Lloyds Banking Group (LSE: LLOY) (NYSE: LYG.US) has fared much better over the last couple of years than its bailed-out peer, Royal Bank of Scotland Group, and the government is expected to continue to sell-off its Lloyds shares this year, ahead of next year’s general election.
Lloyds’ underlying profits rose by 140% to £6.2bn in 2013, and the bank finally managed to report a statutory profit, albeit of just £415m, which is pretty negligible in banking terms.
However, Lloyds’ valuation is beginning to look quite demanding to me — can the bank survive any short-term issues and deliver for investors? To find out more, I’ve taken a look at three key financial ratios that might be used by credit rating agencies when rating financial institutions.
1. Net interest margin
Net interest margin is a core measure of banking profitability, and captures the difference between the interest a bank pays on its deposits, and the interest it earns on its loans.
Lloyds reported a net interest margin of 2.12% for 2013, up from 1.93% in 2012. This is a solid result that is only slightly lower than RBS’s market-leading 2.2% margin, although it’s worth noting that Lloyds’ low cost-income ratio of 52.9% suggests it has less potential for cost-saving than RBS, which could limit future margin growth.
2. Core tier 1 capital ratio
Tier 1 capital is essentially a measure of a bank’s retained profits and its equity (book value). The core tier 1 ratio compares a bank’s tier 1 capital with the value of its loan book.
One of the requirements of the new Basel III banking rules, which come into force in 2015, is that banks will have to meet new, tougher, tier 1 capital standards.
Lloyds reported common equity tier 1 ratio under the expected new rules of 10.0% for 2013 — above the minimum required, and a substantial improvement on last year’s 8.1%. This suggests that Lloyds has made solid progress with strengthening its balance sheet.
3. Loan to deposit ratio
Ideally, the value of a bank’s loan book should equal its deposit book — if loans exceed deposits, banks can have trouble meeting unforeseen demands for cash.
Lloyds’ loan-to-deposit ratio fell from 121% in 2012 to 113% in 2013, showing that it still has more work to do to get rid of non-core loans and maintain a strong deposit base.