By Simon Nixon
The worrying thought for Lloyds Banking Group /quotes/comstock/13*!lyg/quotes/nls/lyg (LYG 4.05, -0.13, -3.11%) investors is that this may be as good as it gets for some time.
The U.K. bank made pre-tax profits of £2.2 billion ($3.55 billion) for the year, largely from cost cuts and falling impairment charges. But drama is likely later this year, if incoming CEO António Horta-Osório cleans house.
He won't be short of things to junk, starting with the 2.5% margin target, which Lloyds doesn't expect to hit until 2014. Margins are being held down by rising funding costs as the bank seeks to repay £160 billion of government and central-bank funding. Another year of flat margins will knock £2 billion off 2011 pretax-profit forecasts, reckons UBS.
Meanwhile, Mr. Horta-Osório will want a hard look at provisions. Lloyds took £4.3 billion of impairment charges against its £27.5 billion Irish loan book in 2010, but provisions still cover just 54% of impaired loans, which include £12 billion of real-estate loans. That looks low. Mr. Horta-Osório also must decide what to do about the rest of Lloyds's £190 billion of noncore assets. With the core Tier 1 capital ratio now a respectable 10.2% and investors focused on return on equity, it may make sense to sell assets, even if it means crystallizing losses.
Longer term, Mr. Horta-Osório has a golden opportunity. Lloyds has twice the market share of previous employer, Santander U.K., a bank making nearly 30% return on equity.
Still, the U.K. has learned to be skeptical of star Portuguese managers running seemingly sure-fire winners—as soccer club Chelsea discovered when José Mourinho failed to take the biggest titles. Lloyds must hope its own "Special One" doesn't face the same fate.
Simon Nixon
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