The death and rebirth of Britain's Lloyds Bank

If there was ever a quintessential symbol of Englishness in the High Streets of the sceptered isle, it was the black horse logo of Lloyds Banking Group. Lloyds has a provenance that goes back to Birmingham circa 1765, well before the Industrial Revolution, in the reign of the Hanoverian Mad King George. Yet Britain's preeminent High Street retail bank faced financial Armageddon with an ill-fated buyout of Halifax Bank of Scotland (HBOS), a merger midwifed by Gordon Brown and Alistair Brown and Alister Darling in the height of the financial crisis. Lloyds was forced to seek a £20.3 billion sterling taxpayer bailout and HM Treasury ended up owning 43 per cent of a humbled international bank that was once a crown jewel of the City.
David Cameron and George Osborne wrote the next chapter in the Lloyds sage when they appointed António Horta-Osório, the Portuguese (this is pre-Brexit Stone Age UK!) chief executive of Banco Santander's Abbey national as the bank's CEO. Horta Osório slashed the bank's dependence on wholesale funding markets, sold £200 billion in toxic HBOS loans, sold the banks's global network (Lloyds now derives 97 per cent of its revenues in the UK), axed 12,000 jobs and closed down 400 branches. This epic restructuring enabled the UK Treasury to sell down its entire stake in Lloyds last May. While the deal and rebirth of Lloyds Bank is also a story of Sophoclean scale, replete with hubris and drama (the current CEO once collapsed due to stress and the shares tanked while he spent two months at The Priory private hospital, it is also a potential money making opportunity for me. Readers of this column know that the big money in global banking stocks is made when things go from Godawful to just plain awful, as we witnessed with the highly profitable trade ideas on Citigroup, Morgan Stanley, Bank of America, UBS, Credit Suisse, ABN Amro and the Argentine Banco Macro. The same virtuous cycle is now happening at Lloyds. Why?
One, Lloyds is highly leveraged to a steeper sterling money market curve which is inevitable as the Bank of England responds to Fed balance sheet unwinding and the post Brexit rise in petrol/food prices (Britain is historically the most pass through inflation prone economy in Europe) with three rate hikes from November and into 2018.
Two, Lloyds expects to generate 200-240 basis points of capital even though it has a Basel Tier One (CET1) capital ratio of 14.9 per cent even now. This makes another hike in the dividend payout and share buybacks inevitable in 2018. By my calculation, Lloyds trades at a forward dividend yield of 7.6 per cent even after its stellar performance last week. Capital return is the sweet spot that ignited a banking Cinderella. Remember Citigroup, which I first recommended in 2012 at 25 after it failed a Fed stress test, Vikram Pandit was ousted in a palace coup and the shrinkage of Citi Holdings began to create excess capital? Citi is 74 now. The real time alchemy of capital return.
Three, Lloyds commands a return of tangible equity of 16 per cent now and the lowest cost to income ratio among its peers in UK banking. Its mortgage margins are set to rise once the Bank of England end its Term Funding Scheme next February 2018 when the first base rate hike would have happened. Ye the sheer scale of capital generation reduces equity dilution risk and facilitates profitable expansion of the loan book. This, ceteris paribus, suggests a valuation re-rating, so does the end of the PPI mis-selling litigation cycle.
Four, I am a keen student of the UK property cycle and Lloyds is the UK's largest mortgage lender. Now that even London home prices have sagged, impairments will rise, as they did in 2018. Yet this is the reason Lloyds is the cheapest major bank in Europe at 9 times forward earnings, 0.95 times book value and a dividend yield of at least 6.4 per cent in 2017.
Five, the acquisition of MBNA's British credit card portfolio and the life/insurance/pension annuity business of Scottish Widows position Lloyds to outperform RBS and Barclays in the next decade. The move into digital/smartphone banking is also a game changer. Lloyds has a 21 per cent market shares in the UK retail/consumer banking even now. Me thinks my black horse will fly higher. How high? At least 85 pence by next summer. The rebirth of Lloyds Bank will be a time to make money for Queen and country in England's green and pleasant land!
The writer is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.