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Jonathan J. Smith

Lloyds Banking Group (NYSE: LYG) was one of three banks, along with Royal Bank of Scotland (RBS-LN) and Northern Rock, to be nationalized by the U.K. government.^[1] The bank provides retail banking, corporate banking, and insurance products to the U.K. and international customers. In addition to RBS, the bank competes against U.K. rivals Barclays (BCS) and HSBC Holdings (HBC), as well as U.S. banks suck as J P Morgan Chase (JPM) and Bank of America (BAC).

Lloyds, like its competitors, struggled through the 2008 Financial Crisis and 2007 Credit Crunch. The primary reason for LYG's struggles was the acquisition of mortgage and loan firm HBOS. The acquisition brought £10 billion in toxic assets to LYG's balance sheets,^[2] as HBOS market value decreased over 50% since the acquisition. The acquisition, along with holding other risky assets, caused RBS to become nationalized by the UK government. The nationalization plans included LYG participating in the Government Asset Protection Scheme (GAPS) plan. Under GAPS, LYG must increase lending to consumers in return for the UK government holding the bank's toxic assets. GAPS has reduced LYG's risk weighted assets by £194 billion and has increased its Tier 1 Capital Ratio% from 8.0% to approximately 18.7%.^[1]

Business Segments

Lloyds operates in three main segments:

UK Retail Banking (42% of Income)

The UK Retail Banking segment provides an array of financial products, including credit cards and personal loans, in over 3,000 branches in the UK. The segment's brands include Lloyds TSB, Cheltenham & Gloucester, and Scottish Widows. After the acquisition of HBOS, this segment became the UK's leading provider of current accounts, savings, personal loans, credit cards, and mortgages.^[3] From 2007 to 2008, UK Retail Banking income increased 4%.^[3]

Insurance and Investments (22% of Income)

The Insurance and Investments segment offers life assurance, pensions, general insurance, and fund management products. The segment's Scottish Widows brand was voted Best Individual Pensions Provider by IFAs in 2008.^[3] From 2007 to 2008, Insurance and Investments income increased 22% due to strong performance in all of its insurance products.^[3]

Wholesale and International Banking (36% of Income)

The Wholesale and International Banking segment provides corporate and commercial banking to approximately 26,000 corporate customers.^[3] The segment also offers specialty products such as auto leasing and leisure finance. From 2007 to 2008, Wholesale and International Banking income decreased 79%, due to impairment charges increasing 68% to £3.012 billion.^[3]

Business Segments Graphical Breakdown

The retail banking firm has a balanced product portfolio, but still gets a majority of it's income from savings accounts.

LYG's insurance segment had a strong 2008, but bank suffered due to losses in WIB.‎

Business Financials

From 2007 to 2008, LYG net income had a £4 billion nose-dive. A reason why the stock crashed was that 79% (£551.4 billion) of RBS risk weighted assets were in credit risk. This has caused the stock to have a beta of 2.12 (compared to the industry-average 1.41), which means the stock has been much more volatile than the market. From 07/08/08 to 07/08/09, LYG daily close prices have been over 97% correlated to UK banking rival Royal Bank of Scotland (RBS-LN).^[4]

Business Financials Graphical Breakdown

With a small international exposure, LYG is reliant on the British Economy.

LYG net income decreased 75.1% from 2007 to 2008 due to holding toxic assets.^[5]‎

Trends and Forces

LYG Becomes Nationalized

Lloyds and Royal Bank of Scotland (RBS-LN) were the two most notable U.K. banks to be nationalized.^[1] After the February announcement that HBOS lost £10 billion in 2008, the U.K. government stepped in and gave the bank £18 billion in capital.^[6] Since then, LYG has been participating in the Government Asset Protection Scheme (GAPS) to save them from miserable 2008 market conditions. Under GAPS, the firm pays a small fee and must increase lending to consumers, in return for the U.K. government to hold the firm's toxic assets, such as property loans and mortgage-backed securities.^[1] GAPS has reduced LYG's risk weighted assets by £194 billion and has increased its Tier 1 Capital Ratio% from 8.0% to approximately 18.7%.^[1] As a result of GAPS, the U.K. government has claimed 43.4% preferred^[7] share of LYG, compared to the government's 70% stake in rival Royal Bank of Scotland (RBS-LN)^[3]

Acquisition of HBOS Proves Costly for LYG

On September 18, 2008, Lloyds acquired mortgage lender HBOS for £1.3 billion in a government-backed deal.^[8] At the time of the deal, HBOS was twice the size of LYG (£681.4 billion in assets compared to LYG's £367.8 billion in assets).^[9] HBOS's customer base and mortgage business looked promising to LYG, even though HBOS lost 43% of its market value in September.^[10]

Due to market turmoil, the acquisition has come at a greater cost to Lloyds. Since the acquisition, HBOS market value decreased by over 50%, from £1.3 billion to £600 million.^[11] The HBOS deal has left billions in toxic assets in LYG's balance sheets. For example, a loan HBOS made to Admiral Taverns has made LYG post a £450 million loss.^[12] In the past month, LYG has been seeking to sell its share of HBOS.^[11] In addition, LYG is expecting to post a loss for 2009, ^[1] as the firm expects corporate impairments to increase 50%.^[1] The bank is optimistic, however, as it has identified over £100 million in toxic assets that it plans to eliminate in 2009 to prevent a situation similar to the Admiral Taverns loss.^[3]

LYG Transitioning from "Rescued" Bank to a "Recovered" Bank after 2007 Credit Crunch and 2008 Financial Crisis

LYG was hit hard by harsh market conditions in the past year, as the firm's stock dropped 80.82% from 06/06/08 to 06/06/09. Luckily for the bank, the U.K. government salvaged them by implementing the Government Asset Protection Scheme (GAPS).

LYG's balance sheets are showing promise, however. The bank announced on 06/08/09 that it will make a £2.5 billion repayment to the U.K. government.^[13] Lloyds boosted capital in the past two months by raising £4.3 billion in an equity issue, as well as closing 164 branches (approximately 1,660 jobs).^[13] After the £2.5 billion repayment, LYG still owes approximately £14.5 billion.^[13] The bank's balance sheets took another hit, however, as LYG took a £450 million loss on loans it made to Admiral Taverns--^[12] the UK's largest pub company by revenue.^[14]

Trends and Froces Graphical Breakdown

LYG suffered in 2007 and 2008 by holding toxic assets, but has improved it's balance sheet by being more conservative.

U.K. GDP growth was the lowest in 2008 since the early 1990's. The U.K. economy, and in turn U.K. banks, have fared similarly as poor as their U.S. counterparts across the pond.

Competition

• Barclays (BCS) -- London-based BCS is the top UK bank rival to LYG.^[15]
• HSBC Holdings (HBC) HSBC is another U.K. bank that competes with LYG for retail customers.^[16]
• Royal Bank of Scotland (RBS-LN) RBS is the largest bank in Scotland by assets, and has over five times as many assets as LYG.^[17]
• Citigroup (C) -- Citigroup offers similar banking products as BCS, and has lost money in five straight quarters.^[18]
• Bank of America (BAC) -- BAC is a bank holding company that competes with BCS for U.S. consumers.^[19]
• J P Morgan Chase (JPM) -- Like BAC, JPM also offers credit provision and investment banking products while competing with BCS for U.S. consumers.^[20]

• Note: BCS, LYG, and RBS financials are given in £. For purposes of comparison, the BCS, LYG, and RBS data in this table was translated to USD using the average USD/GBP exchange rate for 2008 (1.85251) USD/GDP).^[26]

LYG is not the only bank to have suffered from the financial crisis, as competing banks also had double digit losses.

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5 1.6} Seeking Alpha, "Lloyds Banking Group Still Expects a Loss," 05/08/09
2. ↑ The Street Insider, "Morning Movers 2/13: Lloyds (LYG) Lower On Massive HBOS Loss, Coinstar (CSTR) Up On Results," 02/13/09
3. ↑ ^{3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7} LYG 2008 Annual Report
4. ↑ Yahoo! Finance, "Historical Prices"
5. ↑
6. ↑ Seeking Alpha, "Is U.K. Headed for an Even Worse Great Depression?", 02/18/09
7. ↑ Investing Minds, "LYG"
8. ↑ Wall Street Journal, "Lloyds TSB to Acquire HBOS As U.K. Seeks Bank Stability," 09/18/08
9. ↑ Seeking Alpha, "Lloyds Buys HBOS: Good Deal or Bad?," 09/18/08
10. ↑ New York Times, "HBOS may be acquired by Lloyds TSB," 09/18/08
11. ↑ ^{11.0 11.1} Wall Street Journal, "Lloyds Looks To Sell HBOS Company Stakes," 05/24/09
12. ↑ ^{12.0 12.1} Reuters, "Lloyds to take £450 mln hit on pubs loan," 06/14/09
13. ↑ ^{13.0 13.1 13.2} Seeking Alpha, "Lloyd's Balance Sheet Looking Stronger," 06/11/09
14. ↑ Admiral Taverns Website
15. ↑ Barclays 2008 Annual Report
16. ↑ ^{16.0 16.1} HSBC 2007 Annual Report
17. ↑ ^{17.0 17.1} Reuters, Financial Statements, "RBS"
18. ↑ Citigroup website, "About"
19. ↑ Bank of America website, "About"
20. ↑ J.P. Morgan website, "About Us"
21. ↑ Reuters, Financial Statements, "LYG"
22. ↑ Barclays 2007 Annual Report
23. ↑ Citigroup 2007 Annual Report
24. ↑ BAC 2007 10-k, Item 6: Selected Financial Data
25. ↑ JPM 2007 10-k, Item 6: Selected Financial Data, page 14
26. ↑ USD/GDP Exchange Rates