Blank tries to quell HBOS concerns

Sir Victor Blank, chairman of Lloyds Banking Group, on Friday tried again to quell growing concern about its controversial rescue of UK mortgage lender HBOS.

“Acquisitions should be judged over time, not a few weeks after the deal has been completed,” he said. “The unanimous view of every member of our board is that it will be a success.”

In spite of that bullishness, the rationale for creating the UK’s biggest retail bank was looking unquestionably shakier on Friday given the £10.8bn loss reported by HBOS in 2008.

The growing problems in HBOS’s loan book are bound to put pressure on Lloyds to reach agreement with the Treasury to put toxic assets into the government’s Asset Protection Scheme, ringfencing future problems. Sir Victor said talks were continuing about the details.

Lloyds TSB, which was viewed as a prudent bank before it bought HBOS, reported pre-tax profits of £807m, meaning the new Lloyds Banking Group starts life with a £10bn loss to bounce back from.

It was the HBOS result that horrified analysts. Lloyds put some of these losses down to the worsening economy but also said it had adopted a more conservative methodology than HBOS had previously used.

HBOS’s losses included £3.6bn of writedowns relating to toxic structured credit products in its treasury division, as well as a further £6.8bn of losses in its corporate bank run by Peter Cummings, the controversial banker who left Lloyds last month.

The corporate impairment charges were driven largely by HBOS’s lending spree in commercial property. HBOS took a £1.5bn impairment charge in commercial loans and a £1.6bn charge on real estate.

It took a £1.3bn impairment charge on HBOS’s joint ventures division, which took stakes in property companies, as well as a further £1bn on HBOS’s integrated and structured finance unit, which took private equity-style stakes in companies. There was a further £1.3bn collective provision to cover other losses.

In the corporate bank, the proportion of impaired loans jumped from 2.9 per cent of the loan book to 11.9 per cent at the end of 2008.

Impairment losses as a proportion of average advances rose to 5.89 per cent against 0.62 per cent in 2007.

Alex Potter, analyst at Collins Stewart, said: “The scale of the deterioration in the HBOS book has shocked us.”

Particularly damning was Lloyds’s admission on Friday that about £165bn of HBOS’s £432bn entire loan book was outside Lloyds’ normal risk appetite and, of these loans, £80bn were regarded as “higher risk”.

Lloyds said the riskier loans include £31bn of loans such as buy-to-let loans and subprime mortgages. A further £40bn of corporate loans are regarded as higher risk, including £11bn in real estate and £10bn in commercial loans. A further £9bn is in the international banking business, including in Irish property.

Lloyds is putting some of these loans in a non-core unit, where it intends to increase staff supervising them from 240 to 720.

Even HBOS’s retail bank, which was profitable last year, is showing signs of strain.

Impairment losses in HBOS’s retail bank jumped to 0.88 per cent of loans last year from 0.52 per cent.

Alex Potter, analyst at Collins Stewart, said the deterioration was worse in HBOS’s specialised mortgages such as buy-to-let, where arrears jumped to 501 basis points against 327bp.

The mortgage loan books of both HBOS and Lloyds are looking more stressed. With 29 per cent of the combined prime residential mortgage book having a deposit of 10 per cent or less, there is a real risk of negative equity – bad news for a lender’s collateral – given that Lloyds, like other pundits, expects a fall in house prices of 15 per cent this year.

About 16 per cent of Lloyds’ prime mortgage book and 15.1 per cent of HBOS’s prime book have loan-to-value ratios of 100 per cent or higher and are already in negative equity.

The big question is whether Lloyds believes it can successfully work through the problems at HBOS, where impairments, across corporate and retail banking, jumped to 2.28 per cent of all loans, from 0.50 per cent in 2007.

Eric Daniels, chief executive, said on Friday: “We understand the portfolio very well. We have our arms around it. It’s easy in the face of the large numbers and concern around the portfolio to lose sight of the acquisition value to shareholders over the medium term.”

He conceded again that he would like to have conducted more due diligence on HBOS prior to the deal’s completion.

Lloyds indicated last year it would take £8bn of writedowns on HBOS in 2008. The amount ended up being £9.6bn, although Lloyds also pointed to the fact that the UK economy had slumped far more dramatically than expected in the fourth quarter, declining by 1.5 per cent, compared with the 0.2 per cent shrinkage expected by Lloyds. “Whilst we were pretty gloomy,” said Mr Daniels “we were not gloomy enough.”