This week saw Royal Bank of Scotland (LSE: RBS) (NYSE: RBS.US) release a hugely encouraging update that caused its share price to surge by up to 4% on the day of release. It showed that the improving performance of the UK economy is having a positive impact on the bank’s bottom line, since it means fewer bad loans and less impairments than had been expected.
In turn, this should mean an improving earnings profile for the bank in future and is a big step forward for investors in the stock.
Clearly, the performance of RBS is closely tied to the UK economy. However, it’s not the only bank that is largely dependent upon the UK economy for changes to its profitability. Indeed, with arguably even more dependency upon the UK economy than RBS, Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) could prove to be a strong buy right now.
UK Exposure And Sound Strategy
Having acquired HBOS during the credit crunch, Lloyds’ mortgage book swelled to astronomical proportions. This means that its performance is highly correlated to that of the wider UK economy and, as one of the fastest growing economies in the developed world, the future seems very bright for Lloyds in terms of there being fewer bad loans and fewer impairments.
Indeed, Lloyds has positioned itself prudently in recent years to take full advantage of a UK economic recovery. It has disposed of non-core assets that it deems to offer an unattractive risk/reward ratio and become a smaller, more efficient and, it is forecast, more profitable bank as a result.
In turn, this has allowed the government to begin reducing its stake in Lloyds, since the performance of the bank has been strong and is set to get even better. One consequence of the government reducing its stake is improved sentiment, as investors view the sale as a sign that Lloyds is moving in the right direction due to it no longer requiring the government to provide capital.
Looking Ahead
Although shares in Lloyds have risen by an incredible 197% since the start of 2012, they still seem to offer good value. For instance, they trade on a price to earnings (P/E) ratio of just 10 (which is well below the FTSE 100’s P/E of 13.4) and are forecast to yield 4.1% in 2015.
With the UK economy picking up pace and providing a strong tailwind to RBS’s bottom line, it is probable that Lloyds will experience the same positive impact from a wider economic recovery. As a result of this and a sound strategy, great value and huge income potential, Lloyds could prove to be a winning investment over the medium term.
