Investment View: Leave Lloyds for now, but consider a slice of RBS

The consensus is that this softly spoken, no-­nonsense Kiwi might be just the ticket for RBS

Click to follow
The Independent Online

If the Government plans to privatise Lloyds and RBS would it not be better to get in early? There’s an interesting debate to be had on this, particularly given where the banks are right now. For a start we don’t actually know if there will be a “retail” offer – that is, a sale to you and me rather than to City institutions – in the first place.

However, it seems a racing certainty in the case of Royal Bank of Scotland. This, after all, will be an enormous sell-off, the biggest privatisation the UK has seen for years. So the Government will probably need the help of retail shareholders to get the thing off its books and away.

When that happens retail shareholders will probably get some sort of bung to persuade them to join the party. This might take the form of a deal whereby they would only fully pay for the shares after they’d sold them and turned a profit, perhaps combined with some kind of bonus share offer if they sat tight for a while (Standard Life offered such a deal when it demutualised).

The latter may be something UK Financial Investments – the body that allegedly manages the state’s interest at arm’s length from the Treasury – should consider. If everyone who buys into a privatisation immediately sells up to cash in, a share price can become very unstable.

But should you buy in now? With RBS there’s an argument to suggest that you should, and no I haven’t taken leave of my senses.

For a start, the bank’s credibility received a much-needed boost in the way it handled the appointment of Ross McEwan as chief executive, particularly given the rather shabby manner in which the “retirement” of his predecessor Stephen Hester was managed.

Mr McEwan may be a relative unknown, but he has been quietly impressing the City since his appointment as head of RBS’s retail business last year. The consensus is that the softly spoken, no-nonsense Kiwi might be just the ticket as the bank enters the next phase of its recovery.

He even nipped in the bud any fuss over pay by refusing an annual bonus for the next couple of years and taking a lower salary than Mr Hester enjoyed – although he’ll still be eligible for a fat payout under the bank’s long-term incentive scheme.

Mr Hester’s final set of results were respectable enough. Operating profit (which strips out a lot of one-offs and accounting issues) was in line with forecasts. At £1.2bn “core” operating profits – from the businesses RBS wants to keep – were £100m light, but that was offset by decreasing losses in non-core (the remaining bad bits from the Fred Goodwin era, which at £300m or so are at their lowest level yet).

The best bit is that the target for these non-core losses is to have them down to a maximum of £38m by the end of the year, although the £385m set aside for unspecified legal issues is a worry.

It remains possible that non-core assets could be spun off into a bad bank (the Government is carrying out a review). But I remain of the view that this is unlikely and would probably require the approval of the minority shareholders, with the Government (or UKFI) not able to vote.

RBS has been busily propping up the mortgage market, and while it’s still not out of the woods, it’s not that far off a return to normality. There are grounds for thinking the shares could be much higher by the time of any sell-off – and they’ll need to be or the Government will have to explain why, after buying in at 500p, it’s accepting a thumping loss on behalf of the taxpayer.

I’ve changed my view on RBS. Ian Gordon, at Investec, pointed out that net asset value per share is at 445p, so RBS is at a substantial discount, but behind the scenes progress is being made on many fronts. So buy.

Lloyds is a much harder call because the shares look much closer to fair value, and are trading close to the taxpayer’s buy-in price.

It’s making money and the removal of the dividend blocker (imposed when it was bailed out) should happen soon. There may even be a token payout this year. Lloyds is a lot further on the road to recovery; and with George Osborne, the Chancellor, setting a minimum sell-off price of 61p (too low, far too low) the first sales, probably to institutions, could begin whenever he feels it to be politically expedient and achievable.

Lloyds actually trades on a premium (1.3 times by Investec’s numbers) to its net asset value per share. And while there should be a gradual improvement in earnings, particularly in the wake of an improving economy, I don’t feel there’s a vast amount of value left in the shares right now.

With Mr Osborne declaring such a low minimum sell-off price, I also think that 73.6p (the real buy-in price) represents a natural ceiling for the shares. Investors know Mr Osborne is going to sell; they think he’ll be willing to sell at less than 73.6p. With such a large chunk of stock likely to hit the market at a discount over the next couple of years why buy in at the current price?

So, for Lloyds, my view is that it’s best to sit and wait, at least for now.