Not lying, but underlying, at Lloyds

Ah, the 2013 results from Lloyds Banking Group. How much did it make? Well, the “underlying” profit was £6.2bn, but “legacy items” eat half that, while “simplification (sic) and Verde costs” knock off a further £1.5bn. After “volatile items” and tax, Lloyds lost money.

If that’s not clear, try the 88-page announcement, which includes such gems as the asset quality ratio (down) and the return on risk-weighted assets (up). This information overload looms over the forthcoming sale of the state’s 33 per cent holding, as it seeks to attract the masses. The prospectus for the offer will be almost universally unread.

Last September’s placing was to institutions, who could at least pretend to understand what they were buying. Selling shares to Sid is much harder. Lloyds is not another Royal Mail, but millions of novice shareholders might mistake it for a second opportunity to make easy money.

Unfortunately, the easy money has already been made. The shares have nearly doubled in a year, and no longer look cheap. Modern banking is beyond comprehension, so the key indicator here is the dividend. It’s the only number that can’t be fiddled, and provides the best clue to the management’s real view.

Lloyds expects to restart paying next year, with the long-term objective of distributing at least half the earnings. Considering the desperate thirst for capital over the last five years, this seems almost profligate, but Liberum’s brave analyst, Cormac Leach, thinks Lloyds will pay out two-thirds of its profits. On his forecast, that implies 5.3p a share for 2015, or a yield of over 6.5 per cent at 80p..

Such projections are music to a cash-strapped government with an election to win. Lloyds shares will be priced as cheaply as possible without infuriating the Public Accounts Committee, and marketed as a safe income-producing investment in a zero-interest world.

That may sound appetising, but it’s a harder sell than it looks. Public revulsion against bankers’ behaviour is undimmed, since the general view is that they’ve got away with financial murder, and are still at it. Last week saw Barclays paying out 40 per cent of  2012’s £5.8bn capital raise in one year’s bonuses. Antony Jenkins, the chief executive, trotted out the usual guff about needing to keep the investment banking talent. This is pitiful, particularly when the less risky parts of the business, like Barclaycard, are making the profits.

George Osborne will be hoping that we don’t notice, that greed will triumph over revulsion, and that we’ll be grateful for being bribed with our own money. On past form, he’s probably right.

A drug on the market

Cheer up, we’re richer than we thought. Not by much, it’s true, and not the sort of riches to make you feel better, but the UK’s GDP will increase by about £10bn, as the statistics are adjusted to include the economic value of prostitution and drug dealing.

Measuring these activities requires diligent research and fact-finding missions or, more likely, guesswork, but they’re going into the numbers anyway, thanks to a diktat from Brussels. Curiously, this is really quite sensible. Anything that is legal in one member state is to be included for all, and prostitution and drug-taking are both legal in Holland.

Adding these activities allows a fairer distribution of the goodies the European Union recycles from its taxpayers, although there are limits. The transaction must be between consenting adults, thus ruling out the burglary trade. Money-laundering is illegal throughout the EU, and so escapes. Fraud does too, although a guess at its extent would pretty up the published GDP of some EU member countries – as would a grasp on its extent within the EU’s own cash-dispensing machine.

Carney get it right this time?

The governor of the Bank of England expects interest rates to flat-line until, oh, ages yet, say after the general election. This is despite his new forecast of 3.4 per cent growth, a pace which has always spelled trouble in the past. You’d think that Mr Carney had been appointed by a chancellor desperate for re-election. Mind you, previous BoE forecasts have been so poor that Mr Osborne should be worried rather than reassured.

Thinking of buying this? Bottle it

And a warm welcome to the FTSE 100, please, for Coca-Cola HBC. No, not the makers of Coke, but one of the companies that bottles it. CCH, as we’ll call it to avoid confusion with the real thing, is based in Zug, Switzerland, is a refugee from the near-moribund Greek stock market, and its franchise is central and eastern Europe. Unsurprisingly, it hardly trades in London. Yet last week it was lodged uncomfortably in the UK’s premier index, with a market value of £6.5bn.

It’s one of the clutch of shares which have replaced, among others, the late-unlamented ENRC, the Kazak miner which demonstrated that corporate governance crumbles before a determined controlling shareholder. CCH will be different, of course. Coke itself has a big stake, and there’s no suggestion that the newcomer will fail to comply with the rules. Indeed, it comes top of the euro-pops in the Dow Jones Sustainability Index, which measures economic, environmental and social performance.

A different set of rules has propelled this unlikely candidate into the index, along with Sports Direct International, whose driving force, Mike Ashley, had his own robust approach to corporate governance, but there can be no argument about whether the UK index is the logical place to put the stock.

The index trackers have to hold these stocks, and as it became clear that CCH would barge into the FTSE, traders bought in anticipation of the trackers’ forced buying in a thin market. The price did rise last month, but it seems that the tracker managers are getting smarter, using options and forward purchases to get to the required wighting rather than just piling in on the day. The price bump on entry to the index just didn’t happen.

Now the trackers are aboard, the shares will trade on the prospects. These are cleverly aligned with those of Coke itself, but don’t look exactly fizzy, even given Coke’s extraordinary global appeal. SocGen rate the the shares a sell at £18.40, on 26 times prospective earnings and a yield of 1.5 per cent on the broker’s estimate. SocGen will have to find some loose holders first, and good luck with that. Only the slaves to indexation will feel obliged to put their names on these bottle(rs).

Let’s go shopping

Tomorrow promises to be another trying day for Tesco as it reports half-time numbers which nobody expects to be much good. Last month it despatched Nomura and JP Morgan Cazenove as corporate brokers. This week, the brokers’ entirely objective analysts decided that the prospects for the shares were worse than they previously thought.

These are undoubtably tough times for the former masters of the high street universe. Like the FTSE 100 itself, Tesco shares stand at the same level today as they did in 2006, while the company’s turnover is 50 per cent bigger. Profits, on the other hand, are smaller, and if profit warnings come in threes, we haven’t quite finished yet.

However Fresh & Easy, the Leahy memorial to corporate hubris, has finally been given away, and while Tesco has yet to reveal a convincing corporate strategy, its management has plenty of ideas, from adding coffee shops and family restaurants (with non-Tesco brands) to its bloated stores, to on-line films and a cut-price tablet. In short, the management knows it’s got problems, and is not simply hoping that something will turn up, like the economy. As far as the shares are concerned, it just may be that the worst is past. Oh, and there’s the 4 per cent yield while you wait to see whether it really is.

Customer care corner

Douglas French was so cross at the charges levied on his Lloyds Bank debit card for a euro transaction that he wrote to the FT about it. Ah, the power of the press. Hardly had last Monday’s paper hit the stands, than Lloyds was on the phone, offering to refund the £46.77 he had been stung for using a sterling card to pay his E1,833 hotel bill in Germany. Since then, the bank – apparently he’s now with TSB – has changed its policy. It will still gouge its credit card holders, but in future they’ll get a more prominent warning of what’s in store. Who says the banks don’t care about their customers?

This is an updated version of my Saturday FT column, before the subs got at it.

Stop dithering, George, and get selling

Why are we waiting? No, not for the Royal Mail, a privatisation that has made the gestation period of an elephant look rushed, but for the sale of a slice of HMG’s 39 per cent stake in Lloyds Banking. Last week the Office of Fair Trading rubber-stamped the deal to sell the TSB, the last thing in the way. The mails may be totemic, but the Lloyds shares will bring in serious money, and could be done before lunchtime tomorrow.

A placing of 10 per cent would raise over £5bn, and leave the state with nearly 30 per cent, enough to allow an imaginative offer in the future, should anyone think of one, while signalling that the government is serious about getting out of banking. The placing price, even at a small discount to the current 75.5p a share, would allow the Chancellor to boast that he’d made a profit on our investment.

Many big funds have been happily underweight in bank stocks, watching the crisis unfold. Collapsing prices automatically turned the holdings into an insignificant part of portfolios. In the last year however, the more apocalyptic forecasts have been proved unfounded, and bank analysts are making plausible profit projections, with the prospect of paying two-thirds of those profits in dividends.

The resulting recovery in bank share prices – Lloyds has doubled in a year – has embarrassed those funds measuring themselves against the trackers, so a placing of government stock presents a neat way to get back to a comfortable weighting. However, the opportunity may not last long.

The £6bn Barclays rights issue is meandering to market, and Lloyds itself will be offering shares in TSB. The question of how much proper capital a bank needs remains unresolved (although the likely answer is: “more”) and dearer money will trigger trouble for the “delay and pray” borrowers who can’t repay capital even at today’s interest rates.

The eternal rule in markets is that when the ducks are quacking, you should feed them. George Osborne please note.

Performance cars

If that old banger in the garage has a Ferrari badge under the rats’ nests and chicken poop, then you may be the proud owner of one of the best performing assets of the last decade. Knight Frank, presumably bored with being a mere estate agent, released its latest luxury investment index last week, and notes that top end classic cars on the HAGI Index have risen in value by 430 per cent, outpacing everything else in the KF index over one, five and 10 years.

Your car will have gone up in value even faster if you haven’t fiddled around with it, since there’s a whole sub-culture in deciding what is maintenance and what is (ugh) replacement or (even worse) modification. As in most of these luxury “alternative asset” classes, rarity and condition are rewarded by the buyers who have made enough elsewhere to indulge their fantasies. You might pick up one of the 160 Ferrari GT Short Wheelbase Berlinettas that were built between 1960 and 1962 for £3m, but one with an illustrious history on the track could fetch over £10m.

These are big numbers, prompting observers to wonder whether the market isn’t getting somewhat supercharged. On the Tuesday a small cloud, no bigger than a motoring glove, appeared in RM‘s auction room. Lots 248, 250 and 251, the highlight of the sale, stalled. Lord Laidlaw‘s 1955 D-type Jaguar, which some expected to fetch £6m, failed to sell at £4m.

It’s possible that the buyers’ wives didn’t like the colour (blue), or that they considered the weather unsuitable for open-top motoring, but it might mean, as they say in the advertisements for managed funds, that past performance is not a guide to the future, however hot the performance of the cars themselves.

Can you hear me, mother?

Barclays is running an ad campaign pointing out that ears are useful things. Long, long ago, Midland branded itself the Listening Bank, but when one of its managers (they had them, then) locked a client in the office and went home, it was quickly dubbed the Cloth-eared Bank. And there may still be someone left at Barclays who can remember what became of the poor old Midland…

This is my FT column from last Saturday

Form an orderly queue for Lloyds shares, please

The stocks were sold, the press was squared,
The middle class was quite prepared . . .

No, not the sale of the Royal Mail (that’s more like a work in progress) but of Lloyds Banking Group. The state’s £20m-worth of shares is George Osborne’s get-out-of-jail card, and any day now we’ll wake up to find he’s played it.

He seems to have decided not to sell the lot, but today’s conditions may not recur: a rising market, a price where he can claim a profit for the taxpayer, and institutions wondering whether being underweight in banks still makes sense. As the smoke from the great value destruction clears, the attractions of a bank with a domestic market share it would never have been allowed to grab in normal times will become clearer.

The hits to the p&l from loan provisions and PPI are ending, and there’s the prospect of a return to dividends, perhaps as soon as next year. The signals from the heavy-hitting group led by Lord (Mervyn) Davies, that it could buy a sizeable chunk on its own, will also concentrate the fund managers’ minds.

Mercifully, the Chancellor has ditched the whacky idea of Russian-style coupons which yield the holder a profit if the shares are sold for more than the government’s 61p book price. He can still dream of selling the rest of the holding to Sid on attractive terms just before the election, but please don’t call it an attempt to bribe the electorate.

Short circuit

Trafficmaster was David Martell’s big idea, when satnav was a novelty and Google maps unknown. He sold in 2004, and now he’s back, with the suitably-named Chargemaster. This business provides the shovels for the electric car gold rush, and he hopes to put a charging point near you, or near enough to put your faith in battery power.

He’s floating the business, on a tide of state subsidy for the power points. There’s a string of bribes to encourage us to fall for the electric car, but the omens do not look good, since no subsidy can change the laws of thermodynamics. Generating electricity, wiring it into the roadside, pumping it into storage batteries and then returning it to motive power is never going to match refining oil to burn in an engine. Electricity isn’t a fuel, it’s a transmission mechanism. The power must come from a power station.

The business case for these vehicles rests on the EU diktat that by 2020 the average emission from each manufacturer’s fleet must not exceed that of a Toyota Prius today. This is pie in the sky, but the fines for breaching the limit would provide another hidden subsidy, and never mind that electric cars are hardly green at all.

Sensible car buyers are spurning these autos, perhaps fearing that if they forget to plug them in at night, they’re stuffed the following morning. The exception is the Tesla, the fashion car of choice for the cash-laden of California. However, today’s fashion is tomorrow’s out-of-fashion, as the buyers of Trafficmaster shares in 2000 discovered. Valued at £500m then, it was eventually taken private in 2010 for £100m, as Google Maps ate its market. The risks to Chargemaster are just as real. For all the billions being spent on it, the electric car looks like a dead end, even if there’s a charging point there.

Requiem for the FSA

A brewery is just the place for a wake, and that for the late-unlamented Financial Services Authority, on Thursday at The Brewery in Chiswell St, should be one to savour. The FSA bifurcated, and is no more. However, the niceties of the burial must still be observed, with a valedictory annual public meeting. In the past, these were grand affairs, replete with speeches and complaints. This time there may just be complaints. The chairman won’t be in the chair, nor the chief executive on the platform. They’ve dunregulatin’. “Red” Adair Turner has been given £252,000 and Hector Sants £300,000 plus a top job at Barclays following six months’ compulsory rest. Do remember that questions for whoever does turn up must be submitted in advance.

 

This is my FT coloumn from Saturday

Co-op’s banking plans go green about the gills

You really fancy that mink coat, but you can’t afford it. When it’s marked down to 75 per cent off, with easy terms so easy that the store’s lending you the money for nearly nothing, how can you resist? The Co-operative Group’s executives may soon wish they had, as they struggle to work out how to pay for their own sale-time bargain.

Lloyds Banking, the forced seller of 632 branches, last week claimed “good progress” in breaking them away from its network, but it’s now eight months since the Co-op (the only credible buyer) agreed the branches’ £350m price tag, with Lloyds lending the money. Just as a fur coat needs maintenance against moth and insurance against paint-throwers, the Co-op is learning that it may not have a July sales bargain after all. The business needs capital backing, perhaps as much as £1bn, and the Co-op can’t tap its owners. There may be 7m of them, but they’ve only put up £1 each, and they ain’t capitalists.

The Co-op has had a good run recently. Its existing bank, half the size of the Lloyds package, came through the crisis relatively unscathed, while its food stores have almost improved enough to keep up with the competition. But Peter Marks, the chief executive whose deal “took the shirt off” Lloyds’ back, is retiring, and last month the Co-op Bank’s finance director announced his departure. Mr Marks’ successor is not a banker and finds himself requiring a disposal programme to raise the money.

Putting banks together is tough. The Co-op has yet to complete the relatively unambitious integration of the Britannia Building Society, bought in 2009. It’s not too late for the new team to ask whether swallowing Project Verde, as Lloyds dubbed the sale, would make the Co-op so green about the gills as to infect the whole group. As many Co-op members would be quick to point out: only a mink really needs a mink coat.

Blowing a fuse

The bright, sunlit uplands of the low-carbon economy are in sight. Who says so? Why, Ed Davey, today’s Energy Secretary. He’s set a carbon reduction target for 2030, and tells us that when it’s law, clean power stations and “thousands of jobs” will follow.

If wishing would make it so, how happy we would be. Unfortunately for Mr Davey (who will be a distant memory at Energy long before 2030) others can’t share his lovely vision. In his valedictory shot last week, the boss of Ofgem warned that we’d be lucky to keep the lights on later this decade, while the CEO of Centrica (owners of British Gas) is refusing to build new gas-fired power stations, until he sees how screwed-up the legislation turns out to be.

He doesn’t put it like that, of course, but since supplying gas and electricity is the point of his business, it reflects his frustation at the gap between Mr Davey’s green dreamers and the looming energy crunch. Countless studies over many years have highlighted this disconnect, and it’s now too late for any new nuclear stations to arrive in time. Centrica’s decision means it may be too late to build gas stations, too.

The longer-term picture isn’t too bad, thanks to shale gas, although that only goes halfway to taking the carbon out of energy generation. In the meantime, we can expect rolling blackouts – unless we keep the coal-fired burning ’til the point hits home.

Back to school

Promethean World was the poster child for the IPO disasters at the turn of the decade. The share price chart looks like a playground slide, whooshing down from 200p into the 90 per cent club, as discretionary spending on education slumped. Promethean makes interactive whiteboards, to bring the world into the world’s classrooms, and it’s now concentrating on classroom software, to bring all the kiddies’ efforts together electronically.

The brave brokers at Espirito Santo have decided that there’s a chance of this strategy, along with a new CEO, turning the Promethean tide. Well, maybe. Nearly everyone on the planet thinks education is A Good Thing, and would like someone else to spend more on it. Prometheus stole fire from the gods, who were not amused. If Promethean gets really clever with its software, it might provoke a similar response, and find its business disappearing into a smartphone app.

This is an updated version of my Saturday FT article, available here:

http://www.ft.com/cms/s/0/ade13baa-826f-11e2-843e-00144feabdc0.html#axzz2MYzBVfLn

It’s Andy for the Governor

Here’s a new candidate for governor of the Bank of England. Andy Haldane is an insider who thinks and talks like an outsider. On Monday night he was causing waves by claiming that the Occupy protestors were roughly right – and he’s the Bank’s Executive Director for Financial Stability.

His remarks are much more than grandstanding. He has form when it comes to thoughtful analysis of our banking monsters. As he told the IEA : “The square-cubed law explains why a flea, even if it were the size of a man, would not be capable of jumping to the moon. It explains why a hippopotamus cannot turn somersaults. And it explains why King Kong and Godzilla were physiological impossibilities – the weight transfer associated with a single step would have shattered their thigh bones.”

That sounds rather too familiar to the shareholders in Lloyds (King Kong) or Royal Bank of Scotland (Godzilla) as they view the shattered remains of what they had considered one of the safer investments in their portfolio. To get some idea of the scale of banking incompetence (or worse) Haldane calculates that even during the good times, too-big-to-fail translated into an annual subsidy from the world’s taxpayers of $70 billion a year, or half the post-tax profits of the world’s 29 largest banks. Once the implied promise became explicit, the subsidy ballooned to over $700 billion a year. (He measures the subsidy by looking at the difference in yield on bank debt with, and without, state support).

There’s a lot more like this in his excellent lecture, but his conclusion is that we’ve hardly started taking the steps needed to resolve the banking crisis in a way which makes a recurrence unlikely. He is in no doubt that this must change, and that today’s banks are not too big to fail, but just too big. This assertion, and the claim that Occupy was right, have both been made before, but not by a director of the Bank of England. As governor, Haldane would be ideally placed to dismember Britain’s bloated banks. If he hasn’t applied, he should get on and do so.

Not very Co-operative

It rather looks as though Lloyds Banking Group has found a buyer for the 630 branches that the European Commission has obliged it to sell. The only name left in the frame is the Co-Operative Bank, which is said to have won – if that’s the word – preferred bidder status. It’s in danger of finding itself the proud owner.

The Co-Op has had rather a good credit war, so far. It stayed out of the worst of the derivatives madness, quietly rescued the Britannia Building Society and felt no urge to conquer the world outside the UK. The result is comfortably manageable bad debts and a decent-looking balance sheet.

One legacy of the Britannia takeover was its PIBS, which were converted into Co-Op Bank 13% perpetual subordinated bonds. I’ve got a small holding dating from that takeover and have enjoyed the 10% yield on the purchase price. Now I’m getting worried, and I’m not the only one. The price had risen to £156% in May this year, as the market appreciated the resilience of the co-operative model. As the rumours of the Lloyds bid started, the price started to sink.

It’s now back down to my purchase price of £130%. The Co-Op may be about to pay £1.5 billion for the Lloyds cast-off branches, and it’s far from obvious how the bank, with no access to the equity markets, will pay for them without severe damage to its balance sheet. It’s still not to late to gazunder Lloyds, which richly deserves it, and cut the price to bargain sub-basement levels, or even walk away.

Dear Lloyds: nobody wants to buy your bank

It was going to be a hard-fought auction. The chance to buy a fully-formed network of bank branches, complete (one supposes) with all the trimmings, rather than just a property portfolio of variable quality, does not come along often. This week, the informal deadline for the sale of 632 Lloyds Banking Group branches passed. Had the parcel been under the hammer at Christies, the auctioneer would have had to buy the lot in.

There is just one bid, miles away from the £2 billion that Lloyds indicated it had in mind, and even that bidder is pretty picky about what he’ll take. He’d rather pass on some of the mortgages, for example, presumably because he doesn’t share Lloyds’ optimism that they will be repaid. “He” in this context is Lord (Peter) Levene, the man who is credited with saving another Lloyd’s, the eponymous insurance market. His special purpose vehicle, NBNK, has indicated that it might pay £1.5 billion for the £36 billion of deposits and pick-of-litter mortgage assets.

Understandably, Lloyds is underwhelmed by this offer, and has extended the deadline, in the despeate hope that Richard Branson, Hugh Osmond or the Co-Op will come riding to the rescue, saddlebags bulging with cash. The brutal truth is that nobody wants to put proper risk capital into banks these days, because of the widespread suspicion that they need vast amounts more of it. NBNK’s assets add up to just £38m, and it would need to find takers for all sorts of funny money instruments to scrape together £1.5 billion. Meanwhile, the 2013 deadline ticks ever nearer.

Quite why Lloyds ever thought it could stuff anyone with this lot at anything other than a fire sale price is something of a mystery. The solution is as obvious today as it was when the European Commission ordered the disposal. Lloyds will have to break off enough of its business to comply, and fortunately it has a ready-made brand in the shape of the Halifax. For the vast bulk of customers, the credit crunch, forced merger and subsequent banking crisis will have passed them by. Despite the best efforts of its various owners, Halifax is still a valuable and trusted brand, capable of providing real competition to the banking cartel. Lloyds’ new bosses should forget a sale, and give the business to the bank’s shareholders. One day, Halifax Bank might even become attractive enough for the state to find buyers for its 41% holding.

I’m not sure about this Alliance

I’m a shareholder in Alliance Trust. Its subsidiary, Alliance Trust Savings, is home to my (substantial) SIPP. The service from ATS is simple, cheap and exemplary, and I’d recommend it. I wouldn’t recommend the shares to anyone until the management can persuade me they know what they’re doing.

Reading this week’s interim statement does not fill me with confidence.The tone is upbeat, and it is true that in the six months to the end of July, the company’s in-house fund managers mostly beat their benchmarks, if only by a modest margin. Measured by the net assets per share (NAV), coming in 16th out of a field of 34 is described as “progress”, which it is, compared to 20th place last year.

Since that time, the Alliance bosses have had a terrible shock. A resolution forced onto the agenda at the annual meeting demanded a discount control mechanism, and drew a large minority of supporters (including me) from Alliance’s supposedly docile shareholders. As they saw this approaching, the Alliance directors had something of a panic attack. They scrapped the long-standing policy of letting the market decide the company’s share price, and started buying stock to narrow the discount.

And how. Barely a day goes by without another purchase announcement. Since February, the capital has shrunk from 661m to 611m shares. Sometimes the volume figures indicate that Alliance is almost the only buyer. So what has this expenditure of the best part of £200m achieved? Not much, is the short answer. The discount to NAV has narrowed, but only from 17.1% to 15.6% in the six months to end-July. It’s just under 15% now, despite the purchase of nearly 8% of the outstanding shares. At this rate, Alliance would need to spend twice as much again to squeeze the discount down below 10%, as demanded by the failed resolution.

Alliance does not help itself when the ceo claims to have anticipated the market slump and sold shares from the portfolio, because the proceeds mostly went into its own shares, even when the price was hitting an all-time high in July. This hardly looks like clever market timing. One reinvestment, in Lloyds Banking Group, was a mistake. Its price has fallen by a third since then.

I’m on two investment trust boards, both of which have commitments to manage their shares’ discount to NAV. It takes time to convince the traders that a trust really will be there buying if the discount threatens to widen, as often happens in a bear market. It’s a long and sometimes painful process, not a quick fix. Once the market is convinced, the selling pressure abates, and few further purchases are necessary to keep to the mark, but Alliance is miles away from that happy state. Still, ATS is a cracking business from the customer’s point of view. Let’s hope Alliance can eventually make some money out of it.