This article has been adapted from our sister site across the pond, Fool U.K.
Do you see the results as half full or half empty?
The weather is warming up and the days lengthening, but Lloyds Banking Group
The giant bank's full-year results for 2010 showed that it has yet to put the dark days of the HBOS acquisition behind it, with charges resulting from the merger continuing to hold up a return to full profitability.
Worse, while Lloyds' massive high-street branch network and its wholesale bankers made up for much of the damage elsewhere with an impressive performance, rising funding costs could put the brakes on this good-news story, too.
More skeletons in the cupboard and clouds on what was meant to be a sunnier horizon -- Lloyds shares could go only one way, and the price fell nearly 6% to 62 pence.
Heads you win (or lose)
The headline figures are decent -- well, depending on which you read.
On the basis of treating Lloyds Banking Group as if it had owned HBOS for the whole of 2009, full-year profit before tax has surged ahead to 2.2 billion pounds.
But on a statutory basis, shareholders saw a 320 million pound loss, principally because of a 1.65 billion pound integration charge made against the merger, as well as losses on disposals of 320 million pounds.
Which figure is more important? I think there are so many enormous charges dogging these results that it makes sense to look at the combined business figure for a truer idea of where Lloyds is going.
Lloyds isn't going to acquire one of its biggest rivals again in a hurry. And assuming the U.K. government doesn't break it back up, the scale of the combined operation should deliver outsized profits in the years to come.
Horrible HBOS
A cynic might complain that's brushing the enormous pain of the HBOS merger under the carpet, but it's almost impossible to do that.
Impairment charges fell 45% to 13 billion pounds over 2010 -- yet they actually rose unexpectedly in the second half of the year, as the bank marked down yet more HBOS-originated bad debt in Ireland by 3 billion pounds. Only this week, Lloyds announced a further half-billion-pound hit because Halifax is confusing its customers, too.
Better news is that the synergies from combining Lloyds and HBOS -- which presumably consist largely of stopping HBOS from repeatedly shooting itself in the foot -- are now delivering annual savings of nearly 1.4 billion pounds. The bank is confident that it will hit its 2 billion pound target by the end of 2011.
The potential strength of the combined retail business is there to see in the results. Total income from retail rose by 12% to just shy of 11 billion pounds, and markedly lower impairment charges sent this division's profit before tax soaring.
Total customer deposits increased by 5% to a whopping 236 billion pounds, and the new money was predominantly put into instant-access savings accounts and Individual Savings Accounts, which are less expensive to the bank than longer-term deposits are.
Loads-a-money
Growing deposits is important as Lloyds continues to wean itself off government support and reduce the need for wholesale funding.
The bank's loan-to-deposit ratio fell to 154% from 169%, which is good progress, though arguably not good enough compared with some rivals -- or for incoming CEO Antonio Horta-Osorio, who wants the figure down to 120%.
The company continues to deleverage. It has gotten rid of 105 billion pounds in non-core assets and says it's on track to hit its 200 billion pound target. Judicious changes in the asset base further improved its capital position, with the crucial core tier-one ratio up to 10.2%.
Lloyds also successfully issued 50 billion pounds in wholesale funding and reduced its borrowing from the special government-support schemes by 61 billion pounds to 91 billion pounds in 2010. Another 13 billion pounds has reportedly already been repaid in 2011.
This is Lloyds, however, so there has to be a fly in the soup. The snag is that this shift in its funding means the change in net interest margin -- the key indication of how profitable a bank's core business is -- is now expected to be flat in 2011, after the steady improvement to 2.1% slowed up in the second half of the year.
The worry is that this will crimp Lloyds' profit growth, which is probably the main reason for the share price fall.
Black Horse moves from a trot to a canter
As a shareholder who has bought into Lloyds for the long-term story, I'm satisfied with the progress.
Impairment charges have fallen significantly, and even the Irish loan book has been so written off that any further surprise there might conceivably be positive.
And, crucially, the underlying business seems to be functioning well, despite the massive challenge of integrating two enormous and venerable institutions.
For me, the biggest risk is the government's unwinding of the merger, rather than a slightly longer wait for decent earnings attributable to shareholders, or for a dividend.
I'd expect analysts' forecasts to be lowered a little in the coming days, but for what it's worth, they're currently predicting earnings per share of just under 6 pence per share in 2010, rising to nearly 10 pence for 2012. A 2.2 pence dividend is penciled in for 2012.
If it wasn't for the political risk, I think Lloyds would be a steal at 62 pence for patient shareholders. As things stand, I remain content to hold my purchase from lower levels in expectation of brighter days -- eventually.
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