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Lloyds Banking Group: Betting on Britain has obvious risks

The Times

When Lloyds Banking Group called a halt to its £1.75 billion share buyback scheme this week, it was, undoubtedly, a setback for shareholders.

Lloyds announced the move after warning that it would have to set aside a further £1.2 billion to £1.8 billion to cover a wave of last-minute compensation claims over the mis-selling of payment protection insurance. It said that it would now amass less capital than expected this year and that its return on tangible equity would be below its previous guidance of about 12 per cent.

Lloyds is by no means the only bank to have been found wanting in the PPI scandal, which is set to cost the main lenders more than £50 billion. However, it has been the most exposed, with a total bill that is expected to be just short of £22 billion.

The history of Lloyds Banking Group goes back to 1695, when Bank of Scotland was established. It reached its modern form in 2008 during the financial crisis, when Lloyds was put together with HBOS, the stricken lender that was in danger of going under.

It is the largest high street bank in Britain, with more than 2,000 branches, more than 30 million customers and roughly 75,000 staff. As well as offering current and savings accounts, loans, credit cards, mortgages and insurance to individual consumers, it operates a commercial lending business and has a private equity division. Its brands include Lloyds, Bank of Scotland, Halifax and Scottish Widows.

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The bank has completely reshaped itself since the government injected billions into the bank and took a 43 per cent stake during the financial crisis. Lloyds is now in much better financial health after working through the painful process of digesting HBOS and it made a pre-tax profit of just under £6 billion in 2018 on net income of just shy of £17.8 billion. With the dividend restored and as a highly cash-generative business, the bank has moved back into growth mode again.

It has done several striking things in this new-look guise and all of them show just how heavily Lloyds is betting on the British consumer. First, almost three years ago (and just months after the EU referendum) it spent £1.9 billion buying MBNA, the credit card business that was owned by Bank of America Merrill Lynch.

The deal, shortly after the government had disposed of its final stake in the bank, bought in about seven million customers with combined card borrowings of about £7 billion and pushed its market share up overnight from 15 per cent to 26 per cent, only fractionally behind Barclays. Despite worries at the time, Lloyds has successfully integrated MBNA, but, problematically, figures published by the Bank of England last month showed growth in consumer borrowing at a near-three-year low.

Lloyds also has moved to expand in the retirement market, buying £15 billion of pensions and savings from the British business of Zurich, the Swiss insurer, adding about 500,000 customers and a new IT system for these and other assets. This looks like a smart move in a rapidly growing market.

Last October it established a wealth management joint venture with Schroders aimed at catering to — and profiting from — affluent customers. Lloyds injected its £13 billion existing wealth management business into the new jointly owned company that will draw on the investment expertise of both Schroders and its high-end Cazenove Capital operation. This has plenty of potential, but has yet to prove itself.

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Most recently, last week Lloyds snapped up Tesco Bank’s £3.7 billion book of mortgage loans, which brought in a further 23,000 customers. It paid a small 2.5 per cent premium for the assets of about£3.8 billion, but hopes to be able to use its existing economies of scale in the home loans market to make the deal pay.

Yet Lloyds is betting heavily on the UK consumer at an exceptionally tricky time, as household confidence hangs by a thread with weeks to go before Britain conceivably could quit the European Union without an agreement deal over trade and customs.

It illustrates just how difficult the mortgage market is for money providers. Lloyds will generate a higher return from the existing Tesco loans than it would by moving more actively into new lending, where rates are enticing for borrowers but the opposite for lenders. In effect, it has had to buy growth.

While there is plenty of merit in these initiatives, consumers and the economy are under pressure. Recent surveys by Markit and the Chartered Institute of Personnel and Development have shown slowdowns in manufacturing, construction and services, meaning that Britain could be officially in recession when third-quarter GDP figures are published in early November. With banks providing the financing that oils the economy’s wheels, when GDP shrinks, the resulting slowdown in new business means that in all probability they will, too.

Under António Horta-Osório, 55, its chief executive, Lloyds has become a highly efficient, cost-conscious machine and profits have continued to have momentum. The bank may well be able to trade successfully through a downturn, but the pressure will be on and the growth options limited.

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Like those of its peers, Lloyds’ shares have been depressed, largely owing to worries about the effects of Brexit. Up ¼p, or 0.5 per cent, to 52½p yesterday, the shares are valued at only 6.6 times forecast earnings for a dividend yield of 5.66 per cent.

A rating at that kind of level makes it extremely tempting to suggest buying the shares, based on the chances of the slowdown being less bad than is feared. But it would take an investor with nerves of steel to buy into a lender that is virtually 100 per cent exposed to the fortunes of the UK economy at such an unpredictable time.

There are plenty of attractions about a bank that is likely to continue to pay dividends, despite the PPI hit, and is likely to reinstate the buyback programme at the earliest opportunity. Yet the sheer unpredictability of the Brexit outcome, and the subsequent impact on the financial sector as a whole, mean that this particular observer has to stay away.

ADVICE Avoid
WHY Brexit erases the attractions of this otherwise very strong lender and the prospects of a recovery in the price seem dim

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