Why Lloyds Banking Group PLC And Banco Santander SA Are Two Of The Best Banks In The World

Seven years on from the financial crisis, many investors are still finding it difficult to trust the banks, despite the progress the sector has made over the past few years.

But it’s easy to see why investors remain cautious — most banks are almost impossible to understand. Complex balance sheets and shady investment banking divisions have confused some of the world’s top banking analysts. The average private investor stands no chance. 

However, Lloyds  (LSE: LLOY) and Santander (LSE: BNC) are two “investor friendly” banks, which are easier to understand and analyse than their complex peers.

Slimming down

Lloyds has worked hard to slim itself down over the past five years and return to a simple banking model, which reminds me of the 3-6-3 business model.

The 3-6-3 business model was an unofficial rule of banking, introduced in the 1950s. Simply put, this rule describes how bankers would give 3% interest on depositors’ accounts, lend the depositors money at 6% interest and then be playing golf at 3pm. 

Of course, in today’s world it’s not possible to operate a bank in quite that way, but Lloyds is trying very hard to go back to basics. For example, Lloyds’ investment bank has, for the most part, been sold off and wound down. Moreover, management has done its best to remove risky assets from the bank’s balance sheet.

This return to simplicity is also having a positive effect on Lloyds’ cost base and return on equity (ROE) — a key measure of bank profitability. The bank is targeting a ROE of 13.5% to 15% by 2017, and it’s already well on the way to this target.

Underlying ROE hit 16% during the first quarter of this year, while many of the bank’s peers reported ROE figures in the low-teens. Further, the group’s cost:income ratio dropped to 47.7% during the first quarter of this year. More complex banks like Barclays and HSBC reported cost:income ratios of 62% and 55% respectively during the first quarter. 

Unfortunately, Lloyds’ recovery and simplicity has not gone unnoticed, and the bank’s valuation has jumped over the past few weeks. Lloyds now one of the most expensive large banks in the world, trading at a price-to-tangible net asset value of 1.5. Many of Lloyds’ peers trade at a P/TNAV of less than 1.

A different breed

Admittedly, Santander is more complex than Lloyds. Indeed, Santander is a global bank with a European focus while Lloyds is solely focused on the UK. 

Nevertheless, what’s really attractive about Santander is the bank’s record of compliance, or, to put it another way, the lack of hefty fines stemming from illegal activities. Further, Santander was one of the few large banks that didn’t need a bail-out during the financial crisis, despite its exposure to the Spanish property market. 

This record of good performance puts the bank head and shoulders above many of its peers, and customers have flocked to Santander as a result. In particular, the number of Santander’s current account customers in the UK has tripled over the past three years.

And Santander is willing to do things differently to stand out from the crowd, appeal to customers and safeguard investor interests. Santander’s goal to assist, rather than punish, indebted customers helped the group report a 41% net increase in earnings within Brazil during the first quarter, where a sharp economic slowdown has strangled the growth of the bank’s competitors. 

City forecasts suggest that Santander’s earnings will expand by 14% during 2015, and a further 12% during 2016.These figures suggest that the bank is trading at a forward P/E of 12 and 2016 P/E of 10.9.

Driving force

So, all-in-all, Santander’s different way of doing things gives the company market-leading qualities. And the bank’s strong management team is the driving force behind its strong rapport with customers.

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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.