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Why Lloyds Banking Group PLC Is A Bad Share For Novice Investors

Deciding whether I think the UK’s two bailed-out banks should be candidates for a novice’s cash has been tough. As I pointed out when I took a look at Royal Bank of Scotland, there are some compelling reasons to think they would make better investments than the rest of the sector, and my feelings about Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) are pretty much the same.

A nice cushion

The fact that the government has a 33% holding in Lloyds makes for a safer investment than it otherwise would be — the government is not going to react to the kind of short-term events that can cause a private or institutional investor to dive into and out of shares faster than most people change their socks.

Having said that, the taxpayers’ stake is considerably smaller than in RBS, where the figure is over 80%, but it’s still good to have a safe investor on board who is unlikely to sell out unless things are looking very favourable.

But at the same time, Lloyds is still a bank, and it will return to being privately-owned at some stage and will have to face the full force of the free market on its own. And its recent record has been pretty lamentable.

Litany of disaster

To say the takeover of HBOS in 2009 turned out to be a mistake would be like saying Bernard Madoff turned out to be a bit dodgy. At around £10bn, the losses at HBOS were far bigger than expected — and if you can’t trust a bank like Lloyds to do its diligence sufficiently well before such a major deal, would you want to trust your money to it?

Then in 2010, Lloyds was one of the banks caught with its fingers in the money-laundering till after dealings with Iran-based organisations were uncovered. These concealed transactions were prohibited by US law, and Lloyds’ part in them cost it a £350m settlement. Many think it got away lightly.

When stress-testing of the UK’s banks was introduced in 2009, the whole sector was found to be woefully under-capitalised to deal with any form of deep or prolonged recession. The big banks, which were widely seen as bastions of long-term security, turned out to be focused mainly on short-term greed and supported by paper-thin assets. And although some banks found enough private capital to stay afloat, we know only too well what happened to Lloyds.

Shiny future?

Lloyds recorded a pretty staggering pre-tax loss of £3.5bn in 2011, though it is expected to return to profit this year and the City is predicting a resumption of reasonable dividends by 2014 with a yield of about 3%.

Lloyds’ breathtaking incompetence may well be in the past now, and with new management on board and under a new regulatory regime requiring more robust capitalisation, the bank might well be a lean and fit investment once it returns to full private ownership.

Or the banks might just find other ways to satisfy their short-term greed at the expense of long-term shareholders.

It’s not for me

The problem is, we just can’t tell if we are genuinely into a new banking culture, and I certainly have reservations. And the safety cushion that is the government stake will only be there in the relatively short term.

So while Lloyds might well make some money for investors today, with the share price up 80% over the past 12 months its “screamingly cheap” days look to be behind it.

I reckon there are safer and easier-to-understand investments for novices right now.

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> Alan does not own any shares mentioned in this article.