Lloyds Bank

Quick Notes on LLoyds Bank in the UK.

Competition

Lloyds is the largest local bank with a 16-19% share in mortgage lending, the next largest is NatWest (formerly RBS) at 12-13%.  The largest 5 banks have a 60% market share.  Lloyds has ~20% market share of current account balances.  From these numbers, the UK market has 6 large players with > 5% market share.  So there's limited competition, but its not as comfortable as the Australian or Singapore market, controlled by 3-4 banks.

What do they do?

• They primarily make their money from interest (~70% of their Net Income in 2Q).  Primarily mortgages (book size of 307m mortgages, 40m other retail loans and 88m commercial).   Their deposits are 2/3rds retail, 1/3rd commercial (slide 16).  All pretty standard stuff - they are a traditional bank doing savings and loans.
• For their ~30% non-interest income ("other income - slide 18"), 75% of it is from commercial and retail banking.  I assume bank fees.  The remainder is Insurance, Pensions and Investments.

Balance Sheet

• CET1 ratio is 14.1%.  But they want to reduce it to 13% by 2026 and return excess capital to shareholders (slide 24).
• Loan to deposit ratio is 95%, which is on the high side compared to Singapore (low 80s) or US banks (10-year average of 72%).
• They have a large "structural hedge" (slide 17) from the pre-covid zero-interest rate period.  It yields around 1.35% interest, as the hedges expire in a 4% interest rate environment they'll yield more.  The hedge reduced 2023 profits by an estimated 800m (page 4), or 10% of 2023's PBT.  It depends what the interest rates are (actually what the forward curves are) when they expire.

Risks

Digital banks like Starling, Monzo and Revolut have been growing and taking market share.  Especially among young people.  Now 10-15% of the population has bank accounts with each of them.  Lloyds bank fares badly in customer satisfaction, trailing behind them.  But I'm not sure how much money they manage to capture, or how many people use them as their primary bank account and deposit salary - banking is a 2-sided market and you need scale to be profitable.  Only Starling is profitable.  Although the newcomers have made banking easy with mobile app features, its not a moat and can be copied by the incumbent banks.  (FT article).

The UK has been suffering through a recession in the past 2 years.  I think they will tax dividends on foreign shareholders.  Its a no brainer.

Biggest risk is the UK's long term prospects.  It has recovered from its recession, but may continue with weak (below 1%) growth as the past 2 years.  The UK's long term prospects look gloomy due to cheap energy from the North Sea running out, the end of Russian gas, and Brexit.  Politically and economically, they are probably going to become the 51st state - not a bad thing, but a big step down from being Europe's financial centre, or the old "empire on which the sun never sets".

Capital allocation

I like their capital allocation:

There are around 66bn shares issued (p302).  Buying 2bn pounds per year at a price of (lets say) 1 pound each removes 3% of shares every year.

Business Cycle

Banks are cyclical.  Where are we in the business cycle?

UK has been in a tough spot due to rising energy prices from the Ujkraine war and Brexit.  You can find YouTube videos of boarded up sops and houses.  They do have some structural problems to work through.

1Q24 just exited a recession, putting an end to almost 2 years of low/negative growth:

Source: Trading Economics

Hedgeye predicts the UK will have increasing yoy GDP growth in the second half of this year.  But that can change tomorrow.

Valuations

Price to book is 0.85.

At 70p, it would have a 1H annualised PE of 10.2.

Using 2023 numbers (a period of sub-1% growth but very high rates), the PE would be 9.2

Summary

The leading bank in a not-too-competitive market.  Its been recovering and recapitalising from its 2008 blow-up, and is now starting to return money to shareholders.

The stock shot up 6% yesterday when results were released.  I may be late to the party, is a recovery already priced in?  Biggest risk is that the UK recovery is weak.