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Did you say 'yes' to TSB? We ask five wealth managers
by Anna Dumas on Jul 02, 2014 at 14:03
With Lloyds putting TSB on the market at a 30% discount shares looked decent value but is it possible to dismiss the associated risk.
Last month's TSB float valued the 'challenger' bank at £1.3 billion.
The float sees around 30% of the bank's stock released to approximately 60,000 investors. With shares issued at a 30% discount by state-backed Lloyds they look decent value, on paper at least.However, there is concern about the health of its balance and its high exposure to the UK mortgage market. We ask five wealth managers what they made of the float.
Andrew Morris, principal, Alpha Portfolio Management, Bristol
‘We have supported the TSB issue. The main appeal was its attractive core tier 1 ratio, which on a fully loaded basis at 17% compares favourably to Lloyds’ 10.7% and suggests it is the ‘safer’ bank than larger UK rivals. The business has a well collateralised asset base backed entirely by customer deposits.
This, combined with the indemnity from Lloyds regarding potential legacy misconduct issues, makes the shares attractive. However its current disappointing return on equity and an absence of a dividend before 2017 dim its appeal. The books have closed for the IPO. We sense the issue has been well received as essentially the initial tranche, 25% of the company, has been priced to sell, with the remainder of the Lloyd’s shareholding due to be divested before the end of 2015.
‘TSB lasted nine years as an independent quoted bank prior to its takeover by Lloyds in 1995. The reverse poison pill sweetener of £450 million Lloyds is offering in the event of a takeover to assist in migration cost would suggest the new TSB will do well to remain independent for that long.’
David Ridland, partner, Castlebay Investment Partners, Glasgow
‘We will not be supporting the TSB initial public offering (IPO). At Castlebay, we invest in companies by focusing on attractive valuations, strong cash flows and a margin of safety. Analysts say TSB is a growth story that will benefit from rising rates and by taking market share from incumbent UK banks. Yet forecasts for returns, such as percentage return on shareholder equity, are predicted barely to rise to double digits by 2018.
‘In evaluating banks, capital rather than cash is generally king. While TSB’s capital position is strong and well above the required regulatory levels, its returns in a competitive industry are low. We are is not convinced the TSB price represents a margin of safety, both from a valuation and operational perspective.
‘Though TSB may be able to gain market share from the larger banks and increase its profitability slightly, we prefer to allocate our clients’ capital in companies that over time will make higher returns for them.’
Lorne Baring, MD, B Capital, London
‘The questions that really matters are: is now the right time and what’s the right valuation? With the UK economy’s acceleration through forecasts made a year ago it seems the environment for floating the stock is benign.
The government will doubtless be worrying a slowdown could derail plans to IPO the bank later. So the time is right to sell part or all of its stake now. The second question is about correctly valuing the IPO so that the market takes up the offer and taxpayers don’t see a repeat of the mishandled Royal Mail IPO. A massive rise in the share price on IPO is a gain to hedge funds and speculators but a loss for taxpayers.
‘If we were advising HM Treasury today, we would counsel George Osborne that to average out of the position over the next few quarters makes sense and that the valuation should be attractive compared to the sector average but not too attractive. The Post Office went too cheap so this time the Chancellor will need to be wary or he may be compared to Gordon Brown, who sold the country’s gold bullion for a song.’
Ian Woolley, assistant investment manager, Hawksmoor IM, Exeter
‘TSB inherits a low-profitability business. With around 20% of Lloyd’s branches yet only 5% of its loan book, and a mortgage book dominated by loans capped at 2% over base rates (less than half that of the industry average) we see TSB, at least initially, facing high overheads and struggling to deliver a suitable level of return.
‘We believe it will take some time for TSB to gain market share and funnel that growth into suitably profitable, cash-generating performance. TSB knows this too – it has said the first dividend payment will have to wait until at least 2017. We consider the up to 20% discount to its book value good, though nothing to get overly excited about and a fair reflection of the risks associated with the group.
‘Finally, it is worth noting that Lloyds is selling just 25% [later upgraded to 39%] of its holding in this IPO, yet must sell its remaining stake over the coming 12-18 months, which adds up to a huge volume of selling pressure to come.’
Duncan Burden, equity analyst, Sanlam, London
‘While the float price may confer a positive reaction in early trading, as long-term investors we try to ignore short-term noise. The TSB story is compelling on many levels: the prospect of rising interest rates; a government determined to encourage competition in UK banking; TSB’s return to mortgage intermediary channels; and the attraction of a low risk mortgage book. But with low risk comes low return.
A large proportion of TSB’s mortgage book is fixed at 2% above base rate, versus a sector average of 4%. On this basis, TSB stands to benefit the most on a relative basis as interest rates normalise, but investors will not reap the benefits overnight. Earnings are forecast to be negative until fiscal 2016.
We believe these modest earnings are contingent on an accelerated normalisation of interest rates. TSB’s fixed cost base remains high and under-utilised, which stands to dampen ROE for the medium term. Patience and a more attractive entry point will be the key attributes for a profitable long-term investment in TSB.’