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Why Lloyds Banking Group PLC Is A Better Bet For Me Than TSB Banking Group PLC

Even though TSB (LSE: TSB) was spun out of Lloyds (LSE: LLOY) (NYSE: LYG.US) earlier this year, the two high-street banking giants are completely different companies. For example, TSB has taken the UK high street by storm, snatching around 10% of the UK new current accounts market during the second quarter, a near 40% jump from the previous quarter.

What’s more, TSB’s net interest margin — a key measure of banking profitability — hit 3.6% during the second quarter, compared to Lloyds’ reported 2.5%… that 1.1% makes all the difference. 

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Trouble aheadTSB

Still, while TSB is attractive on some metrics, the bank has to iron out some fundamental issues before it can be considered to be an attractive investment. The most pressing of these issues is the fact that TSB still shares Lloyds’ IT system, an integral part of any modern bank.

TSB is going to have to develop its own IT system over the next few years. Lloyds has donated £450m for this task but it won’t be easy.

Then there’s the issue of TSB’s balance sheet. Indeed, TSB’s management has stated that the bank will expand the balance sheet by around 40% to 50% per annum over the next few years. Unfortunately, this target has raised concerns within the City that TSB will be forced to chase quantity over quality, loosening lending criteria to attract the volume of business required to hit targets. Lloyds is not targeting the same aggressive growth targets; in fact, Lloyds is tightening lending criteria.

Nevertheless, TSB’s fully loaded Common Equity Tier 1 capital ratio — capital cushion — came in at 18.2% for the first half of this year. Lloyds only reported a ratio of 11.1% for the same period. So, TSB has room to take additional risk. 

However, even though TSB does have a robust, cash-rich balance sheet, the company is not expected to be in a position to offer a dividend to investors until at least 2018. Lloyds, on the other hand, is expected to request regulators permission to recommence dividend payouts this year.

Current City forecasts estimate that Lloyds will offer a dividend yield of 1.7% this year, followed by 4.3% next year.

Growing profits  

Along with the prospect of an attractive dividend payout, Lloyds is also growing its profits at a faster rate than TSB. During the first half of this year Lloyds’ underlying profit jumped by more than a third to £3.8bn, while TSB’s first half profit before tax, on management’s preferred basis – excluding exceptional items – fell 16.9% to £78.6m.

And it seems as if this is going to be the trend going forward. City analysts are currently forecasting that TSB’s earnings per share will fall 21% this year, followed by 22% next year. In comparison, Lloyds is expected to report high single-digit earnings growth for the next few years. 

It seems as if Lloyds is the better bet, although only you can decided if Lloyds fits in your portfolio. I’d strongly suggest you look a little closer at the company before making any trading decision.

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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.