August 1, 2013 3:19 pm

Lloyds Banking Group: weather forecast

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Recent share price gains should not cloud investors’ judgment

The sun is shining in Lloyds land. Shares in the bank are up 140 per cent in the past 12 months, following a results-inspired jump on Thursday. None of the other UK banks comes close. There is talk of the government selling down its 39 per cent stake. And the first-half results looked sparkly. The bank is lending more, especially to businesses, and is doing so more profitably. The net interest margin widened to more than 2 per cent, and is expected to improve again in the second half. Provisions for bad debts were lower, especially in the non-core book. And to top it all, Lloyds is seeking regulatory approval for a dividend.

The best reaction to spending too long in the sun is to go inside and take a cold shower. The bank is still dealing with the past. Non-core assets are still almost a tenth of the total. It still has to offload the package of branches – codenamed Verde – that it tried to sell to Co-op. Verde cost Lloyds £370m in the first half. The mis-selling claims also keep coming, with a £500m provision taking the total to £7.3bn.

Added costs from any of these sources could dent Lloyds’ profits and hence its ability to strengthen its capital base. The Basel III core tier 1 ratio is a decent, but not overly comfortable, 9.6 per cent, so it could do without further damage from the profit and loss account. Given the scale of the legacy issues that Lloyds is still dealing with, talk of a dividend looks premature.

Most of all, look at the valuation. The share price has jumped in the past year but earnings forecasts are more or less where they were last August. On 1.3 times tangible book value, the shares are now rated only a touch below HSBC and Standard Chartered. True, Lloyds is recovering just as the emerging markets that drive the other two are faltering. But over the long term Lloyds is a play on the UK economy. And the outlook for that is distinctly cloudy.

Email the Lex team in confidence at lex@ft.com

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