Here’s some reading for the UK’s Independent Banking Commission, ahead of its first public appearance on Friday.
It’s an in-depth report from JP Morgan on the profitability of Lloyds Banking Group’s retail operations.
If — as reported at the weekend– the IBC is really interested in reducing the market position of Lloyds (and also RBS) then they might be interested in the conclusion of the report. Lloyds will continue to make above-normal profits from its retail operations for some time, the report says:
The most meaningful improvement in UK retail banking profitability has taken place in Lloyds Banking Group where having reported a RoE of 7.5% in 2009, this is expected to come in at 27% in 2010E and to continue to improve to 33% in 2011E, where in line with the sector trend, it is expected to peak and then start leveling off.
We find two main differences when comparing Lloyds UK retail banking to its peers;
(i) with mortgages accounting for an estimated 60% of retail banking profits or 45% at a Group level in 2011E a more significant portion of mortgages rolling onto SVR have helped boost the NII. We see asset margins holding up relatively firmly so this trend should continue;
(ii) more importantly, when we attempt to match asset and liability duration we find a substantial part of the improvement in earnings is a result of this mismatch. With a relaxation of the liquidity rules, we do not expect this to change in the short term but still present a sensitivity analysis on the potential impact on profitability as this is key to our view on the stock.
In our base case, we have assumed Lloyds will continue to run its retail banking operations with a significant duration mismatch. Hence Lloyds UK retail banking is expected to produce a 22% RoE in 2014E, higher than the sector average at 17%.
In the absence of harsher regulatory requirements however, we believe above normal profits will continue for longer and should help the stock maintain its momentum for now. Strong earnings generation at this earlier stage is also an important factor considering the pro cyclical nature of the new Basel III deductions, allowing for an estimated common core Tier 1 ratio under Basel III of 12.8% by 2014E from an anticipated 6.2% at YE 2010.
Whether that’s enough for the IBC to look again at the Lloyds/HBOS merger is unclear.
Still it’s further evidence for the view that the deal – cooked up at the height of the financial crisis – has significantly reduced competition on the UK high street. It’s a situation that’s unlikely to improve even if Lord Levene of Portsoken, the chairman of Lloyds of London, does manage to raise £3.5bn and buy a load of branches off Lloyds.
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And in fact, Levene doesn’t really seem to have any innovative ideas for the bank he wants to build — above offering better customer service.
From the Sunday Telegraph:
So what will the new banking company be for and how will it be different? “It’s supposed to be a new, old-style bank without a lot of the add-ons that came with the old-style banks in terms of customers being shunted off into call centres and local über-branches,” he says.
The most important thing we need to do is to work out how to avoid the many complaints you see about banks being very off-hand with their customers, not giving them a good service, not knowing who they are and generally leaving them pretty unhappy. “It’s also about what we’re not going to do. We’re not going to get involved in investment banking [nor] in any foreign operations.”
Genius. That will have Lloyds, RBS, Barclays, Nationwide and Santander quaking in their boots, we’re sure.
And to think Levene’s cash shell NBNK is trading at a 17 per cent listing to its IPO price on that.
Still, Levene will undoubtedly turn up the volume this week on competition in UK retail banking, and that might hurt the Lloyds share price. Although the following is worth considering, according to this sector watcher:
We note that Lloyds is in no rush to sell its UK retail banking assets and that there is no requirement to accept bids at any price. Eg. Lloyds will look to maximise the disposal price.
Key Points: 1) We do think the UK banks’ share prices are sensitive to this report.
2) Concerns over ‘break ups’ for greater competition will weigh on Lloyds while concerns over splitting up banks with ‘casino banking’ and retail banking operations will weigh on Barclays and RBS.
3) We think the commission is likely to look into both competition and separation of activities but unlikely to rule in the end that the UK banks should be broken up and we would buy on weakness.
Related links:
UK banks, sucking on the blood of depositors – FT Alphaville
Zen and the art of flogging UK banks – FT Alphaville
So, what was that Lloyds profit again? – FT Alphaville