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Why We Are Still Not Feeling TSB Bank Group Plc

 

Company Overview

Following a state bailout during the financial crisis, EU regulations have forced Lloyds Banking Group (LBG) to slim down as a business. This has led to a number of disposals over the years, with the most recent being 631 of the group’s high street branches that have formed a new challenger bank under the brand of a Lloyds subsidiary, TSB.

The original TSB was formed more than 200 years ago by Reverend Henry Duncan, who, during a time of economic hardship, wanted to create an institution that would cater exclusively for the poor people of Scotland. The reverend’s model proved a success and within five years had led to a proliferation of similar organisations across the UK.

The new spin-off has proved the most politically palatable means through which LBG can satisfy EU regulatory instructions to reduce its  scale, while forming a new “local banking” entity to help increase competition within the UK financial sector.

The primary business of the bank is in serving retail and business banking customers with mortgage loans, personal current accounts and savings products, household insurance services and a wide array of business banking services.

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TSB Bank Group Plc Reports Positive First Half to 2014

Following an oversubscribed June flotation, the shares have held up relatively well in unrestricted trading despite increasing levels of volatility across global financial markets.

On July 31st, the group announced half-year results for the period ending June 2014, which leads us to review both the bank’s financial performance, as well as its future prospects, once again.

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First Half Performance – Key Points

Management reported a statutory profit (before tax) of £128.5 million during the first half, which represents a significant increase (163.9%) upon the same period one year ago.

In addition to the jump in profits, TSB’s net interest margin also increased by 13 basis points over the period, while the Lloyds Mortgage Enhancement saw impairments as a percentage of loans fall by 10 bp.

In terms of strategy and performance against objectives, TSB attracted 9.2% of all new current account business over the period, which drove an increase in customer deposits of £600 million and offers testament to management’s efforts to compete with the incumbent “big six.”

The group also announced that it is on track to deliver its mortgage intermediary function by Q1 2015, which will increase its visibility among UK mortgage brokers.

On the downside, the group experienced a minor contraction in both new mortgage lending and business banking revenues as a result of lower volumes and margins. In addition to this, operating expenses also increased by 23% from £271.1 million to £333.5 million.

The market’s reaction to the update was mild, with the shares barely moving for most of the day.

TSB Bank Group Plc Share Price Hourly Intervals

TSB Bank Group Share Price

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Why We Are Still Not Feeling TSB Bank Group Plc – the Takeaway

On the face of things, TSB appears to have got off to a good start in life as a listed company devolved from Lloyds ownership.

However, when looking underneath the surface, TSB’s top line numbers overstate the day-to-day earnings capability and performance of the bank. This is because much of the increase in profits can be attributed to either “one off” exceptional items or streams of income which are far from guaranteed over the longer term.

Most notably, the rapid acceleration in post-tax profits, to £128.5 million,  includes a gain of £63.7 million that was made through withdrawing from Lloyds Banking Group’s defined benefit pension scheme (Cost saving).

In addition to the one-off credit to the income statement, a further £31.6 million of profit for the period was derived from the Lloyds Mortgage Enhancement (See our earlier report – TSB Bank Plc Part 2, 12 June 2014).  

While the mortgage enhancement will provide additional income to TSB for some time to come, the bank will not benefit from further pension-related credits. This means that without further improvements, earnings for H2 are likely to be substantially lower than during the last six months.

From a valuation perspective, and stripping out one-off exceptional items, TSB’s earnings per share for the six months ended in June were 7.6 pence. This is substantially lower than the reported 63.3 pence, and holds negative connotations for the group’s valuation going forward.

Assuming a constant adjusted performance in the second half, along with a constant share price, TSB looks set to complete its first year as a listed entity trading on an earnings multiple of 18.7X 2013/14 EPS.

This is expensive, particularly when compared against the 13.55 X 2013 earnings for an internationally diversified group such as HSBC, or the 14.55 X for the industry as a whole (Reuters figures – HSBC and Industry).

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Looking further out

Looking further out little has changed regarding the challenges that the bank will face over the longer term. In short, the pursuit of balance sheet growth is likely to prove a long uphill slog for a bank whose core products are mortgages and current accounts.

With switching activity in the current account market notoriously low and due to become the subject of a Competition and Markets Authority review, any growth that TSB achieves in this regard will be likely to take some length of time.

This is while the UK economy careers toward a tightening monetary policy environment which will doubtless lead to lower levels of activity in the housing market. Assuming that TSB achieves its target of having a mortgage intermediary function in place by Q1 2015, the bank will then be forced to compete for a diminishing pool of eligible buyers in a post MMR rising rate environment.

Past here, and assuming that TSB does achieve the growth that it is targeting, the group faces a potential reduction in revenue and a rapid escalation in costs when the LBG mortgage enhancement becomes callable in 2016, and when the LBG agreement to provide back office and IT infrastructure expires a short time after.  

As a result, the newly listed entity does not just face growth challenges over the years ahead but it is also at risk of suffering significant setbacks in terms of costs, revenues and earnings. Consequently, we remain un-attracted to the shares.

The next event of significance for the group is the release of its Q3 Interim Management Statement on 24 October 2014.

Earlier reports

TSB Bank Group Plc Part 1, 25 April 2014

TSB Bank Group Plc Part 2, 12 June 2014

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