It was a long time coming, but Lloyds (LLOY) finally floated TSB (TSB) - or at least 35 per cent of it - last month. TSB, of course, is Lloyds' vehicle for hiving off the 631 branches demanded of it by the European Union competition regulators in 2009 as the price for state support during the financial crisis. Lloyds, however, has given birth to a robust new player, void of the legacy issues which continue to afflict other higher street banks, and which looks well placed to grow amid a recovering UK economy. Yet, crucially, TSB's shares trade below estimates of tangible book value, leaving them looking churlishly rated for the banking sector.
- Solid long-term growth prospects
- Low-risk mortgage book
- Plenty of capital
- Shares cheaply rated for the sector
- No dividend likely for years
- Mortgage book looks low margin
The bank certainly won't suffer from the problems of inadequate scale usually associated with new entrants. It begins life with a branch network that accounts for 6 per cent of the UK's total bank branches and boasts 4.2 per cent of UK current accounts. Indeed, it's already the UK's seventh largest bank and has also been born with an enviably robust loan book. Not only has Lloyds provided the new lender with an indemnity, effectively protecting it from such issues as PPI-type compensation misery, but around three-quarters of TSB's book comprises mortgage loans. They're historically low risk, so the lender's asset quality should be good. Neither is TSB exposed to the vagaries of the interbank funding market: as at end-March, it had £23.3bn of cheap and stable customer deposits funding a total loan book of £23bn.
With economic recovery now looking well entrenched - the International Monetary Fund expects the UK's economy to grow nearly 3 per cent this year - TSB should be able to grow solidly, too. Prospects for grabbing a greater share of the current account market look promising as 164 former Cheltenham & Gloucester branches, which only became capable of offering personal accounts a year ago, push into the market. Growing the mortgage book shouldn't prove overly challenging, either. After all, and amid a booming housing market, the Bank of England's second-quarter credit conditions survey reported that demand for mortgages had continued to increase significantly. TSB's efforts here should be helped once it reintroduces a mortgage intermediary sales function in early 2015, and analysts at broker BTIG expect the bank's loan book to grow 40-50 per cent by 2017.
TSB BANKING (TSB) | ||||
|---|---|---|---|---|
| ORD PRICE: | 286p | MARKET VALUE: | £1.43bn | |
| TOUCH: | 285.8-286.3p | 12-MONTH HIGH: | 300.5p | LOW: 284.5p |
| FORWARD DIVIDEND YIELD: | nil | FORWARD PE RATIO: | 7 | |
| NET ASSET VALUE: | 299p† | |||
| Year to 31 Dec | Pre-tax profit (£m) | Adj. earnings per share (p) | Dividend per share (p) |
|---|---|---|---|
| 2012 | 39 | ** | ** |
| 2013 | 67 | ** | ** |
| 2014* | 224 | 33 | nil |
| 2015* | 215 | 30 | nil |
| 2016* | 318 | 44 | nil |
| % change | +48 | +47 | - |
*BTIG estimates †Pro-forma figure as at end-March 2014 Normal market size: 3,000 Matched bargain trading Beta: na | |||
Moreover, with a Basel III basis core tier-one capital ratio (which compares equity-type capital to assets, weighted for risk) of 21.6 per cent, TSB doesn't lack the capital to support growth either. Indeed, that ratio leaves it as easily the best-capitalised of the larger UK banks. Being capital-rich, however, doesn't signal fat dividends. Management has made it clear that capital will be used to support growth in the near term and that a maiden dividend isn't anticipated until 2017. In time, however, management expects TSB to be able to support a payout that's equivalent to 40-60 per cent of underlying earnings.
TSB won't start life as an especially robust profit-maker, however, and BTIG expects fairly flat earnings until 2016. To begin with, the cost base appears chunky and analyst Shailesh Raikundlia of Espirito Santo Investment Bank estimates the bank's current cost-to-income ratio at over 72 per cent, which looks high for the sector. The focus on mortgages means fairly modest margins, too. Indeed, about two-thirds of the mortgage book comprises variable rate products that are capped at 2 per cent above the base rate. That's considerably lower than the average for non-rate guaranteed products in the market. As interest rates begin rising, however, many such loans could be refinanced to more profitable fixed-rate products.
Neither should investors neglect the earnings help that Lloyds is being required to offer TSB in the first years of its life. Specifically, the former Office of Fair Trading (now part of the Competition & Markets Authority) recommended that TSB should receive the economic benefit of £3.3bn-worth of Lloyds' mortgages until end-2017. In aggregate, that will enhance TSB's profitability by £220m.
