Saturday, November 26, 2016

LLoyds Bank

A quick look at Lloyds, the largest bank in the UK.

The only two UK-listed banks serving the UK market are Lloyds and RBS.  Both went under in 2008 and had to accept government bailouts - pages 3 and 4 here give a brief history.  They are slowly mending, though still making large provisions to pay for past misdeeds.  Lloyds is the stronger of the two.

Market Share

The UK banking market is highly concentrated for savings, less so for mortgages:
  • For savings accounts: A UK government report states "The four largest banks (LBG, HSBCG, RBSG and Barclays) in Great Britain (GB) accounted for approximately 70% of active PCAs (Personal Checking Accounts) and 80% of active BCAs (Business Checking Accounts) in 2014".
  • For home loans: Moodys is cited saying that in 2014 the top 5 players had 2/3rds of the market: "Lloyds was the industry leader, controlling 24 per cent1 of the market share, followed by Santander UK with 13 per cent, Nationwide with 12 per cent, and Barclays and Royal Bank of Scotland (RBS) with 10 and eight per cent, respectively."

There are new entrants:
  • There has been new entry into retail banking in recent years. Metro Bank (PCA and SME) was the first organic entrant to the UK banking market in more than 100 years when it received its banking licence in March 2010.  Aldermore Bank (primarily SME but not BCA) entered in 2009. Several other new entrants have their roots in ancillary financial/retail services such as Tesco Bank (PCA 2014), the Post Office (PCA 2013/14), Virgin Money (PCA 2014), and Marks & Spencer Bank (M&S Bank) (PCA 2012). Handelsbanken (PCA and SME) has also significantly extended its UK operations more recently almost doubling its network between 2011 and 2015.
  • There are also a number of banks that have just been authorised or are in the process of being authorised including Atom Bank (authorised in June 2015, digital-only PCA and SME), Starling Bank (digital PCA), Civilised Bank (SME) and OakNorth (authorised in March 2015 SME but not BCA). In addition to traditional bank lending, alternative finance has been growing very rapidly in recent years. It has been estimated that the alternative finance sector had grown by around 160% in the year to 2014. Despite the rapid growth, alternative finance currently accounts for a very small share of SME lending (less than 2% of SME lending). 

Non-Interest Income

Trading and Insurance

Lloyds says that they do "not have a programme of proprietary trading activities".  So why is their "Net Trading Income" so high?

The "Net Trading Income" is tied to its insurance profits 2 , 3.  I can't untie the numbers in any meaningful way, so I add them all together:

This follows the stock market.  Looks like a typical insurance operation where they lose money on insurance and make it up by investing the float.  As expected, a large part of their "Trading and financial assets" held are equities (43%), followed by bonds (33%) and Loans/Advances to Customers (21%) 4.  So the above number is gonna drop when the stock market falls.

Fee and Commission Income

Fees do not seem to be affected by the economy.  Gross fees (i.e.: ignoring their direct costs) are broken down below.  "Other income" includes "Fiduciary and other trust income", Insurance Broking, and others:

Combining all of the above categories, and deducting costs, gives us net fees:

Bank fees in the UK are high, and have been the target of a government inquiry.

Other Operating Income 

Operating Lease income (blue above) is from Lex Autolease.  The increase in 2009 is when Lex Autolease was created from the takeover of HBOS.  Since it happened after the recession, we can't tell if operating lease income is affected by the economy.

Other Income (red above) is very spiky. I have removed one-off items from it 5.  Fortunately its low in 2015, so we can ignore it.


To get an idea of how much of their earnings come from interest vs non-interest, the above income categories are shown for 2015:

This excludes operating costs, and any provisions deducted from interest income.

Other Numbers

The CET1 ratio was 13% at end of 2015, which is OK.   However, RWA does not account for systematic risk.  Tangible Assets were 18.6 times Tangible Equity6, which is too high.

In 2015, (non-interest) operating costs were 2.5% of Deposits.

For Derivatives: The notional amount of derivative exposure is 5.9X total asset value - very high.  Lloyds says that they only hold derivatives for their customers or use them for hedging.


After removing the one-off items from their 2015 results (PPI provisions and TSB sale), their EPS rises from 0.8p to 6.7p.  At a share price of 60p, thats a PE of 9.

Other Risks

The two main risks are:
  • A falling pound, from Brexit
  • UK house prices have been rising for 4 years, and are due for a correction.

The previously rising pound and rising house prices may have fed on each other on the way up, and might unwind now.


I like it because its simple bank which makes most of its profits from deposit, loans, and fees, with a little insurance on the side.  It has minimal proprietary trading.  And operates in one country.  When its legacy problems eventually go away, it will be cheap at today's price.

Its operations are simpler than the Singapore banks.  However, leverage based on the assets/equity ratio is too high...I don't fully trust the CET1 ratio as RWA can be manipulated and doesn't detect systematic falling house prices.  I prefer to use both.

The main risk is the economic and housing cycles: is this the top?

[Edit: 28th Nov 2016: Bought 7191 NYSE:LYG ADRs at USD 2.9192.  1 ADR equals 4 shares.  Total cost USD 21,000.92.]


1 Lloyds market share will have dropped since then, as TSB was 50% owned by Lloyds in 2014 and sold off in 2015.

2 See table 1.35 in 2015 AR: Of the 140,536m of "Trading and other financial assets" on the balance sheet, almost 2/3rds (63%) is held for insurance. 

3 From the A lot of their insurance products are ILPs, whose value rises or falls based on some underlying investment. The rise/fall in value of previously sold insurance products is recorded under "Insurance Claims" (See 2015 AR's footnote 10, the entries "Change in insurance and participating investment contracts" and "Change in non-participating investment contracts"). However this is offset by LLoyds holding the underlying investment, and the offset is recorded under "Net Trading Income".

4 2015 AR footnote 15

5 See the text in footnote 9 in the ARs. Lists costs for restructuring, or managing liabilities for their past misdeeds.

6 I am including the "Other Equity Instruments" (Convertible notes issued in 2014 - see footnote 45) as part of the Shareholders Equity.  Otherwise it jumps to 20 times.

No comments: