As Lloyds flies free, RBS years away from leaving state hands

* Different paths for bailed out banks

* Lloyds has rebuilt as UK focused lender

* Loss-making RBS (LSE: RBS.L - news) still more than 70 pct state-owned

By Andrew MacAskill and Lawrence White

LONDON, May 17 (Reuters) - Lloyds Chief Executive Antonio Horta-Osorio travelled at the front of the British Airways plane last week, enjoying the extra leg room in the business section on his way from London to the bank's annual meeting in Edinburgh.

On the same flight in the economy section were RBS board members and other staff on their way to attend their own shareholder meeting in the Scottish capital being held on the same day a few miles away, people on the flight told Reuters.

"This is what happens when your bank makes money," said one person on the flight, who asked not to be named.

The journey illustrates the diverging fortunes of the two British lenders bailed out by the government during the financial crisis with more than 66 billion pounds ($85.2 billion) of taxpayers' money almost a decade ago.

Lloyds and RBS declined to comment on their travel arrangements for the annual meetings.

Lloyds said on Wednesday that Britain had sold its last remaining stake in the bank, making the lender the first to re-emerge from British state ownership in a symbolic step for the country's recovering banking sector.

In 2011, Lloyds had made a bigger loss than RBS as it was forced to compensate customers for the mis-selling of payment protection insurance and was more exposed to what became Britain's costliest consumer scandal.

But six years on, Lloyds, which at one point was 43 percent owned by the government, has emerged as the type of bank RBS is striving to be -- a UK lender focused on retail and corporate banking.

At Lloyds when Portugal's Horta-Osorio took over in 2011 he made an early decision to reduce the bank's dependence on short-term funding and scaled back the bank's global reach from 30 countries to six.

Lloyds's plan now is to diversify away from an over-reliance on mortgage lending, by growing other business lines such as credit cards. The bank bought the MBNA UK credit card business from Bank of America (Swiss: BAC-USD.SW - news) for 1.9 billion pounds in December.

In contrast, the government still owns more than 70 percent of RBS and the Treasury recently said it has not budgeted to sell any shares in the bank for the next five years.

HIGH-RISK STRATEGY

Although RBS always had a bigger challenge in rebuilding after the crisis, the two banks faced similar tasks in reducing their global footprint, cutting costs and disposing of businesses to comply with state-aid rules.

One senior British banking executive said he thought six years ago that RBS was more likely to escape first from government ownership.

RBS's recovery was slowed because the bank originally tried to trade its way out of crisis via its investment bank, according to Peter Hahn, a professor at The London Institute of Banking & Finance.

Stephen Hester, who took over as chief executive of RBS after the bailout, believed that it should continue as a large universal bank, with worldwide investment banking operations, which were then benefiting from post-crisis stimulus measures by governments around the world.

Hahn said over the following years its profits from investment banking began to slump and the long-shot strategy failed.

"It went for the Hail Mary pass. That delayed a lot of the recovery," he said.

In 2013, the government ousted Hester and ordered the bank to focus on lending to British households and businesses and to maintain only a smaller investment banking business to service corporate clients.

There is still work to be done. In February, RBS booked losses of almost 7 billion pounds for 2016, its ninth straight annual loss.

HOLDING ON

Laith Khalaf, an analyst at Hargreaves Lansdown (Frankfurt: DMB.F - news) , said the government also made a mistake by paying too much for RBS shares initially and then holding on to for too long in the hope that that it could meet its original intention of selling the shares at a profit.

He said the government would have been better selling the shares at a loss because almost a decade of government involvement has been bad for the bank.

"If the government sold at a loss it wouldn't make particularly pleasant headlines for the Treasury, but they seem to be coming round to acceptance that they may have to do that," he said.

As recently as 2015 the government was still predicting that it would make a profit on its bailout from the banks.

British finance minister Philip Hammond acknowledged last month that this was unlikely. He explicitly said for the first time that he may choose to sell the government's majority stake in RBS at a loss.

One of RBS's biggest mistakes compared with Lloyds was in how it handled its obligations under EU state aid rules, analysts said.

While Lloyds spun off its TSB branches in 2015 to Sabadell bank, paying 450 million pounds to the Spanish lender to fund a new IT system, RBS opted for a more ambitious path of trying to create a standalone lender called Williams & Glyn with its own IT system.

RBS abandoned the costly project this year and is now applying to the EU with an alternative set of proposals to meet the state aid obligations.

"That was one of RBS's biggest mistakes, spending two billion pounds on an abandoned standalone project, it defies belief both before and after the event that they took that route," said Ian Gordon, an analyst at Investec (LSE: INVP.L - news) in London.

(Editing by Keith Weir)