenue at a time when borrowers are keen to pay down debt.

At best the Portuguese banker believes the UK can hope for a “subdued recovery” followed by “modest growth” for a number of years. And, as he has always noted, Lloyds’ fortunes are more closely wedded to the UK economy than those of any other British bank.

Compounding his worries must be the fact that, after a 10 per cent fall on Thursday, Lloyds’ shares hit a 2½ year-low of 35p, less than half of the average price paid by the government for its 41 per cent stake, and 40 per cent lower than when he took over.

Mr Horta-Osório described the first-half figures as “resilient” in the face of difficult markets.

Much of Lloyds’ fall back into the red was self-inflicted, given that the chief executive’s decision to take a £3.2bn hit on mis-sold loan insurance was responsible for the bulk of its £3.25bn first-half pre-tax loss.

Stripping out the PPI charge and some other accounting factors, Lloyds posted a £1.1bn pre-tax profit, although this was still sharply below the £1.6bn it made a year ago.

Its core businesses were hit by worse-than expected loan losses, particularly in the wholesale business, which while lower than the year before, suffered a sharp jump in the second quarter, and Ireland, where bad loans increased by 22 per cent. Almost two thirds of the bank’s Irish loan book is now impaired.

Meanwhile weak lending growth resulted in a 10 per cent fall in net interest income at the retail business.

Nevertheless Mr Horta-Osório highlighted a number of key areas where he felt he had made progress, largely around efforts to strengthen the bank’s balance sheet and funding position.

Lloyds accelerated the repayment of its government-backed funding in the first half, repaying £59.5bn, including the last chunk of its exposure to the special liquidity scheme. It had £37bn of outstanding government and central bank funds at the end of June.

It also raised £25bn of funds in the wholesale markets in the first six months, meaning it met its full-year quota ahead of the latest round of eurozone jitters.

Mr Horta-Osório has slimmed down the bank’s sprawling balance sheet, stripping out £30bn of non-core assets in the first half.

He has also made headway in improving the bank’s poor customer service - complaints made about Lloyds to the regulator fell by almost a quarter in the first six months - and has increased its retail deposit book by 3 per cent.

However analysts say that even with the sharp recent fall in the share price the arguments for buying the stock at this stage look unconvincing.

Given Lloyds’ guidance that its profit margin on loans is likely to be squeezed in the second half, and the fact that it is still shrinking the balance sheet, they expect revenue to weaken further.

There is also some concern that UK interest rates may not rise as early as the bank hopes, putting more pressure on its profitability.

Mr Horta-Osório has been keen to stress the challenges faced by the bank - and play down expectations of a quick recovery. Investors must now hope the growth strategy he outlined in June, which centres around cutting £1.5bn of overheads by 2014, is aggressive enough to overpower the broader market woes.

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