Lloyds Favors Earnings Growth Over Dividends in MBNA Purchase

Updated on
  • Deal to add 650 million pounds to Lloyds’s annual revenue
  • British bank negotiates 240 million-pound cap on PPI payouts

Lloyds Banking Group Plc agreed to buy Bank of America Corp.’s MBNA credit-card business in the U.K. for 1.9 billion pounds ($2.4 billion) in cash, prioritizing earnings growth over short-term dividends to counter weaker lending income amid low interest rates.

The bank’s shares climbed as much as 3.3 percent after the company said Tuesday the acquisition will boost earnings per share by 3 percent in the first year. The purchase will use about 80 basis points of common equity Tier 1 capital, a measure of financial strength that determines how much the bank has available for dividends and buybacks.

Chief Executive Officer Antonio Horta-Osorio is pushing into higher-margin credit card business to help offset the impact from record-low Bank of England interest rates, which threaten to erode profitability on lending. The acquisition of MBNA, which has an 11 percent slice of the U.K. market, will almost double Lloyds’s current share to about 26 percent, beating Horta-Osorio’s growth targets and raising the bank into the same league as Barclays Plc, which controls about 27 percent of the market through Barclaycard.

“A deal would be a good use of excess capital and the terms of today’s announcement looks attractive,” Joseph Dickerson, an analyst at Jefferies International Ltd., said in an e-mail. “We estimate MBNA U.K. will lift the contribution of consumer finance business to 21 percent of group pretax earnings, up from the current 17 percent, thereby reducing reliance on U.K. mortgages.”

Payout Target

The stock rose 2.6 percent to 64.2 pence at 3:44 p.m. in London, compared with a 0.4 percent rise for the FTSE 350 Banks index. Lloyds said it was confident it could deliver “progressive and sustainable” ordinary dividends in 2016 and continues to target a payout ratio of at least 50 percent of sustainable earnings over the medium term.

The acquisition of MBNA, which has about 7 billion pounds of assets, will add 650 million pounds a year to Lloyds’s revenue, equivalent to a 4 percent increase. It will also boost the lender’s net interest margin by about 10 basis points a year, Lloyds said. The bank has previously said the margin would be around 2.7 percent in 2017.

The benefits come at the cost of a hit to the firm’s common equity Tier 1 capital ratio, which stood at 13.4 percent at the end of September. Horta-Osorio has pledged to return excess cash above 13 percent to shareholders and some analysts previously questioned whether acquiring MBNA was better than growing dividend payments.

“Whilst the company has reiterated plans to deliver a ‘progressive and sustainable’ ordinary dividend, this transaction may limit Lloyds’ ability to pay a special dividend on top,” analysts at Citigroup Inc. led by Andrew Coombs wrote in a note to clients. He said consensus was for dividends per share to increase from 2.25 pence last year to 3 pence for 2016, which “may now need to fall.”

‘Benign Point’

Lloyds said it expected to complete the deal by the end of the first half of next year, and will keep the MBNA brand separate from its other card products. The bank forecasts an underlying return on investment of about 17 percent in the second full year after the acquisition.

Lloyds is expanding into unsecured lending at a time of historically low impairments in the U.K., buoyed by flat BOE rates that have helped British borrowers keep up repayments. However the sector could be at greater risk in the event the nation’s vote to leave the European Union hurts the economy more than anticipated, as credit card debt can often sour faster and isn’t secured with physical assets.

Lloyds will be “broadly doubling up its exposure to credit cards at a particularly benign point in the bad debt cycle, and ahead of a potential slow-down in the U.K. economy once the terms of the U.K.’s exit from the EU are reached,” Gary Greenwood, an analyst at Shore Capital in Liverpool, England, wrote in a note to clients. “The risk cannot be ignored.”

PPI Liabilities

As part of the deal, the London-based bank negotiated a 240 million-pound cap on MBNA’s future payouts for the payment-protection insurance scandal. Bank of America, which said it would see a minimal after-tax gain on the sale, remains liable for any additional charges at the business above the cap.

MBNA had a 244 million-pound regulatory provision set aside for PPI redress as of the end of last year, according to its annual report. Lloyds has taken more than 17 billion pounds in charges for PPI claims over the past five years, more than any other major British lender.

Lloyds was up against private-equity firms including Cerberus Capital Management and Advent International in the MBNA bidding process, people familiar with the matter have said. About 1,700 people based in Chester, England, will join Lloyds as part of the transaction.

Bank of America bought MBNA in 2006 for $35 billion. As borrower defaults rose and regulations reduced the industry’s prospects, it twice wrote down the card unit’s value, sold MBNA businesses in Canada and Ireland and folded the U.S. business into its own operations. Some of the U.K. card assets were sold to Richard Branson’s Virgin Money Holdings UK Plc in 2013.

Lloyds hasn’t made a major acquisition since its ill-fated takeover of HBOS Plc during the 2008 financial crisis left the bank in need of a bailout. The government still owns 6.9 percent of the lender after selling down its stake, unlike at Royal Bank of Scotland Group Plc where the state owns 73 percent and the bank isn’t allowed to make acquisitions under EU rules until it has disposed of its Williams & Glyn business.

“The MBNA brand and portfolio are a good fit with our existing card business,” Horta-Osorio said in the statement. “The acquisition, funded through strong internal capital generation, increases our participation in the expanding U.K. credit card market with a multi-brand strategy.”

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