Lloyds' rough ride

Lloyds Banking Group released an unscheduled and fairly dour interim management statement last Thursday reiterating its February announcement that it expects to report a loss before tax in 2009.

We think Lloyds is in for a rough ride as economic conditions deteriorate in the UK and Ireland and we're leaving the bank unrated for now.
In its brief trading statement, Lloyds indicated that net interest margins are being compressed by the bank's decision to move towards longer-duration, more expensive wholesale funding and that credit quality has deteriorated sharply. The bank said that it expects impairments on corporate lending to increase 50% in 2009 as compared with 2008.

Much of this increase will come from HBOS' legacy portfolio, making it increasingly clear that whatever due diligence Lloyds performed on HBOS' asset book before agreeing to buy it was woefully inadequate.

Lloyds said that most of the deteriorating commercial real estate assets in question have been included in the asset protection scheme, but we note that Lloyds must bear the first 10% of losses alone, plus 10% of any remaining losses. We think that losses are likely to be heavy, and can't help but wonder if the UK government will impose even harsher terms on the asset protection scheme as the details are finalized over the coming months.