Lloyds Banking Group PLC (LLOY.L) is a financial services group providing a range of banking and financial services, primarily in the United Kingdom, to personal and corporate customers. The company operates in five segments: Retail, Wholesale, Commercial, Wealth and International, and Insurance. Its main business activities are retail, commercial and corporate banking, general insurance, and life, pensions and investment provision.

Are you ready for the Next Lloyds Sell-Off?

Antonio Horta-Osorio – group chief executive

George Culmer, group finance director

Price-earnings ratio: 11.5

Market Cap £59,610M

Price (20 Jan 2013) £0.83

Lloyds Banking group achieved its turnaround in 2013; now the clock is ticking on the next phase of the UK government’s exit plan from the lender.

Reports at the weekend suggest that the government will look in the next couple of weeks to sell another batch of Lloyds’s shares, with a book build for institutional investors followed by a retail offering.

Labour leader Ed Miliband’s call for the breakup of Britain’s biggest banks has accelerated sale plans for Lloyds, which announces annual results on February 13th. If the government moves quickly with its next share sale, that will make Miliband’s plan more difficult because it would create many more retail shareholders who would object to a breakup of the bank.

The bank’s share price has nearly doubled in the past year, as it launched a successful share sale, and now it is trying to persuade regulators to allow it to re-instate its dividend.

The bank announced third-quarter underlying pre-tax profit of £1.5bn ($2.4bn), up from £831m for the equivalent period a year ago. The results met analysts’ expectations, but on a pre-tax basis, which includes an additional charge of £750 million over the mis-selling of loan payment protection insurance and losses on asset disposals. This pushed it to a loss of £440m for the third quarter.

Lloyds has made good progress cutting costs and selling assets as it re-focuses its business on lending to UK retail and corporate customers.

It is in talks with Aberdeen Asset Management to sell its Scottish Widows asset management arm, and it has announced plans to float or sell TSB Bank, as required by a ruling from the European Commission in 2009, relating to laws covering banks bailed out by taxpayers.

The bank is also shrinking its international empire – on October 10, it announced the sale of its Australian operations to Westpac Banking Corporation. In September, it sold a portfolio of European commercial real estate loans to hedge fund Cerberus for £263m.

“The nine months to the end of September have been important for the group,” chief executive Antonio Horta-Osorio said in a statement, adding that the bank was on its way to “becoming a better, simpler, low-risk bank”.

The bank is owned 33% by the UK taxpayer and needs to have approval from the Prudential Regulatory Authority as it seeks to re-instate the payment of dividends for the first time since the financial crisis.

The bullish tone struck by Lloyds comes on the back of a successful sale by the UK government of £20bn of its stake in an accelerated book build to institutional investors last month, reducing its stake to 33%. As the UK’s biggest mortgage lender, Lloyds is a proxy for the UK’s economic recovery and the timing of the government’s stake sale coincided with an improving outlook.

The shares were placed with City institutions, another positive sign, and the government is hoping to sell its entire stake by the General Election in 2015.   Speaking at the third quarter results, Horta-Osorio said that he had “sympathy” with a plan to involve retail investors in the next sale and that now looks likely to be mid-February.

But have the City institutions had the best of the action? Well, yes and no. Stock markets were at their highs at the time of the initial sale, and the bank faces some pressures. Firstly, the Bank of England has said it will force all UK banks to sit a stress test to see if their balance sheets are sufficiently healthy and their capital ratios sufficiently high to survive another crisis. It is likely to force UK banks to hold more capital. Over the summer, the PRA forced Barclays to raise capital after the regulator forwarded a target for all UK banks to meet a new leverage ratio of 3%.  Lloyds said its leverage ratio was 4.2% at the end of June, which is above the minimum requirement, but regulators are likely to continue to demand stronger balance sheets.

Both banks were bailed out by the UK taxpayer following the financial crisis in 2008, but while RBS faces the prospect of more upheaval in the shape of a further government break-up, Lloyds has achieved its turnaround.

Lloyds may be stronger than some of its rivals in capital and leverage, but the uncertainty surrounding the tests will mean that even if it is successful in persuading the PRA to lift the dividend freeze, Lloyds is unlikely to pay anything more than a token dividend – 0.5p according to analysts at Citigroup.

The progress the bank has made in 2013 means its shares now look fairly valued, and that limits upside.  However, the shares do look cheap compared to peers. Lloyds currently trades on a price-to-earnings’ ratio of 11.5, compared with 16.3 for the rest of the banking sector. The FTSE100 trades on a P/E of 15.  Lloyds’s price to book ratio is 1.22, meaning that investors believe it is fair value, and that it is one of the stronger players in the industry – many European banks still trade at a discount to their book value.

The bank’s share price has nearly doubled in the past year…

But the lender is now growing its loan book again and is a participant in the UK government’s ‘help to buy’ scheme designed to help first-time buyers onto the property ladder.  However, there are already fears of a renewed housing bubble in London and the South-East.

Lloyds also has less exposure to investment banking than peers such as Barclays and RBS. This is a positive as investment banking is the activity that finds itself in the cross-hairs of regulatory scrutiny. While Barclays is under pressure to respond to the rising cost of fixed income trading, Lloyds has very little exposure in this area. The entire banking sector has endured turmoil since the financial crisis, and still has to negotiate a number of challenges, but investors should remember that banks are correlated with the yield curve – in other words, as interest rates climb, banks profit. With interest rates in the UK and many parts of the world at record lows, a recovering economy will lead to higher base rates.  The Black Horse is a leaner, meaner beast and easier to understand – and best placed to take advantage of an improving UK economy.


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