TSB is the part of the Lloyds Banking Group that the Co-operative Bank would have bought, had Project Verde not gone all wrong. Instead, Lloyds has listed TSB as a separate company and is selling it off in tranches. Ironically, there is now growing market speculation that TSB will acquire the Co-operative Bank. Project Verde, it seems, could go into reverse.
The initial TSB share sale has now gone through – and Lloyds’ executives are probably relieved that the sale to the Co-operative Bank collapsed. Had Project Verde gone ahead, Lloyds would have reportedly received £750m from the Co-operative Bank. Instead, the sale of shares has sparked substantial interest from both institutional and retail investors. While Lloyds had intended to sell an initial 27.5% of its ownership stake, demand was so great that it instead sold 38.5% of TSB. This sale and subsequent share market surge has valued TSB at £1.45bn. This is twice the figure on offer from the Co-op, though slightly below the £1.5bn valuation shown in Lloyds’ own accounts.
Individual investors bought about 30% of TSB. Lloyds Banking Group indicated that it was optimistic that the success of the divestment meant that the Government’s sale of its stake in the state-rescued Lloyds would proceed in a fairly short time frame.
Whether TSB is a good buy for investors is something that only time will tell, of course. Like the grocery trade – see this column in the last issue – retail banking is becoming a cut-throat trade. There is a growing consensus that the banking sector is unhealthily dominated by four banks – RBS, Barclays, HSBC and Lloyds – that control about 75% of the market. State aid rules are forcing Lloyds to divest the TSB portfolio and require RBS to sell off much of its business, which it will do under the Williams & Glyn’s brand. But this will only go a small way to redressing the lack of effective competition.
Chancellor George Osborne has argued that a new breed of challenger banks should be encouraged. These include Santander – which is already large – Tesco, Virgin, Aldermore, OneSavings (the private equity purchased Kent Reliance business) and Metro Bank. Others, including the Archbishop of Canterbury, Justin Welby, argue that this is insufficient and that the largest banks have to be broken up more fundamentally to avoid future bail-outs of ‘too big to fail’ banks and to promote keener competition.
On this, I agree with the Archbishop. Four dominant banks do not constitute a competitive market. And to avoid further inordinately expensive banking bail-outs we need to create a financial structure where the collapse of any one or two banks would not risk bringing down the whole financial system.
One option being considered by the Government is to require banks to allow an ‘instant switching’ system of current accounts. I am not persuaded that this is sufficient. Making it easier to move banks has not, as yet, led to a big swathe of current account transfers. Customers are resistant to moving banks, even when it is clearly to their advantage to do so. Fear seems to deter a move.
The level of keenness to invest in challenger banks is perhaps surprising given the possibility of a more competitive environment. The market value of TSB is above that justified by its recent profits. Although it made a profit of £172m last year, more than £100m of this was achieved from a tax gain. However, suggestions from the Bank of England governor Mark Carney that interest rates could begin rising this year gives hope to the banking sector, and its investors, that profits will increase. This will particularly help TSB, whose sale comes with a large mortgage lending portfolio.
TSB becomes the UK’s seventh largest banking operation by turnover and it is financially strong, meeting its capital and liquidity requirements. And despite the collapse of Project Verde, the future of the TSB is likely to be of interest to News readers, not least because even though the Co-operative Bank is no longer a co-operative or mutual, it has managed (so far) to retain the co-operative name. Its eventual ownership is therefore significant – as is what happens to the Co-operative Group’s minority stake in the bank.
In addition, the TSB is being trumpeted by some as the equivalent of the John Lewis Partnership for the banking market. This is misleading. The TSB prospectus states that staff are being encouraged to become shareholders. But while the John Lewis Partnership is employee owned, TSB staff have each been allocated a £100 shareholding in the new company, giving them only a small minority stake in the bank.
But if we want to see how an actual mutual is operating in the current market conditions we should look to the Nationwide, the largest financial mutual. It is, though, a mutual by ownership, not in governance. There is a lack of genuine member engagement and democracy at Nationwide – which is why there has been such strong co-operative movement resistance to proposals by Lord Myners to adopt a similar model of director election for the Co-operative Group.
Nationwide had a very strong 2013/14 year. Mortgage lending rose by 31%, member deposits rose by £4.9bn and it opened 430,00 new current accounts – no doubt some of these won at the expense of the Co-operative Bank. Nationwide’s pre-tax profit position improved by 303% to £677m.
As discussed previously in this column, Nationwide became so enthusiastic in lending – and therefore contributing to the national economic recovery – that it had to strengthen its capital position. It is doing this in two ways – building up its reserves from retained profits, while issuing core capital deferred shares. It now has a very strong capital ratio. (It rose from a marginal position of 9.1% available capital last year, to 14.5% this year, which is the strongest ratio amongst similarly sized banking institutions.)
Although I have sometimes felt that Nationwide was almost accidentally left behind in the demutualisation rush of its competitor large building societies, it is demonstrating a strong commitment to mutuality in its current operations. It is focusing on the wider well-being of the economy and prioritises lending to first time borrowers, rather than focusing on sales to the highest income borrowers. And Nationwide is at the forefront of technological developments, with an apparently strong IT system. It reports positive progress with new digital wallet payment systems.
What we have therefore learnt is that a strong mutual can thrive in current market conditions, if it is properly managed, but also has access to the capital markets in a way that does not undermine its mutual status. This Nationwide has this access as a building society, through the core capital deferred shares, but this route was not available to the Co-operative Bank, as a PLC subsidiary of an industrial and provident society.
It is also apparent that investors have strong expectations that the market will evolve in the next few years to create both a more competitive and a more profitable banking environment, which will assist the expanding ‘challenger’ banks. This is exactly the time when the Co-operative Bank should have been positioned for healthy growth through organic means, rather than by acquisitions. But that route was choked–off by the grievous strategic errors that News readers know only too well.