RBS is often cited as the ultimate basket case of the UK banks. And it's true that RBS is still a mess.
But after looking at Lloyds Banking Group's latest results, I reckon it's in even more of a state than RBS.
Like RBS, Lloyds has a 'good' bank and a 'bad' bank. The core bank put in a reasonable performance in 2011, with pre-tax profits up from £2.2bn to £2.7bn.
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The trouble is that there's a lot of bad stuff offsetting this. The effect of writing off bad loans was less significant than in 2010, but was still a whopping £9.8bn.
Throw in a hit of £3.2bn for mis-selling payment protection insurance and Lloyds lost £2.8bn compared to £320m in 2010. There's no escaping the fact, these are terrible figures.
Yet that's not what concerns me about Lloyds. It's the bank's financing structure that's the real problem.
Lloyds is very vulnerable to a new credit crunch
Have a look at the chart below. It shows how banks are financing their loans.
UK banks: loans-to-deposits ratio
It seems sensible for banks not to lend out more than they take in from customers' deposits. But during the boom years that view was seen as old-fashioned.
Instead, many banks borrowed extra funds from the financial markets so that they could make more loans and more profits. When these markets dried up, many banks were in trouble (it's what brought down Northern Rock).
These days, as you can see from the chart, the likes of HSBC, Standard Chartered and even RBS are fully financing their loan books with deposits. Lloyds on the other hand, has a loans-to-deposits ratio of 135%. It is still reliant on £251bn of wholesale finance.
This is a very risky proposition for two reasons. Firstly, Lloyds is vulnerable to a credit crunch scenario; the turmoil in the eurozone means that this remains a real threat.
Secondly, it is vulnerable to rising funding costs. We think that banks in general and given its funding position, Lloyds in particular will have to increase the amount of financing they get from deposits. But if they want to do that, then they're going to need to pay people higher interest rates in order to attract their savings.
That's good news for you and me (finally), but it means higher costs for the banks. And if they can't pass these costs on to borrowers, then profits will fall.
There could be lots more write-offs to come
Lloyds still has £141bn of non-core' assets that it wants to get rid of. As with RBS, these assets will probably trigger more losses when sold.
Also, don't forget Lloyds' large exposure to the UK and Irish property markets, along with commercial real estate and leveraged finance loans. These are not the sort of assets to hold in a weak economy.
We suspect these loans will inflict more pain on Lloyds' shareholders. The tangible net asset value (NAV) per share of 58.6p should therefore be taken with a hefty pinch of salt.
And as with both Barclays and RBS, Lloyds has had to admit that its hopes for future earnings have been too optimistic. They are all saying that their hopes of earning 12-15% returns on shareholders' money were too high or will take longer to achieve.
This shouldn't come as a shock. Higher capital requirements, writing fewer loans at lower interest rates, and potentially rising funding costs, are bound to result in lower profits and lower returns.
Lloyds was targeting a return on equity (ROE)of 12.5%-14.5% by 2014. Let's step back and think about how it could achieve that. As we've said before, banks aren't particularly good businesses. Their returns on assets (profit after tax/assets) are typically less than 1% - sometimes a lot less.
It's only by leveraging these poor returns by 20 or 30 times (assets/equity) that were they able to generate high returns for shareholders back in the good old days'.
This is pure financial engineering and nothing to do with talent. So with lower returns and less leverage, what ROE can a bank realistically expect to earn?
Take Standard Chartered's best-in-class ROE of 11.4%. This was achieved with returns on assets of 0.85% and leverage of 13.3 times. Are Lloyd's assets as good as Standard Chartered's? We don't think so. Only by taking big risks and using high leverage can Lloyds make acceptable returns.
From our point of view, an acceptable investment would be a single-digit ROE (paid out in dividends) alongside low leverage. Lloyds and most of its peers are still a long way from this position.
Last year, as with RBS, we warned readers to avoid Lloyds when it was trading at around 48.5p a share. It's now 36p and we still wouldn't buy it. Steer well clear.
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