David Prosser: The wise follow Lloyds to the promised land

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The Independent Online

Outlook They may take some convincing right now, but the day will come when shareholders in Lloyds Banking Group thank their lucky stars for Eric Daniels, Sir Victor Blank, Lord Stevenson and Andy Hornby. After all, had Lord Stevenson and Mr Hornby, formerly HBoS chairman and chief executive, not allowed HBoS to expose itself to such shockingly high-risk loans – and on such a scale – the bank would not have needed a Government-brokered rescue bid from Lloyds last autumn. And had Sir Victor and Mr Daniels, the pair's opposite numbers at Lloyds, spent a bit more time doing some due diligence on HBoS, they might not have agreed to take it on.

That would have robbed shareholders (taxpayers included) of an exciting future because, leaving aside for the moment the bad debt writedowns that plunged Lloyds to a £4bn loss in the first half, this is a bank with great positions in all its key retail markets. For example, Lloyds enjoys a 27 per cent share of the On mortgages market. On savings, it has about 20 per cent of all customers, while on current accounts, the key building block for a retail bank, it is thought to enjoy a 30 per cent share. One way or another, including the bank's insurance arms, more than half of the UK's adult population are Lloyds customers.

In any other environment, this is a deal that would have been blocked on competition grounds. The recession has taken its toll on Lloyds's cyclical banking business but, once the economy begins to recover, it is difficult to think of any other company better placed to benefit. Moreover, the group is moving towards another golden windfall for the bottom line – annual savings of £1.5bn from the integration of the Lloyds and HBOS businesses from 2011 onwards.

What about those awful impairment charges, then? Well, there's no way to sugar the pill – it's difficult to find words to describe the scale of incompetence there appears to have been in HBoS's commercial lending business, which was responsible for four-fifths of the £13.4bn Lloyds had to write down for the first half.

However, there is some good news. Firstly, Lloyds reckons impairment charges have peaked and bad debt provisions will decline from the second half onwards. And secondly, the bank expects that three-quarters of the assets on which it is making impairment charges will end up in the Asset Protection Scheme – the taxpayer-underwritten insurance fund that will cap Lloyds's potential loss at a maximum of £25bn.

In other words, even if Lloyds is wrong about calling the bottom of the bad debt decline, it is hedging the worst of its future downside. That will leave the group as a whole free to enjoy its competitive advantages it its core business. There's a risk, of course, that the competition authorities may yet come calling, particularly if Lloyds expands its market shares. But as regulatory risks go, this one looks much less frightening than the sort of pressures rival lenders face on their investment banking operations, a problem Lloyds doesn't have to worry about. As for the taxpayer, we don't yet know how big a bill – if there is one – the Asset Protection Scheme is facing. But the day is approaching when Lloyds's stock moves back up above the 102p per share that the Government paid for its stake.

When and if we get there, selling up at a profit quickly might be a smart bet, just in case the ongoing state aid inquiry into Lloyds being conducted by the European Commission forces the group to make some difficult choices about disposing of key assets. That, however, is the only truly dark cloud now remaining on the bank's horizons. A slower-than-expected economic recovery might postpone the arrival of the days in which Lloyds gets to cash in on its market dominance, but won't cancel them altogether.

By then of course, three of those four bank bosses will have departed, leaving only Eric Daniels to enjoy the promised land. It is pretty likely the other prime mover in this affair won't be around either, with the chances shrinking by the day of Gordon Brown – who encouraged Sir Victor to talk to HBoS – remaining in office. Who knows, shareholders might even thank him too, one day.

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