Lloyds: Beyond the headlines

16th March 2012

There can be a lot of complicated factors going on beneath the surface of any bank's results but, ultimately, we are looking for two things. In terms of reward, we want to see a bank's tangible book value – a measure of fair value – increase; in terms of risk, we want to see a bank's capital improve. With Lloyds, both headed in the right direction so, once more, despite any headlines you may have seen to the contrary, we would view this as good news.

Beyond that, one or two details are worth teasing out of the results – the first being the progress of Lloyds' ‘core' and ‘non-core' operations. Like Royal Bank of Scotland, the group has distinguished between all the parts of the business it wants to continue doing in the future and the rest – the bits that will wind down over time – meaning it really is at present a tale of two businesses.

The group's core business generated an earnings-per-share number of approximately 6.5p, which on a ‘normal' price/earnings multiple of 10x would imply a share price of 65p. At present, Lloyds' share price is almost half that. Clearly this is not a great environment for banks but you can see that, despite all the negative headlines, Lloyds is still managing to deliver some attractive levels of profit.

For its part, the non-core business has lost the group in the region of 4p a share as it is gradually wound down but the beauty of a bank here is this process happens automatically. Say, for example, a bank has been offering five-year car loans to customers and then decides to stop – in five year's time, it would no longer have any car loans on its books as they would just roll off.

Lloyds' non-core business started the year at £143bn of risk-weighted assets and finished it at £109bn – in other words, the ‘bad bank' element reduced by a quarter. Over the next three years or so, we would expect the remainder to decline to such an extent it will be almost unnoticeable in the context of the accounts, in the process revealing the true nature of the core business. Yes, those years are likely to be volatile and risks will persist but the fundamentals of the UK banking sector continue to head in the right direction.

One other figure worth highlighting from Lloyds' results is its direct exposure to the sovereign debt of the troubled peripheral eurozone economies. The group's total assets amount to £970bn while its exposure to the government and central bank debt of Greece, Ireland, Italy, Portugal and Spain – across its core and non-core businesses – is £68m, which for a group of Lloyds' size is neither here nor there.

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