Does 19% loan growth make Shawbrook Group plc a better buy than Lloyds?

Challenger bank Shawbrook (LSE: SHAW) has released a positive third quarter trading update today. It shows that there has been little impact on its performance from the EU referendum. Could now be the time to buy it instead of Lloyds (LSE: LLOY)?

Shawbrook’s customer loan book exceeded £4bn in the third quarter, which represents growth of 19% versus December 2015. Shawbrook has also achieved sustained growth and disciplined risk-adjusted margins, with its cost-to-income ratio being in line with management expectations.

Its net interest margin remained stable at 5.6%, with continued tailwinds expected from its deposit book repricing following the interest rate cut in August. Gross originations for the first nine months of the year were £1.5bn, which is an increase of 23% compared with the same period in 2015.

Shawbrook continues to make good progress in each of its divisions. The Property Finance division achieved record levels of originations in the third quarter despite the expected slowdown in the property market in August. The Business Finance division has made good progress in expanding its distribution capabilities as the Regional Business Centres are rolled out, with a number of them expected to be operational by the end of the year. Meanwhile, Shawbrook’s Consumer Division has further widened its distribution channel with the announcement of a partnership with Saga.

Looking ahead, Shawbrook is forecast to increase its bottom line by 11% in the current year and by a further 18% next year. This puts it on a forward price-to-earnings (P/E) ratio of just 7.2, which indicates that it offers excellent value for money.

Uncertain future?

However, Shawbrook faces an uncertain future. Brexit may not yet have caused much pain in the economy, but the Bank of England expects unemployment to rise and GDP growth to slow. This could hurt demand for new loans and Shawbrook’s profitability could fail to meet expectations. And with it being UK-focused, Shawbrook could endure a tough period over the next few years.

Therefore, it may be logical to stick with a larger bank such as Lloyds, which has a better diversified business model as well as size and scale advantages over Shawbrook. Lloyds trades on a forward P/E ratio of 8.5 and while that’s higher than Shawbrook’s rating, it’s highly appealing nonetheless. It also indicates that Lloyds has a wide margin of safety to protect against share price falls.

Furthermore, Lloyds is a superior income stock to Shawbrook. Lloyds currently yields 5.5% from a dividend that’s covered 2.3 times by profit. Shawbrook yields 1.4% from a dividend that’s covered 8.4 times by profit. As such, Shawbrook may have excellent long-term income potential, but Lloyds provides a better income return right now. Although Shawbrook is a sound buy for patient investors, Lloyds remains the more enticing stock for purchase at the present time.

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Peter Stephens owns shares of Lloyds Banking Group and Saga. 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.