UK taxpayers on track to make a healthy return on their investment.
This stock picking malarkey isn't half as difficult as they claim. Fully 60 million UK investors woke up today to discover that their punt on Lloyds Banking Group (LSE: LLOY) had moved into the black as the share price hit 74p in early trading.
Bollinger all around!
Of course, when the Government injected our money into Lloyds in October 2008 in exchange for more than two fifths of its equity, the public wasn't exactly sold on it as a share trade.
Even the most aggressive boiler room scam artist would baulk at deploying the Government's sales patter -- that unless we, the taxpayers, bought into Lloyds, as well as Royal Bank of Scotland (LSE: RBS) and any other UK bank that needed our money, then it'd be baked beans around the campfire by Christmas.
Yet as Warren Buffett put it, you make money by being greedy when others are fearful. The Government -- and us taxpayers -- backed Lloyds when the market was threatening to take the old nag to the glue factory. I think we'll be well rewarded.
Impairments down, profitability surging
Today's half-yearly results to 30 June 2010 show how speedily Lloyds is recovering, as the bank reduced provisioning for bad loans while reaping cost savings from its merger with HBOS:
- Profit before tax of £1.6 billion -- that's more than twice analysts' estimates (versus a nearly £4 billion loss in the first half last year).
- Banking net interest margin improved to 2.08% versus 1.83% in late 2009 and 1.72% for this time last year.
- Impairments down to £6.6 billion -- better than anticipated, and well down on the £13.3 billion this time last year.
- Headed for annual savings of £1.3 billion following its merger with HBOS by the end of the year, and £2 billion by the end of 2011.
- Core tier one capital improved to 9.0%.
- CEO Eric Daniels sees "returns on equity of more than 15% of the medium to long-term".
True, these are unusual times. Lloyds is borrowing money cheaply, yet like other UK banks it's currently able to lend at a wider spread than has been usual in recent years, making retail banking very profitable. Slashing jobs has also boosted profitability.
How long this sweet spot will last for if and when interest rates rise is an open question. Arguably with the demise of competitors and the merger with HBOS, Lloyds can dictate terms in a market it now dominates.
In addition, rising interest rates would probably only happen against a backdrop of a strengthening economy recovery -- by which point impairments would likely have dwindled away to nothing, further boosting profits.
Nice problems to have
It all leaves the Government with a headache, albeit preferable to the migraine it'd have if Lloyds were losing billions.
For a start, when does it dispose of its shares? Estimates for the price at which the Government starts to see a profit vary -- from just 63p a share if you take into account the fees paid to the Government by Lloyds to a little over 73p. Either way, its 41% stake represents both a profitable opportunity and the potential to depress the share price, especially if it releases shares to the public at a discount.
Then there's the thorny issue of bank lending. Lloyds says it has written £14.9 billion of new mortgage business to UK homeowners in the first half, and committed £23.7 billion to businesses. Both are ahead of Government targets.
Yet dig into the numbers and we see "loans and advances to customers" actually fell 1% to £368 billion, compared with the first six months of 2009.
Lloyds says it is lending to good customers but that many prefer to pay down debt. This is a hot potato for politicians, who won't see lending grow until people and companies become much more confident about the economy.
Finally, at some point we'll hear complaints that Lloyds is just too big. It must dispose of 600 branches over the next few years, but will that assuage competition concerns? Unlikely.
What price recovery?
Those among the 60 million de facto shareholders in Lloyds who feel conflicted about its return to profit should remember there are no certainties in equity investing.
Lloyds is a beneficiary of the softening of upcoming banking regulations, but if there's a double-dip recession, its impact will outweigh any theoretical risks the Basel committee might have presented.
Personally, I don't think Lloyds' projections are too bullish. It is looking for GDP growth of just 1.3% in 2010 -- surely in the bag -- and 2.1% for 2011, while its forecast for impairments assumes static house prices in 2010, and growth of 3% in 2011. It sees commercial property prices growing by just 6% this year and 2% next year. Finally, it predicts unemployment will peak in 2010.
An alternative concern for some analysts is a perceived funding gap for UK banks, which will see them having to rollover hundreds of billions in the next year or so. You can find arguments for and against this being an issue -- I think it's overblown.
To back Lloyds is certainly to back a continuing economic recovery. I expect the bank to be earning at least 6p a share in 2011, putting them on a prospective P/E of 12 -- down from over 60 for the current year 2010!
But if you're more gloomy about the economy, you wouldn't want to buy Lloyds. Especially as the Government has already done so for you…
More from Owain Bennallack:
> Owain owns shares in Lloyds.
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