Lloyds Banking Group (LYG)

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Jonathan J. Smith

Geoffrey Jordan

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. The bank competes against U.K. rivals Barclays (BCS), Royal Bank of Scotland (LON:RBS), and HSBC Holdings (HBC), as well as U.S. banks such as J P Morgan Chase (JPM) and Bank of America (BAC).

Lloyds 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]

Company Overview

Lloyds Banking Group is a financial services group providing a range of banking and financial services, primarily in the United Kingdom, to personal and corporate customers. The Company operates in four segments: Retail, Wholesale, Wealth and International, and Insurance. Its main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision. It also operates an international banking business in over 30 countries. Services are offered through a number of brands including Lloyds TSB, Halifax, Bank of Scotland, Scottish Widows, Clerical Medical and Cheltenham & Gloucester. In February 2010, Computershare Limited acquired HBOS Employee Equity Solutions from Lloyds. In February 2010, Lloyds sold its 70% stake in esure to a management buyout vehicle to be called esure Group Holdings Ltd. In March 2010, Capita Group Plc acquired Ramesys Holdings Ltd from Lloyds.

Business and Financial Metrics

During 2009 Lloyds delivered resilient trading performance against the backdrop of a marked slowdown in the UK economic environment and continued challenges in financial markets. Statutory profit before tax in 2009 was £1,042 million, compared to £760 million in 2008, largely reflecting the impact of an £11,173 million credit to the income statement from the gain arising on the HBOS acquisition (negative goodwill) which offset the significant increase in impairments during the year.^[3] Profit attributable to equity shareholders was £2,827 million and earnings per share (EPS) totalled 7.5p.^[3] On a combined businesses basis, the Group reported a loss before tax in 2009 of £6,300 million, compared to a loss before tax of £6,713 million in 2008.^[3] Whilst the Group delivered resilient revenues, lower costs and a strong trading surplus performance, up 35 per cent to £12,355 million, profits were adversely impacted by significantly higher impairment losses which increased by £9,108 million to £23,988 million. ^[3]

Business Segments

UK Retail Banking (42% of 2009 net income)^[3]

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.^[4] From 2007 to 2008, UK Retail Banking income increased 4%.^[4] The retail banking segment offers the following services:

• Secured lending - mortgages
• Unsecured lending - credit cards, loans, and overdrafts
• Internet and telephone banking
• Current accounts
• Savings accounts

Wholesale (39% of 2009 net income)^[3]

The Wholesale and International Banking segment provides corporate and commercial banking to approximately 26,000 corporate customers.^[4] The segment also offers specialty products such as auto leasing and leisure finance. The Wholesale division serves in excess of a million businesses ranging from start-ups and small enterprises to global corporations, with a range of propositions fully segmented according to customer need. The enlarged division, following the acquisition of HBOS, comprises Corporate Markets, Treasury and Trading and Asset Finance. Corporate Markets comprises Corporate, Commercial, Corporate Real Estate, Specialist Finance and Wholesale Markets. The wholesale banking segment offers the following services:

• Corporate markets
• Treasury and trading
• Asset finance

Wealth and International (10% of 2009 net income)^[3]

Wealth and International was created to give increased focus and momentum to the Group’s private banking and asset management activities and to closely co-ordinate the management of its international businesses. Wealth comprises the Group’s private banking, wealth and asset management businesses in the United Kingdom and overseas. International comprises corporate, commercial, asset finance and retail businesses in Australia, Ireland and continental Europe. The wealth and international segment offers the following services:

• Wealth management
• Asset management
• International banking

Insurance (9% of 2009 net income)^[3]

The Insurance and Investments segment offers life assurance, pensions, general insurance, and fund management products. The Insurance division is a bancassurance provider in the United Kingdom providing a wide range of long-term savings, investment and protection products, together with individual and corporate pensions. It is also a distributor of payment protection and home insurance in the United Kingdom. The division consists of three business units: life, pensions and investments United Kingdom; life, pensions and investments Europe, and general insurance. The insurance segment offers the following services:

• Life assurance, pensions, and investments
• General insurance

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.^[5] 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^[6] share of LYG, compared to the government's 70% stake in rival Royal Bank of Scotland (RBS-LN)^[4]

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.^[7] 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).^[8] HBOS's customer base and mortgage business looked promising to LYG, even though HBOS lost 43% of its market value in September.^[9]

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.^[10] 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.^[11] In the past month, LYG has been seeking to sell its share of HBOS.^[10] 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.^[4]

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.^[12] 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).^[12] After the £2.5 billion repayment, LYG still owes approximately £14.5 billion.^[12] The bank's balance sheets took another hit, however, as LYG took a £450 million loss on loans it made to Admiral Taverns--^[11] the UK's largest pub company by revenue.^[13]

Competition

• Barclays (BCS) -- London-based BCS is the top UK bank rival to LYG.^[14]
• HSBC Holdings (HBC) HSBC is another U.K. bank that competes with LYG for retail customers.^[15]
• 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.^[16]
• Citigroup (C) -- Citigroup offers similar banking products as BCS, and has lost money in five straight quarters.^[17]
• Bank of America (BAC) -- BAC is a bank holding company that competes with BCS for U.S. consumers.^[18]
• J P Morgan Chase (JPM) -- Like BAC, JPM also offers credit provision and investment banking products while competing with BCS for U.S. consumers.^[19]

• 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).^[25]

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} Lloyds Banking Group 2009 Annual Report
4. ↑ ^{4.0 4.1 4.2 4.3 4.4} LYG 2008 Annual Report
5. ↑ Seeking Alpha, "Is U.K. Headed for an Even Worse Great Depression?", 02/18/09
6. ↑ Investing Minds, "LYG"
7. ↑ Wall Street Journal, "Lloyds TSB to Acquire HBOS As U.K. Seeks Bank Stability," 09/18/08
8. ↑ Seeking Alpha, "Lloyds Buys HBOS: Good Deal or Bad?," 09/18/08
9. ↑ New York Times, "HBOS may be acquired by Lloyds TSB," 09/18/08
10. ↑ ^{10.0 10.1} Wall Street Journal, "Lloyds Looks To Sell HBOS Company Stakes," 05/24/09
11. ↑ ^{11.0 11.1} Reuters, "Lloyds to take £450 mln hit on pubs loan," 06/14/09
12. ↑ ^{12.0 12.1 12.2} Seeking Alpha, "Lloyd's Balance Sheet Looking Stronger," 06/11/09
13. ↑ Admiral Taverns Website
14. ↑ Barclays 2008 Annual Report
15. ↑ ^{15.0 15.1} HSBC 2007 Annual Report
16. ↑ ^{16.0 16.1} Reuters, Financial Statements, "RBS"
17. ↑ Citigroup website, "About"
18. ↑ Bank of America website, "About"
19. ↑ J.P. Morgan website, "About Us"
20. ↑ Reuters, Financial Statements, "LYG"
21. ↑ Barclays 2007 Annual Report
22. ↑ Citigroup 2007 Annual Report
23. ↑ BAC 2007 10-k, Item 6: Selected Financial Data
24. ↑ JPM 2007 10-k, Item 6: Selected Financial Data, page 14
25. ↑ USD/GDP Exchange Rates