Britain’s Old Bank

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Tuesday May 16, 2017

As our regular readers know, we made big bets on a pack of financial stocks in the wake of the credit crisis with the emphasis on buying institutions that had not only the wherewithal to survive, but with hefty upsides.

Some, such as Bank of America, were in the much maligned category of “too big to fail.” Others — such as Bank of Commerce Holdings — were small, well-run regional banks that could absorb non-lethal losses and bounce back relatively quickly.

All of these early picks had huge gains. With some profits crystallized and others moving closer to being realized, Ben decided it was a good time to review potential opportunities to recycle capital into banks that were still worth buying.

If they are still trading at a bargain price nearly a decade after the debacle, it stands to reason that these are institutions that managed to hang on by their teeth and are still limping along.

Or they might still be cheap because of negative sentiment associated with a new macro problem. London-based Lloyds Banking Group, which also trades on the NYSE as an American depositary receipt, ticks both of these boxes.

Not to be confused with Lloyd’s of London, which is synonymous with insurance, Lloyds Bank also has an extended history, established in 1765. Talk about a long track record! After successfully becoming one of Britain’s largest banks with the acquisition of Trustee Savings Bank in 1995, Lloyds met with disaster when it attempted to swallow HBOS in 2009.

As with Bank of America’s ill-considered purchase of Countrywide around the same time, Lloyds badly underestimated just how severe a downturn might be and the size of the liability it had taken on. A complete implosion was narrowly averted with the mother of all bailouts and British government taking a 43.4 percent stake.

The recovery has been slow and torturous, but after years of restructuring and withering fines for an insurance product scandal, the bank’s profit is accelerating sharply. The dividend was reintroduced in 2015 and a special payout of �2.2 billion ($3.9 billion) was announced in the most recent quarter.

Keeping a lid on the stock price has been the relentless selling of billions of shares by the government. It has now recovered all �20.3 billion from the bailout, and holds just less than 2 percent.

The other major negative factor is uncertainty surrounding Brexit. A time frame of April, 2019, has been put forward for completing the withdrawal, but negotiations have barely started and the financial services sector is just one of a plethora of issues to hammer out.

Those who reckon they have a clue how this will unravel would be wise to consider that predictions by most well informed “experts” on how the British economy would perform postreferendum have been dead wrong.

Lloyds is mitigating this risk by augmenting its presence in Berlin and plans to apply to have that branch turned into a subsidiary, which would become the hub of future European operations. How many jobs will be exported to the continent will depend on the shape of post-Brexit trade deals.

The situation has similarities to the difficult negotiations between the European Union and Greece: lots of posturing and threats, but in the end the sides muddle along with a series of baby steps toward a new normal.

This happens at a pace and with a scale that allows large corporations to adapt without too onerous a hit to the bottom line.

Ben liked the way Lloyds’ prospects were shaping well enough to initiate a position last December at US$3.11. With fundamentals such as capital ratios and net interest margin continuing to improve, and selling by the government drawing to a close, he is looking to add to his position on share price weakness.