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Wednesday, 5 August 2009

Lloyds / HBOS: not all it seems

There has been much scribbling about the HBOS losses occurring at Lloyds with the usual furrowed brows and dark mutterings, but all may not be quite as it seems for the share price of Lloyds jumped 12.5% this morning.

Lloyds announced that they had made a £4bn loss on a pro-forma basis, mostly due to a £13 bn writedown of assets, mostly from the HBOS portfolio. Not good, but what is all this “pro forma” nonsense. Don’t public companies simply have to report their results according to the relevant generally accepted accounting practice?

And so they do, and in Lloyds case, things don’t look so bad at all when they do because their interim group accounts show an £11.2 billion gain on negative goodwill on the acquisition of HBOS. What does that mean? It means that Lloyds paid £11.2 billion less for HBOS than they was implied by the book value of the company. Accounting rules allow them to recognise this as a profit, although it does not give rise to a taxable capital gain, which would only happen if the HBOS shares were ever sold.

The £11.2 billion discount is less than the £13 billion writedown, but some of that £13 billion will have come from Lloyds, and a banking protfolio can expect to have writedowns even in the best of times, so the extra loss doesn’t seem all that bad in the context of such a large acquisition. In fact the discount is worth more than the cost of the writedown, because whereas any tax on the gain on the HBOS shares is deferred until they ae sold, if ever, the asset writedown is a trading expense allowable against corporation tax at 28%, or a monetary value of around £3 billion.

Which is why Lloyds actually reported a pre tax profit of £6 billion and rather than a £2 billion tax charge on the £6 billion profit, a £1 billion tax profit, giving a profit after tax of £7 billion. That is not bad at all taking into account the doubling of Lloyds assets, its enhanced market share and the potential for future cost savings.

Which explains the share price rise and why, unlike all the other scribblers, I am not complaining about the loss to shareholders from HBOS writedowns, which were fully allowed for in the merger price and hence fully allowed in the price at which the government bought its shares in Lloyds, but I am complaining about the extra £3 billion free ride that Lloyds is getting from the tax man.


Sterence said...

As a Lloyds shareholder I wish I could share your outrage at what a great deal I have got. Before this merger I had a bank stock worth between £3 and £4, yielding about 7%. Now I have something that rose today to 92p. Woop woop. Sure, maybe I would have been diluted to some extent anyway, but there's no reason to believe Lloyds on its own would be the basket case it now is, had the merger not been forced down our throats. And do you really believe that the present writedown represents a complete cleanup of HBOS's balance sheet?

Alex said...

I appreciate your outrage on your share dilution, but there is significant "potential" in the business post-merger.

Is this a complete cleanup of HBOS' balance sheet? Probably not because a bank's assets are never risk free until they are all repaid, but I suspect that Lloyds will have taken a very conservative opinion and written off as much as they could, which is why they flashed the £4bn loss in big letters and blamed HBOS while actually booking a £7 bn profit.

If they could have found a few billions to write off they would have done so, but the fact that they didn't implies that those losses weren't there and they will be growing their Tier 1 capital base quite strongly.

Old Jock said...

In other words, Lloyds have quietly managed to broker a good deal whilst making it look like the government have forced a bad deal on them... good PR at this moment in time and quite sly...

Alex said...

Not quite. They wrote off £12 billion last year and £13 billion this half year, although some of that would have been Lloyds losses in the normal course of business in a recession.

Overall they have taken a bit of a hit, and my guess is that it wasn't a deal that they would have liked to have done if they had a choice. Lloyds are stopping the business lines of about 40% of the HBOS book, but it does have some long term upside through reduced costs and increased market share.

What is odd however, is that they are talking about a pro-forma loss when in reality they are increasing their regulatory capital.