Lloyds (LSE: LLOY) (NYSE: LYG.US) is a decent banking business with one major problem. The UK government still holds a large stake in it.
Unless the Treasury gets its stake down, and quickly, Lloyds stock will enjoy minimal upside in the next six to 12 months. And even then, Lloyds stock will be under pressure. The exit deadline for the Treasury is somewhere between now and the general election in May 2015.
The Sword Of Damocles
Every single time the Treasury will decide to trim its Lloyds stake, currently at 24.9%, Lloyds stock will fall. It’s likely that the UK government will try to divest, in three tranches, up to 8.3% of Lloyds’ equity capital each time, which simply means three very bad days of trading in the next year or so.
For the British bank, one way to prevent the fall in its equity value, or just to limit investors’ losses, would be to consider a stock buyback program. Stock buybacks seldom deliver long-term value, but they are tax-friendly – as opposed to dividends – and could be a useful tool in certain cases.
Lloyds Paper
Investors are wary of the massive amount of Lloyds paper in the market. Total shares outstanding at Lloyds are 71bn (free float 75.1%), which compares with 16bn for Barclays (94%) and 18bn for HSBC (97.8%).
That’s not necessarily a massive headache. But preventing a plunge in Lloyds stock is just as important for the UK government as for investors. The more the stock goes down, the higher the loss will be for the taxpayer. If Lloyds stock drops 7% from its current level, the Treasury won’t be in the black. In this context, the announcement of a brand-new dividend can probably wait for another year.
Some analysts have recently argued that it is important that Lloyds shows it can pay dividends again as the UK government will find it easier to sell Lloyds paper. That’s at least debatable. Any payout at this stage will be merely symbolic, and analysts are banking on unrealised earnings. By no means Lloyds’s turnaround is finished, although first-quarter figures were encouraging.
What’s Going On
Lloyds is de-risking its balance sheet. In less than three months, the British bank has sold more than £600m of European and UK commercial real estate loans. Regulators will be pleased.
The bank has also opted to buy back certain notes called “enhanced capital notes”, or ECNs, and may continue to do so in months to come. This will marginally improve profitability, but retail investors were not impressed. Lloyds had decided unilaterally to cut its losses on expensive capital, forcing retail investors, who are key to its future success, to forgo high coupon payments.
Meanwhile, it has looked at ways to release value by spinning off TSB. Well, TSB could be a damp squib, to quote a senior banking source in the City.
A Bet Worth Taking?
Lots has been going on in recent times, but Lloyds stock hasn’t really performed. It is flat for the year and it has gone nowhere in the last three months, in spite of significant corporate activity.
Lloyds stock is priced at 1.4x tangible book value, which is a rich trading multiple for a bank that has yet to prove it can be profitable in challenging market conditions. The British bank is a bet on the rise of interest rates in the UK and is a decent choice for the long run if the UK recovery speeds up and outpaces other developed economies.
Yet volatility won’t remain subdued forever.
