Commentators are wringing their hands at today’s results from Lloyds: PBT down significantly, more provisions, and the woe will never seem to end. Hardly a compelling investment proposition. Take a step back from today’s results though: where does equity value come from in banking? Is this an opportunity to pick up the dominant UK banking franchise at a discount?
Deposits are, in my view, one of the main sources of equity value in banking. A bank is only as good as its ability to collect large amounts of cheap money from the public. Lloyds, with £419bn of customer deposits (75% of which are non-corporate), has the largest deposit base of any British bank. Competition is growing and barriers to switching are falling but this deposit base is a formidable source of competitive advantage. Retail money doesn’t move and it is cheap, both vital attributes for lending operations. Banking has become a messy business but the value of these deposits is unchanged.
If we look-through all the provisions and restructuring charges, Lloyds produced about £2bn of operating profit in the first quarter. Down 6% on the same period last year, but the full year should still come out somewhere in the range of £8bn. The market cap, at time of writing, was £48bn. Yes, we have all the provisions but, some day, these will end. At that point, you are left with the dominant brand in UK banking.
The risks are numerous but not fatal, in my view. First, we now know, with the imposition of time bars on PPI claims, that all these provisions will eventually end.
Second, it will be very difficult for Lloyds to grow significantly from here. Not only is Lloyds very large in relation to the British economy but, in aggregate, the non-banking sector isn’t borrowing. If I had to guess, I would say that this will probably change but, given the current valuation, we aren’t going to lose money if Lloyds doesn’t grow. Growth would be nice, Lloyds has the capital to lend more if it wanted to but this isn’t make or break.
Third, we have the risks of the economic cycle. In my view, and this will sound churlish given recent history, I believe the risk here is close to zero. Even in the worst days of the crisis, actual losses on mortgage lending were relatively small and Lloyds is very well-capitalised. This could all change but as…
