MENU

Could this challenger be the next Lloyds Banking Group plc?

Photo: moneybright.co.uk Cropped. Licence: https://creativecommons.org/licenses/by/2.0/

Before the financial crisis, Lloyds (LSE: LLOY) was one of the UK’s most respected and trusted banks. The group had a reputation for stability, prudent capital allocation and customer service. The bank’s reputation with clients drew new business to the group and profits expanded rapidly. In fact, Lloyds was generating so much cash in the run up to the crisis that its dividend yield often exceeded 7% as management returned as much cash to investors as possible. 

Unfortunately, Lloyds’ success turned out to be its downfall. The bank’s cash-rich balance sheet and desire for growth gave management the confidence to bid on collapsing banks during the crisis, but these banks turned out to have toxic balance sheets, which floored Lloyds. 

Today, it’s only just beginning to rebuild its reputation, but the group now has to compete with the new kid on the block, Metro Bank (LSE: MTRO)

Challenger growth 

Metro Bank was founded in 2010 and at the time of its founding was the first new high street bank to launch in the UK in over 150 years. Founded by multi-billionaire Vernon Hill, Metro Bank set out to be different from the start. With a customer-focused attitude, the bank has attracted £7.3bn of customer deposits, up 270% in just two years. Over the same period, lending has grown from £1bn in 2014 to £5.2bn today. Clearly, this kind of growth can’t last forever, but the bank’s growth may have some way to go before it reaches saturation. 

In an interview last year, Mr. Hill highlighted that the size of the UK retail deposit base in the south of England could be as much as £1trn. If Metro Bank can capture just 5% of this total market, the group’s deposit base can grow sixfold from current levels. With approximately 750 people a day opening accounts at the bank during the third quarter, it looks as if the demand is there and the sky’s the limit for Metro Bank.  

Maiden profits  

Metro Bank reported its maiden profit only a few weeks ago. For the third quarter, the group reported a profit before tax of £567,000 on revenue of £53.4m. Costs are high at the group as it concentrates on expansion and customer acquisition but over time customer numbers should grow to the level where escape velocity is possible. City analysts expect the bank to achieve this next year. A pre-tax profit of £30m is pencilled-in for 2017, up from a full-year pre-tax £16m that’s planned for 2016. Revenues are expected to hit £295m next year, up from £195m for 2016. 

As Metro Bank grows, it appears Lloyds is shrinking. The company is cutting costs by removing staff from its stores and shutting branches around the country. Unfortunately, this seems to be hurting the company’s sales. Lloyds revenue is expected to fall to £17.1bn next year, from £17.3bn for 2016. Pre-tax profit is expected to increase to £6.5bn from £6.3bn but this appears to be a result of cost cutting alone, not sales growth. 

Catching up

Metro Bank is still a tiddler compared to high-street giant Lloyds but the group is growing rapidly, and its appeal with customers will continue to drive growth. If the company hits its target of £50bn in deposits, it’s likely the shares could double or even triple from current levels.  

Make money, not mistakes

A recent study conducted by financial research firm DALBAR found that the average investor realised an annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually thanks to poor investment decisions. 

To help you streamline your investment process, realise and understand the most common investor mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.

The report is a collection of Foolish wisdom, which should help you avoid needlessly losing too many more profits. Click here to download your copy today.

Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.