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UK Banking Sector

UK Banks – Notable themes

The UK banking sector has reported Q4 2014 and 2014 preliminary results.

Broadly speaking 2014 could be generalised as follows:-

a) Significant falls in loan impairment ratios (an impairment is a provision against a loss). Except Standard Chartered (impairment loss $2.14bn v $1.61bn in 2013), Barclays (£2.16bn v £3.04bn), HSBC ($3.85bn v $5.85bn), Lloyds (£1.2bn – 60%). This confirms a trend in place since 2012.

b) Reducing profit drag from non-core portfolios/ generally a strong reduction in assets in non-core portfolios due to good progress in asset sales in 2014; Lloyds sold TSB/ St James Place, RBS / Citizens and Barclays exited its Spanish operations.

c) Higher legacy/ FX settlement/ ongoing PPI costs. This is the major area of concern given the large increase in provisions. Barclays increased its FX related provision to £1.25bn from £500m.

d) Mixed bag in terms of costs/ income ratios Lloyds 51.2% reduced 1.7% otherwise expenses were high at HSBC. New cost savings initiatives were announced at RBS.

e) Low growth in tangible net asset value per share (TNAV – tangible net assets refers to the balance sheet less intangible assets) BARC +2p, HSBC +1 cent, Standard Chartered +13 cents (Lloyds Banking/ TSB are exceptions). The lack of TNAV growth was a disappointment in the 2014 finals.

f) Poor / zero dividend growth; banks remain unwilling to increase shareholder returns, which is hardly a positive catalyst. Annual dividend growth is either zero or negligible (Barclays 6.5p unchanged, HSBC 50 cents +2 cents, Lloyds 0.75p, RBS and TSB nought and Standard Chartered 85 cents unchanged). HSBC has delayed a share buyback decision over 2015.

Peer Group Profit Before Tax (£/$m*) Return On Equity (%) EPS (p/cts*) TNAV (p/cts*) Comment
Barclays 5,502 5.1 17.3 285 TNAV +2p
HSBC 18,680* 7.3 69* 928* EPS miss
Lloyds Bk 1,762 3.0 1.7 54.9 0.75p dividend
RBS (3,470) -8% 0.5 387 Change underway
StanChart 5,193* 7.8 145.9* 1,611* PBT -25%
TSB 170.2 8.2 40.6 327 TNAV +66p

Source; CSS Investments Ltd

There are a number of generalised “cooling” factors impacting the UK banking sector that could have an impact on 2015 outcomes. These include a relatively stagnant UK property market, intensifying “price” competition from mortgage wars to personal loans and structural competition from the revived “challenger” banks. There is substantial uncertainty ahead from the UK General Election and likely higher Base Rate in summer 2015.These factors could adversely impact credit demand in 2015, before one off items are considered.


Which UK banks should continue to improve?


RBS 2014 results was an attributable loss of £3.5bn, it included £1.3bn of restructuring charges, £2.2bn of litigation costs, a £1.5bn write-off of net deferred tax assets, the £320m dividend for Dividend Access share and a £4bn write down relating to Citizens Bank. The £4bn Citizens write down does not impact RBS tangible net assets or regulatory capital. RBS tangible net asset value was 387p a gain of 24p over 2014.We view this positively. RBS achieved a £73bn decline in risk weighted assets to £356bn helping common equity tier 1 ratio rise by 0.26% to 11.2%.

Company Royal Bank of Scotland
Share Price 373
Target Price 425
52 Wk Hi/Low 404/295
Shares O/S 6.36bn
Market Capitalisation £23.75bn
Avg Daily Volume 9.6m
Dividend Yield 0%

Source; Fidessa plc

Key Catalysts

The RBS 2014 £6.95bn operating profit (2013 loss £3bn) excludes restructuring, conduct and litigation costs is a glimpse of the performance that RBS is capable of. New impairments declined to £1.1bn from £8.4bn in 2013. This was a very solid improvement. RBS is in the midst of a transformation that will see a more predictable performance, hopefully with greatly reduced one off costs. In our view 2015 will see lower one off expenses and a lower cost base (RBS have guided to an £800m cost reduction) making the business more predictable. We view positively RBS prospects for 2015.

Key Risks to Price Target

i) Key strategy challenges ahead as RBS sells off its non-core activities and refocuses on UK.

ii) The UK government holds over 82% of RBS – a sale of RBS shares by the UK is possible.

iii) RBS is operating in a highly competitive UK market for financial services.



TSB’s impressive 2014 preliminary results and strong 23% capital levels, makes it first choice in the emerging “challenger” bank group. We expect the momentum to continue in 2015 helped by the branch refresh programme. The branch network is expected to be slimmed down (c. 400 odd branches have lease expiries) TSB could let some leases expire, cheaply exiting some of the weaker branches. Furthermore the IT issue is likely to be addressed in 2015 –offering profit opportunities in 2016-2017. In our view the 20.5% discount to TNAV is too high and should narrow to closer to 5% once the Lloyds share position is exited.

Company TSB
Share Price 260
Target Price 310
52 Wk Hi/Low 297/247
Shares O/S 500m
Market Capitalisation £1.29bn
Avg Daily Volume 322k
Dividend Yield 0%

Source; Fidessa plc

Key Catalysts

There are factors relating to the spin-off that represent opportunities for TSB:_

  1. TSB receives £450m from Lloyds if it migrates its IT platform to a third party provider. A new deal could generate significant earnings improvement of c. £60m – this profit enhancement could take place over 2016-2017
  2. TNAV at 327p rose 66p in 2014; we expect growth in 2015 of c.15p.
  3. The expected Lloyds disposal would clear an overhang in TSB and improve the investor perception.

Key Risks to Price Target

i) TSB is operating in an increasingly competitive environment and is vulnerable to mortgage price wars and other competitor activity that would reduce its net interest margin.

ii) TSB is unlikely to pay a dividend in 2015 or 2016.

iii) Lloyds TSB are bound by EU rules to dispose of its remaining 50% stake in TSB in 2015.

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