Lloyds is back in the black – but hold the celebrations

Lloyds Banking Group hailed a return to profits yesterday but there is still some way to go before investors can be really confident of its prospects, reports James Moore
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The Independent Online

So the Black Horse is bucking and kicking again. Against all expectations – and after risking its existence as a quoted company by joining forces with the vortex that was Andy Hornby's HBoS – the Lloyds Banking Group is back in the black again.

Chief executive Eric Daniels said yesterday that after losses of £6.3bn (when the bank still said it had had a good year) in 2009, the profits are now flowing again and the numbers will be firmly in the black at both the half- and full-year stages.

Mr Daniels believes that the bank is on track to deliver cost-savings of £2bn annualised from the merger with impairments falling and income rising. Despite low interest rates, margins – the difference between the price at which Lloyds lends and the cost of funding its lending – are solid at about 2 per cent and should stay there for the rest of the year.

Lloyds is also sticking to its UK growth forecast of 1.8 per cent (although many economists would say that is a little optimistic), while it believes that the threat of a "double-dip" recession is receding (but the bank will not put any numbers on how the odds have changed).

"We are tracking in line with guidance, or better. We will be profitable at the half year and profitable at the full year. Growth in income is being driven by margins that are back up and costs and impairments that are back down. We expect that the UK will grow this year, although the recovery is not as robust as you would usually expect coming out of a recession," says Mr Daniels, adding: "The nice part is that our business proposition is doing extremely well."

So is Lloyds the comeback kid and what's behind its change in fortunes if it is? Part of the reason that Lloyds is able to demonstrate such a turnaround is its approach to provisioning at the height of the financial crisis, something Mr Daniels admits when he talks about the company's "prudent" stance. This "kitchen-sinking" has meant that, with a recovery – even a weak one – the company has been able to report that its performance has been better than expected when it comes to loan losses.

This has been helped by the fact that with low interest rates and lower-than-expected unemployment, people have not been defaulting on their home loans at the level that had been feared. Corporate defaults have also eased – again, as recovery has taken hold – and this has been a big driver for the black horse's return to (near) racing fitness.

As Ian Gordon, analyst at Exane BNP Paribas, wrote: "Our existing forecasts see the group impairment charge plunging from £24bn in 2009 to £13.6bn in 2010, and this is validated by today's commentary, with wholesale impairments coming in significantly lower than the fourth quarter of 2009 (£2.7bn), and retail impairments (both secured and unsecured) also showing modest improvement."

The wealth management and international units have been the only real problems, but as Mr Gordon points out, these "did at least show improvement vs the disappointing fourth-quarter 2009 charge of £1.7bn". Like Mr Gordon, Morgan Stanley's Steven Hayne also sees the improvement in loan impairments as key to the bank's performance rather than the three pots of gold at the end of the rainbow that Mr Daniels talks of. Mr Hayne wrote yesterday: "We believe that [the] consensus profit [forecast] may drift up, but mostly on more aggressive impairment reductions – we leave ours unchanged for now. In our view, while margins may meet the 2 per cent guidance, the deleveraging appears to be slower and some of the non-core [business] is high-yielding assets."

Both raise concern about the slow pace at which Lloyds is shrinking its balance sheet. Mr Daniels has an answer for this: he says that the bank is replacing bad (old) business largely inherited from HBoS with (good) new business. Which pretty much has to be taken on trust given the voluminous reports banks produce with their results that appear designed to confuse. Another disappointing part of the results were the sales at life insurer Scottish Widows by contrast to a sector where growth has been ratcheting up. Lloyds' explanation is that it has been jettisoning unprofitable lines and focusing on the money-earners. Which is what life insurers say all the time.

It is worth remembering that yesterday's good news couldn't prevent the shares from falling as the latest downgrades of Greek and Portuguese debt shook the market and once again brought the issue of Britain's own little problem with public sector debt to the fore of investors' minds. And it's worth asking how Lloyds would be doing if it had stuck to its conservative guns and declined the Government's plea that it merge with a punch-drunk HBoS. One analyst said last night: "Now we're debating a share price of 70p to 80p. If the merger hadn't happened, we'd probably be debating 200p to 250p."