Lloyds eyes exit from state ownership as RBS faces long haul

By Matt Scuffham

LONDON (Reuters) - Lloyds Bank is poised for a return to private ownership within 18 months, while part-nationalised rival Royal Bank of Scotland faces some major hurdles before it can regain independence.

The British government viewed its September sale of a 6 percent stake in Lloyds as a milestone in the country's recovery from the 2008 financial crisis, during which taxpayers pumped a combined 65 billion pounds ($106.4 billion) into Lloyds and RBS, and is keen to sell the remaining 33 percent before the next election in May 2015.

The finance ministry and UK Financial Investments (UKFI), the agency that manages Britain's bank stakes, are assessing options after this week's expiry of a lock-in preventing the government from selling more Lloyds shares. The stake is worth about 18 billion pounds.

Banking and political sources said the remaining stake is likely to be sold in tranches, the first of which could be to financial institutions such as pension funds and insurers after the bank reports full-year results in mid-February.

Private retail investors are likely to be included in later sales and UKFI is assessing the level of demand.

"The balance of probability is that the next sale will be to institutions, but that is not set in stone. There is flexibility for a retail offer," one source with knowledge of government thinking told Reuters.

The Treasury and UKFI declined to comment on the process.

Strong public demand for Royal Mail , Britain's biggest privatisation for decades, and for Direct Line , the insurance business spun off by RBS, suggests there would be strong interest, but the bank's dividend prospects could be key.

HANDLE WITH CARE

Lloyds is in talks with Britain's financial regulator to determine whether it can start paying dividends for the first time since its 20 billion pound 2008 bailout, making the stock more attractive to private investors.

However the sale is structured, it will need to be handled with care. This week Britain's public spending watchdog said taxpayers lost at least 230 million pounds on the first sale, contradicting finance minister George Osborne's assertion at the time that the shares had been sold at a profit.

Though the shares were sold at 75 pence - above the price at which they were bought - the National Audit Office calculated that they would need to have been sold at 80 pence for the government to break even.

Lloyds shares are currently trading at 77 pence and the average 12-month target price among 27 sector analysts polled by Thomson Reuters stands at 81.2 pence.

Lloyds has said it will set out its dividend policy alongside its full-year results after talks with the regulator.

Analysts expect the bank to pay a small 2013 dividend in February. The average forecast stands at 0.2 pence, according to a Thomson Reuters poll of 15 analysts. For 2014 that rises to 2.4 pence.

Although the path to recovery has been smoother for Lloyds than RBS, there have been bumps in the road. Lloyds has repeatedly underestimated the cost of compensating customers for mis-selling loan insurance and has now set aside 8 billion pounds to deal with the matter - more than any other bank.

Its sales culture came under renewed scrutiny last week when Britain's financial watchdog imposed a record 28 million pound fine for the way the bank encouraged staff to sell 2 billion pounds of products that customers didn't need.

Banking industry and political sources said it could take RBS - 82 percent-owned by the government - three to five years to return to private ownership.

PLENTY TO PONDER

Chief Executive Ross McEwan's efforts to rejuvenate RBS have been hindered by the resignation of finance director Nathan Bostock, IT problems affecting more than a million customers and damaging accusations over its treatment of small businesses.

While Lloyds Chief Executive Antonio Horta-Osorio can toast what he has described as the bank's return to "being a normal company", RBS counterpart McEwan has plenty to ponder.

Top of his in-tray is a strategic review, the findings of which he will reveal alongside the bank's full-year results on February 27. RBS has already announced plans to revamp the bank's structure, creating an internal 'bad bank', and spin off its U.S. business Citizens and 314 branches in Britain. February's review will switch the focus to operational issues.

McEwan is keen to tackle customer service, an area the bank's executives concede has been neglected during a massive restructuring, which resulted in 900 billion pounds being shed from its bloated balance sheet.

The bank and the Treasury are also in advanced talks with the European Commission to free it from government rights to receive an enhanced dividend ahead of other investors once the bank returns to profit.

Lloyds is expected to report 2013 net income of 3.1 billion pounds, Thomson Reuters data shows, while RBS is forecast to post a net loss of 1.2 billion pounds.

Taxpayers are currently sitting on a profit of about 800 million pounds on the government's remaining 33 percent stake in Lloyds and a 16 billion pound loss on RBS. ($1 = 0.6111 British pounds)

(Editing by David Goodman)