Can Daniels steady Lloyds' ship?

CEO's optimistic view of its bad loans have left some analysts confused, writes James Moore
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Ever since its shotgun wedding with HBOS, Lloyds Banking Group – once the most boring of banks – has found itself at the centre of a perfect storm. The weekend saw the winds whipped up by another batch of bad press, after a whistleblower claimed the bank had plans to close hundreds of branches. The story was swiftly denied but it won't be the last such revelation.

The steady flow of unfavourable stories is being fuelled by the need for the bank to enter the Government's asset guarantee scheme to cover it against what could be multi-billion-pound losses from a string of bad loans, most of which were advanced by HBOS. For Lloyds to enter the scheme, the EU is all but certain to demand disposals, on competition grounds, which ought to help the bank raise some much-needed capital. But increasingly, the City seems to believe that the bank could raise a lot more from the public markets, reducing its reliance on what is a very expensive form of insurance that the bank may not actually need.

In July Lloyds revealed some pretty awful numbers: £4bn was lost and £13bn of bad loans were written off. The financials made the Black Horse look like a dray horse on its last legs, but ever since its shares have performed like Derby winners. On Friday they closed at 111.34p, up 6.64p. That made Lloyds the best performer in the FTSE 100. The optimism was fuelled by chief executive Eric Daniels predicting that the bank's bad debts have peaked.

City institutions have bought into the story because they see Lloyds as a recovery play, and that has led to speculation that they might just be willing to back a cash call with the aim of keeping the company out of the scheme. Mr Daniels said at the results that Lloyds expected to place £260bn of assets into it. The company has to burn through £25bn before calling on more taxpayer's cash (Lloyds is 43 per cent-owned by the state but the taxpayer will be a majority shareholder as a result of the scheme's £15bn premium) but has already gone through the first £10bn.

The rate of losses from the portfolio is slowing. Why go into it if things have been getting better, particularly when the idea of a share issue appears to be finding support among the institutions? "Certainly it appears that the institutions would support a capital raising. It would probably be done by a book build and might not even require much of a discount," said one analyst.

Disposals could also help. Speculation has centred on a possible sale of Scottish Widows, whose future Deutsche Bank's Mike Lamb is currently reviewing. There would at least one ready buyer, in the form of Clive Cowdery, who has identified it as a target for the UK super-insurer he wants to create following his controversial takeover of Friends Provident.

The latter is unlikely, however. Mr Daniels has described Widows as a "core part of the group" and bankers from rival firms say they did not want the review work because the chances of it resulting in a mandate to sell Widows are slim. The review is par for the course in a business which has just been through a big merger. If there were any real likelihood of a sell-off, they say, a more heavyweight player in financial institutions would have snatched the work. Mr Cowdery may have to be content with Clerical Medical, a lesser prize that Lloyds has closed to new business.

Lloyds hasn't commented publicly but privately, insiders have attempted to dampen down the excitement surrounding the scheme. At the results Mr Daniels deflected any suggestions that Lloyds should not go into it, describing it as a necessary precaution – "like a householder's fire insurance".

And it is worth remembering that several analysts have questioned his statement that bad debts have peaked. The statement was in stark contrast to what fellow part-state owned bank Royal Bank of Scotland said, and Mr Daniels himself admitted that as a general rule, bad debts do not peak until several months after a recession is over. Charles Stanley, the broker, said it was "confused about [Lloyds'] rationale for coming to the conclusion that the peak in impairments has passed".

The bank could yet use the recent optimism as a chance to raise some capital and reduce the amount of assets going into the scheme – thus saving on the premium – but having staked his reputation on what looks increasingly like a very bad deal, Mr Daniels is likely to be in safety-first mode from here. The economy is not out of the woods yet and that fire insurance will probably be necessary. What the latest furore does, however, do is make it look like the bank is at the mercy of events rather than in control of them. Mr Daniels needs to rectify this swiftly if that storm isn't to engulf him and sink his bank along with his career.