Lloyds Banking Group has flown out of the starting blocks on Wednesday morning, showing a clean pair of heels to the rest of the UK banks.
Its near 30 per cent advance is in large part due to bullish note from house broker Citigroup, which has had its research blackout lifted following the completion of the HBOS deal.
Unsurprisingly, Citi has stuck a “buy” rating on the company. It also reckons the shares are worth 120p.
According to Citi analyst Tom Rayner they key question is whether Lloyds has enough capital to weather the economic downturn and whether nationalisation is inevitable. The answers are no and no respectively.
The key question for investors in Lloyds Banking Group is whether it has enough capital to withstand the economic downturn and, if not, how dilutive recapitalising the group would be for existing shareholders. Under our stresstest scenario, the core capital ratio falls to 3.4% requiring £3bn to get back to the FSA’s minimum level of 4.0%.
If the government provided 100% of the required capital under our stress-test scenario, public ownership would increase from 43% to 57% and dilute NAV per share to 122p. Lloyds Banking Group is
currently trading at a 47% discount to this outcome, seemingly reflecting fears of full nationalisation, something we view as unnecessary and inconsistent with the stated aims of the government.
In summary then, nationalisation can be avoided if all Lloyds needs is a another £3bn from HMG. But how does Rayner arrive at that figure and is it realistic?
Here are his workings.
Figure 17 shows that under our stress-test scenario we would expect both HBOS and Lloyds TSB to exceed the FSA’s 4.0% floor Equity Tier 1 ratio, although both would have breached this level were it not for the significant capital injections from the UK government. However, our analysis indicates that the proforma LBG group could fall to 3.4% if we unwind the benefit from the gain on HBOS’ debt. This prudent approach suggests that c£3bn of further capital may be required to restore the Equity Tier 1 ratio to 4.0%, although as we discuss later in this note, this is likely to be mitigated by the support provided by the recently-announced government initiatives.
Rayner also makes the point that the Government’s Asset Protection Scheme (GAPS) and measures by the FSA to address procyclicality could eliminate the need for a capital injection altogether.
We estimate that utilising the Government’s Asset Protection Scheme (GAPS) could cap the post-tax credit loss on Lloyds Banking Group’s (LBG) high-risk assets at c£16bn, which is £9bn below our £25bn worst-case stress-test scenario. Figure 4 summarises the impact of this on LBG’s core capital ratio, with detailed workings shown in Figures 19 & 20 on page 14. Although we have had to estimate the likely terms of the scheme with full details not due until late February, we believe that the stress-test Equity Tier 1 ratio could be boosted from 3.4% to 5.3%.
So, there you have it. The case for the defence on Lloyds. Comments on a postcard, or down below please.
Related Link:
Uneasy start for Lloyds Banking Group – FT Alphaville