Lloyds reported a loss of GBP 136 million for the second half of 2012, bringing the full-year loss to GBP 570 million. The driving force behind the full-year loss was provisions of GBP 3,575 million for redress of mis-sold Payment Protection Insurance (PPI), GBP 1,500 million of which was incurred in the fourth quarter.

On a management provided underlying basis, Lloyds earned a profit before tax of just GBP 2,607 million in 2012, which implies a pitiful after-tax return on equity of about 4%. Lloyds’ core profitability was better–the core division’s underlying return on risk-weighted assets was 2.56%, which implies a 15% post-tax return on equity. Group profit, though, was weighted down by GBP 3,547 million of losses from the non-core division. While the nomoat bank made progress on reducing its non-core division– non-core assets fell GBP 42 billion in 2012–legacy issues may mar Lloyds’ bottom line for some time.

Non-core assets were GBP 98 billion at the end of 2012, more than twice shareholders’ equity, and PPI provisions may not yet be complete. Lloyds’ core division performed fairly well, considering the difficult environment in the U.K. Retail, Lloyds’ biggest core segment, reported income that was largely flat with last year and a mere one-basis-point drop in net interest margin to 2.08% despite the persistent low-rate environment.

Loans fell 3% as demand stagnated, but the negative impact was largely offset by a 5% drop in non-interest expenses. Already modest loan losses fell further to just 0.36% of loans. With little more room to cut costs further or reduce loan losses, material profit growth will have to wait for wider economic growth.

Analysts and investors are more concerned about Lloyds’ legacy issues. Its noncore division remains large at two times equity despite substantial reductions. Management plans to reduce the portfolio by another GBP 20 billion in 2013, which will likely mean additional losses.

After that, progress is likely to slow and the portfolio is likely to remain large relative to equity in the medium term, which poses risks of higher losses if the economy turns south. To date, Lloyds has reserved nearly GBP 7 billion, the most of any U.K. bank, but during the conference call management couldn’t assure investors that more wouldn’t be necessary.


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