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Lloyds-MBNA: Making Brexit Nice Again

Doubling down on U.K. looks risky, but returns justify it.
At Closing, May 25th
65.67 GBp
At Closing, May 25th
30.16 USD

As Brexit tempts banks across the Channel or the Atlantic, Lloyds Banking Group Plc is doubling down on Britain.

British Discount

Lloyds shares have underperformed European peers since the June Brexit vote

Source: Bloomberg

The country's biggest mortgage lender agreed on Tuesday to buy Bank of America Corp.’s MBNA credit-card business in the U.K. for 1.9 billion pounds ($2.3 billion) in cash, its first major purchase since being bailed out eight years ago.

The deal makes sense -- even taking into account the potential economic slowdown ahead and the risk Lloyds shareholders will be deprived of special dividends in the short term. The returns and market share gains are lucrative enough.

House of Cards

Lloyds' market share in credit cards is set to almost double with MBNA, reducing its reliance on mortgages

Source: Company statement

MBNA will boost Lloyds's annual revenue by about 650 million pounds, or 4 percent. Net interest margin and earnings per share would also rise -- although the bank will have to do some heavy lifting to make cost savings. Crucially, the card business's underlying return on investment is expected to hit 17 percent within two years -- well above Lloyds's 10 percent cost of equity.

The other big help is something that's absent: a surprise bill for compensating customers who bought payment-protection insurance. Lloyds has been the bank worst hit by PPI, the costliest scandal in British banking. It's set aside 17 billion pounds for compensating clients so far.

MBNA will come with about 240 million pounds of provisions for future claims -- and Lloyds says its liabilities are capped at that amount, leaving Bank of America on the hook for any nasty future surprises. That removes a big potential sting in the tail from the deal.

It's not a free lunch, though. Lloyds has had to fend off competition from private-equity firms and is paying more than double the business's book value of 800 million pounds.

Nervy investors might frown upon the decision to double market share in any part of the U.K.'s financial industry, let alone credit cards, considering the potential loan losses ahead.

Good Times

Adjusted loan-loss provisions at Lloyds have fallen in recent years, buoying the bank's profits

Source: Bloomberg data

Adjusted loan-loss provisions at Lloyds have steadily fallen every year since 2011, according to Bloomberg data. That benign environment may change next year if a slowing economy and rising unemployment take their toll.

The deal will also wipe 80 basis points off Lloyds's core equity Tier 1 capital ratio, which stood at 13.4 percent at the end of September. The bank has pledged to return surplus cash to investors when the ratio exceeds 13 percent. Lloyds may now have to cut or scrap a special dividend payout, forecast by Shore Capital analysts to be 1.45 pence for the full year. 

But considering the financial incentives for taking risk in this environment -- not least with Mark Carney rolling out ultra-cheap funding to banks after Brexit -- it makes sense for Lloyds to try and do more than just return cash to shareholders or hunker down and hoard it.

With more than 40 challenger banks nipping at incumbents' heels and organic growth hard to come by, it's right to consider this kind of acquisition to bolster margins and market share.

Investors may have to wait longer for a special dividend, but sometimes even banks need to reinvest. With Lloyds tied to the U.K.'s economic fortunes regardless of what lies ahead, doubling down on Brexit may turn out to be the right bet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lionel Laurent in London at

    To contact the editor responsible for this story:
    Edward Evans at

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