TSB Banking Group (LSE: TSB) published a strong third-quarter update today and reported a 28.8% increase in pre-tax profits, an increased 9.7% share of new current account openings, and a slight increase in capital strength.
This impressive showing prompted me to take a closer look at TSB’s former parent, Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US), to see which of the two banks might be the better buy in today’s market.
What I found was that three key numbers all pointed in the same direction — towards TSB.
TSB reported a net interest margin — the profit a bank makes from taking deposits and making loans — of 3.6%. That’s considerably higher than Lloyds, which reported a figure of 2.4% for the first half of this year.
Interestingly, Lloyds’ 2.4% net interest margin is one of the better figures from the big banks — it appears that smaller banks like TSB are able to earn bigger profits from basic banking activities than their larger peers.
TSB currently trades at just 0.8 times its book value, compared to 1.2 times for Lloyds.
Lloyds’ valuation is more typical of a well-established bank, suggesting that TSB shares have the potential to be re-rated by as much as 50%, as the market gains confidence in the bank’s operations and growth.
The Common Equity Tier 1 (CET1) ratio is one of the most important regulatory measures of a bank’s capital strength, and affects its ability to withstand a fall in the value of some of its assets.
Lloyds has a CET1 ratio of 11.1%, which is pretty decent, but TSB is way ahead, with a CET1 ratio of 18.8%!
TSB also has loans totalling just 91% of its deposits, whereas the equivalent figure at Lloyds is 109%, suggesting that Lloyds is more dependent on borrowed money than TSB.
Time to buy TSB?
TSB isn’t perfect — its cost to income ratio is a whopping 72.2%, nearly 50% higher than Lloyds’ impressive 50% figure. I also wouldn’t want TSB’s loan to deposit ratio to be much lower, as it might indicate the bank was struggling to find profitable opportunities to lend, which would hit profits.
However, TSB’s shares have fallen by around 10% since its flotation earlier this year, and now look like a decent buy to me, thanks to the bank’s strong net interest margin, discount to book value and strong balance sheet.
Roland Head 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.