Good Bank, Bad Bank

Ian McVeigh, co-manager of the Jupiter UK Growth Fund, comments on recent developments in the UK banking sector:

We welcome the decision to push forward the return of Lloyds Banking Group to full private ownership.

Lloyds Banking Group’s confident response to the Prudential Regulation Authority report on its capital position reflects a view we have had of the bank for some time, namely that its stabilisation had far outrun the alarmist rhetoric of many self-interested critics.

In analysing the effect of the various stress tests, it has been clear to us that the circumstances in which Lloyds would need significantly more equity capital represented an extreme and very unlikely outcome for the UK economy.

Lloyds have said that they expect to reach a 10% fully-Basel 3 loaded equity/capital ratio of around 10% by the end of this year. As capital continues to accumulate from the recovery in profits that the current strong management team is driving, the capital position should improve further.

This should set the scene for a period of significant recovery in dividends that ought to make the shares attractive to private investors as and when the Government looks to reduce its holding.

The situation at RBS is more difficult. The Government stake is higher and the position of the investment banking arm in what is currently a state-owned entity was always going to present greater problems than at Lloyds which has a much simpler business model.

For these reasons the valuation of RBS is currently much lower. It trades at a significant discount to book value while Lloyds trades at around book value. The significant difference in valuation clearly demonstrates the market’s prior awareness of RBS’s greater problems.

The issue of the good bank/bad bank is a curious one. As many have noted, it might have been a good idea three to four years ago, but the scale of the rundown of the problem assets is such as to make this potentially expensive and destabilising move rather hard to explain.

Nonetheless the delivery of the 2009 RBS Recovery Plan has far exceeded expectations. The share price has notably lagged the reality of that recovery. As people look more at the facts and pay less attention to rhetoric that should enable the bank to be privatised. Given the critical role that RBS has in the SME lending market, it is vital to get that lending out of the hands of the state.