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TSB PLC – IPO – Neutral

TSB IPO Background

As a condition of the Treasury’s financial assistance in 2009, Lloyds is obliged by the European Commission to fully divest itself of TSB by 31 December 2015. Lloyds had considered the disposal of the TSB’s 631 branch network “Project Verde” via a sale to a competitor. However advanced talks with NBNK and Co-Op Bank fell through, leaving Lloyds with only the IPO option. The IPO is a rather inelegant solution and reliant on retail shareholders who should expect further stock sales in 2014/15. Those further share disposals are likely to be to UK institutions.

TSB holds a 6% UK market share (as measured by branch network) drawn from former C&G / Lloyds branches. The network is high quality and covers 89% of UK retail centres (its main strength). However the sale of a bank hived out of a branch network is unusual and carries operating risks, not least that TSB clients could view the mandatory switch over of their accounts negatively.

IPO valuation is on the high side

The TSB have indicated a price range for the IPO of 220p to 290p suggesting a valuation of £1.1bn to £1.45bn. This range suggests Lloyds is attempting to value TSB at a maximum discount of 25.7% to a minimum discount of 2.09% to TSB CET1 capital of £1.481bn. This is a key metric for bank valuations. It is core to the decision as to whether or not to invest, yet by using a price range it is unclear what discount will apply. We view this pricing approach negatively and the price should have been fixed.

Advanced acquisition talks with Co-Op in early 2013 centred on a price of £750m. Lloyds is now attempting to realise at least £350m more for TSB apparently on the basis of management accounts showing PBT for 2013 of £67m against £39m in 2012. This indicates a pro-forma EPS of c 10.3p (P/E 21.3x- 28.1x) for FY2013 another pointer to an expensive valuation.

TSB cost/ income ratios of 66% have trended down c.3% since 2011 but the surprise is ultra- low potentially unsustainable impairments of £27m (15bps) in a mortgage book of £17.4bn. This could be the best it gets for UK mortgage impairments. On the mortgage book itself (87% residential / 13% BTL) with an average indexed LTV ratio of 46% with only 7.7% (£1.33bn) of higher risk mortgage loans with LTV >90%, this should be considered high quality with the caveat that TSB faces a challenge in that a high proportion of the mortgage book (45.3%) are interest only mortgages (more problematic post the April Mortgage Market Review). The TSB is very dependent on the UK mortgage NIM for EPS growth over the 2015-18 period, as other areas such as cards (£2.1bn portfolio)/ insurance are relatively small divisions.

Conclusion

The Offer closes on the 17th June with pricing and admission on 20th June – in our view the pricing uncertainties and lack of cash dividend are negatives. Overall there is little incentive to “fly blind” on TSB. NEUTRAL

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