One of the Sturdiest Banks in Europe
Now that narrow-moat Lloyds has substantially completed its turnaround, its moaty retail and commercial bank will be the biggest driver of results going forward.
Lloyds Banking Group (LYG) now one of the sturdiest banks in Europe. It nearly destroyed itself in 2008 with its notorious acquisition of HBOS, and the U.K. government ended up with 43.5% of the combined group. Now, after years of bailouts and setbacks, the bank has essentially righted itself, and the government has largely sold down its stake. We're encouraged that the U.K. recovery is continuing, and we expect to see double-digit return on equity in 2016 along with a 2016 forward projected dividend yield of at 5.8% as a result.
Lloyds has closed HBOS’ worst businesses, wrote down much of its bad assets, has re-emerged as the powerhouse U.K. bank that it once was. Net interest margin in the core bank finally began to tick up in early 2013 and continued to rise through 2015 as funding costs declined. The loan/deposit ratio has fallen to 108%--and will be closer to 100% as noncore loans decline. Credit losses have fallen to about 0.1% of loans--well below what we see as a medium-term level--and runoff assets have fallen by 94% since 2010, to GBP 11 billion at the end of 2015.
Now that Lloyds has substantially completed its turnaround, we think its moaty retail and commercial bank will be the biggest driver of results going forward, rather than legacy issues. The retail bank (about 30% of risk-weighted assets) is especially attractive and has a 25% share of the U.K.'s concentrated banking market. The unit is efficient--as costs consume 50% of revenues--and pre-tax returns on equity are already near 40% even with low interest rates. While its commercial bank (50% of RWAs) has returns closer to the mid-teens, we see positive signs there too--loan losses fell to 0.01% of loans in 2015--as loan growth picks up with economic expansion.
Having said that, we expect Brexit to introduce a period of slower economic growth in the U.K., lower loan growth, higher loan losses, and higher legal and compensation expenses. We're also concerned that misconduct charges, while well past the peak, may not be completely over. We're penciling in an additional GBP 3 billion of regulatory charges over the next five years.
Morningstar Premium Members gain exclusive access to our full analyst reports, including fair value estimates, bull and bear breakdowns, and risk analyses. Not a Premium Member? Get this and other reports immediately when you try Morningstar Premium free for 14 days.
Stephen Ellis does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.