Lloyds Banking Group is also Saf

British Prime Minister Liz Truss was kicked out by bond market vigilantes earlier this week. As we do not yet know who will be the next leader of the country, owner of Lloyds Banking Group PLC (LSE: LLOY, Financial) (LYG, financial) could be considered a somewhat contrarian gamble.

Fundamentally, however, retail banking is in good shape and well positioned to benefit from the UK macro situation. Lloyds’ balance sheet is now very positive as interest rates rise, as its funding is heavily weighted to long-term cash deposits, well matched with assets of similar duration.

It’s no wonder this stock is one of the gurus

David Herro (Trades, Portfolio) the main financial holdings of its Oakmark International Fund. I think Lloyds has been overlooked by the market, but it’s a good carry trade as the stock should follow the hawkish interest rate environment. Higher interest rates will bring margin and revenue growth to the UK’s largest retail bank.

Expressed in dollars for Lloyds’ US Certificate of Deposit, the stock is down nearly 29% year-to-date, largely due to the weak pound. Similarly, London-listed shares are down 12.5% ​​as fears over the UK economy and general political instability have deterred investors. Additionally, the high volatility of UK government bonds, known locally as gilts, and rising gilt yields spooked some investors. As UK banks are large owners of gilts, jumps in yields or lower bond prices would mean Tier 1 base capital levels would fall. With the respected Jeremy Hunt now in place as UK Chancellor of the Exchequer or Finance Minister, things appear to have calmed down in government bond markets, helped by Bank of England actions to ensure order.

More fundamentally for Lloyds, and something the bank can control, is that its very size is a competitive advantage. Rivals such as Monzo failed to gain traction and upset Britain’s big five banks – Barclays PLC (BCS, Financial), Lloyds, HSBC Holdings PLC (HSBC, Financial), Banco Santander SA (SAN, financial) and NatWest Group PLC (NWG, Financial). Deposits are sticky, giving these big banks a financial edge. UK consumers have also been saving more thanks to the economic uncertainty and as a result that money is ending up in higher deposits in banks.

We can see this in the latest Money & Credit report from the Bank of England. Households increased their cash levels to the highest rate since 2010 and paid off their debts. Deposits recorded net flows of 4.3 billion pounds ($4.8 billion) in July, compared to 2.6 billion pounds in June. In addition, term deposits increased by £2.8 billion to the highest levels since November 2010. Savers are depositing more now that short-term interest rates are approaching zero. This demonstrates that banks like Lloyds are now much less dependent on capital markets.

Net interest margins

Lloyds’ position as the UK’s largest mortgage lender also gives it economies of scale. If demand for mortgages drops, the bank is confident that it can cut mortgage rates to regain market share. On the other hand, he can manage the risk if he is worried about credit risk by increasing his margins for new loans.

The bank is poised to gain market share from smaller, specialist lenders as these groups rely more on capital markets for funding, and its cost of capital is rising faster than those from sticky deposits including Lloyds. benefits. Lloyds’ market share in the UK mortgage market has remained stable at around 18%, with NatWest holding the second-largest share at around 12%.

A Berenberg research report sent to me recently noted that for every one percentage point increase in interest rates, UK bank revenues can increase by four to eight percentage points, which probably means an 8-20% increase in pre-tax profits.

Lloyds focused on mortgages, so it has a relatively small commercial banking business and no investment banking to speak of. Lending outside of mortgages has been quiet and the bank has been focused on building up capital reserves, so the rise in interest rates hasn’t really affected growth in non-mortgage lending, as it it was already such a small line of income. The bank’s focus on cost control during the pandemic has given it a very strong balance sheet now. He also has a high Piotroski F-Score of 8.

The bank announced a loan-to-deposit ratio of 95% as of June 30, which is a conservative figure. Generally, less than 100% is good, while more than 100% is bad, as this indicates that the loans are not funded by volatile capital markets.

Currently, the UK labor market is quite tight and wage growth is strong. The country’s current shortfall in housing supply means Lloyds’ mortgage-dominated asset base should be resilient even in a downturn. This makes Lloyds less risky than Barclays, which has a much larger credit card business where writedowns could develop.

Evaluation and conclusion

Lloyds is trading on a forward price-to-earnings ratio of 6.4. It has a tangible price-to-book ratio of just 0.7 and a dividend yield of 5.1%, which is near a one-year high. All of these metrics are better than its industry peers, according to data from GuruFocus.

With the pound potentially stabilizing at current levels, Lloyds looks pretty cheap.

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