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New Lloyds' latest results shift the focus to fundamentals rather than speculation

08/02/2012

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Lloyds kicked off the new results season for UK banks on 26 July and perhaps the first thing to note is how good it is to be able to focus once more on the facts and fundamentals of the sector rather than the speculation and scandals that have surrounded it of late.

As regular visitors to the value perspective will be aware, when analysing bank results, we find it useful to focus on two particular numbers – tangible book value and capital. Tangible book value – a measure of a bank’s fair value – gives us an idea of the changing upside in the business while capital ratios indicate how safe or otherwise it should be as an investment.

In that context, the interesting thing about Lloyds’ first-half results is that, despite increasing its provision for potential payment protection insurance mis-selling claims by a further £700m – to a total of £4.2bn –  the bank’s tangible book value declined only slightly while its capital ratios continued to move in the right direction.

There were two other noteworthy aspects to the results – the first being the continuing decline in bad loan provisions. In other words, Lloyds’ expectations about the ability of people to pay back what they have borrowed continue to improve and non-performing loans – that is, loans on which a payment has been missed – are trending downwards across every division. Be it mortgages, credit cards or current accounts, those expectations are growing, if not exactly better, then certainly less bad than had been feared.

The results also contained firmer guidance on the dividend ordinary shareholders may expect to receive from Lloyds further down the line. When the bank accepted state aid following its £12bn takeover of HBOS in September 2008, it was barred by European Union rules from paying a dividend. That block is over but, for other regulatory and political reasons, Lloyds has yet to resume dividend payments.

For those who are interested – and, if you are, you would probably be in a minority – the final piece of the regulatory jigsaw is known as ‘CRD IV’ and also comes courtesy of Europe. Its introduction has been delayed somewhat but the current timetable suggests Lloyds should be in a position, by the time of its third-quarter interim management statement, to have the regulatory side of the puzzle completed.

At this point, the only potential stumbling block to a resumption of Lloyds’ dividend would appear to be political. Second-guessing politicians is rarely advisable but, with an election not so far in the future, it is at least possible they would prefer to limit the possibility of banks being used as a stick with which to beat them. In that regard, the resumption of dividend payments would certainly illustrate lloyds was paying back the money the government lent it four years ago.

It is too early for income investors to get too excited – CRD IV could contain some new wrinkle that would take the dividend off the agenda once more – but, barring unforeseen circumstances, it is now down to the politicians and the UK regulator, the financial services authority. As things stand, once the regulatory aspect is confirmed, there is seemingly no financial reason why Lloyds cannot resume some form of dividend, which would certainly get people focusing on the company – and the sector –for the right reasons.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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