June 18, 2014 1:30 pm

TSB sale draws cool response from some investors

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Lloyds Banking Group’s plan to float a quarter of its retail banking business is facing resistance from some fund managers, who are concerned about TSB’s desire to increase its loan book quickly.

Lloyds last week announced that the pricing for TSB’s flotation will be between 220p and 290p a share.

At the bottom end of that pricing, some analysts believed TSB looked cheap, at just £1.1bn against its book value of £1.5bn, which reflects the company’s assets minus its liabilities.

Lloyds on Tuesday narrowed the price range to 250p-270p, a significantly higher valuation than when the Co-op Bank offered £750m for it in April 2013. Many in the asset management community do not believe this pricing is low enough.

Patrick Barton, portfolio manager at Oriel, the UK fund house, is particularly concerned about TSB’s desire to increase the size of its loan book at a rapid pace.

TSB holds £23.3bn of deposits from 4.5m customers and has £19.7bn of loans and mortgages, which it plans to increase by 40-50 per cent by 2017.

The chief executive of TSB, Paul Pester, also wants the bank to increase its 4 per cent share of the UK’s current-account market, given that it has a 6 per cent share of all bank branches in the UK.

Mr Barton says: “[The listing] is not immediately interesting because the level of business TSB books at the moment is not commensurate with the level of its book value.

“The danger of that is trying to grow the loan book aggressively to gain market share. There are a lot of historical examples which [show] if you try and grow the loan book faster than the market, you inevitably end up getting lower-quality business as your incumbent will try to hold on to the best business. It becomes quite horrendous.”

Mr Barton adds that the risk of building a low-quality loan book would be exacerbated in any future downturn, potentially leading to “much unpleasantness – job losses, irate shareholders and dividends being passed”.

Final pricing for the flotation is expected to be announced later this week, with conditional dealings beginning on the London Stock Exchange on the same day.

A financials-focused fund manager, who asked not to be named, agreed that the “big question for investors is whether TSB can credibly grow its asset base without taking on too much risk”.

He says TSB’s ability to grow was hampered in the run-up to its ill-fated sale to the Co-op Bank. The deal fell through in early 2013 when the Co-op discovered it had a £1.5bn capital shortfall.

The fund manager adds: “TSB is highly uneconomic as a business right now – the only real way they can get returns equal to the cost of capital is by growing the mortgage book over three years and hoping mortgage margins stay at the same level.

“It is a really quirky bank given that most UK domestic retail franchises are doing brilliantly and this one is not. That all says to me, to be interested in it, it will need to be very cheap. My sense is it will not fly off the shelf – I think the complexity is putting people off.”

He concedes that TSB has some advantages, particularly as Lloyds has promised to immunise TSB against any historical mis-selling charges. In December, Lloyds was fined a record £28m by the UK regulator for “serious failings” in its sales practices.

Nick Hungerford, chief executive at Nutmeg, the online wealth platform, says there is comfort to be taken from the fact that Lloyds has promised TSB a £450m “dowry” to cover integration costs if TSB leaves Lloyds’ technology platform.

He also believes that Lloyds has successfully managed the public relations around the sale, in particular by revamping TSB’s sales structure to limit excessive bonuses. This has emphasised that investors are buying a “solid” company in the face of a stuttering market for initial public offerings, according to Mr Hungerford.

He adds: “TSB, once separated from Lloyds, will be the best-capitalised bank in the UK, with a core tier one capital ratio of 17 per cent. Because of the media saying it is cheap and focusing on the bottom end of the price range, demand will build.”

Other investment professionals, meanwhile, are drawn to TSB’s potential to deliver stable dividends, although these are not expected before 2017.

Jason Hollands, managing director for business development at Bestinvest, the financial advisory company, says: “TSB wants to focus on core, traditional banking rather than the racier investment banking activities that we have seen elsewhere over the past couple of decades.

“Over time this should make it a solid, cash-generative business with less volatile earnings that can grow a sensible dividend, rather than an opportunity to generate stellar returns.”

But Oriel’s Mr Barton believes the wait for dividends might deter retail investors at this stage. He says: “The bigger issue for a lot of retail investors is the complete absence of yield for an extended period of time, which will probably put a dampener on a significant level of retail demand.”

Nutmeg’s Mr Hungerford adds: “TSB will not pay a dividend at least until 2017 as it looks to grow its balance sheet by 50 per cent, so the company won’t be held by the big ‘income’ fund managers.”

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