Lloyds’ MBNA Swoop Works – Unless Brexit Bites

Unless UK unemployment soars, Lloyds Banking Group’s purchase of Bank of America’s UK credit cards business should be a decent punt. The UK lender is paying 1.9 billion pounds ($2.4 billion) to buy MBNA, whose 7 billion pounds in assets would almost double Lloyds’ share in cards to around 26 percent, only a smidgeon behind market leader Barclays.

The most glaring risk is that Lloyds Chief Executive Antonio Horta Osorio is doubling down on the UK before negotiations have begun in earnest over Britain’s departure from the European Union. Another big worry is that, with interest rates at rock bottom, bad loans will mount. Then there’s a probe of the UK credit cards market by the Financial Conduct Authority, which is yet to propose new rules.

Lloyds investors should be able to get comfortable with most of these pitfalls. MBNA’s loan portfolio is supposedly of better-than-average quality. The FCA’s initial findings suggest competition is reasonably robust, though it could restrict new lending to address a concern over high debt levels.

Meanwhile, Horta Osorio would be bulking up cheaply, assuming pre-tax savings that Lloyds estimates at an annual 100 million pounds. Though they look high, at 30 percent of MBNA’s cost base, integrating two businesses onto one shared platform could bring big benefits. If they materialise, Lloyds would be getting the business for about six times 2016 earnings – a reasonable eight times even without them. Rivals trade at far higher multiples. Assuming the MBNA assets’ 123 million pounds of first-half net profit persists, the acquisition would make almost a 13-percent return on investment even without cost savings, when Lloyds’ overall return on equity for the first nine months of 2016 was just 5.9 percent.

For a Brexit disaster scenario to derail that, UK unemployment would have to double from its current rate of below 5 percent before MBNA would start to lose money, says a person familiar with its business. On the plus side for investors, Lloyds was one of the best performers in recent UK bank stress tests. As of the end of September, it had sufficient excess capital to pay for half of the deal and its intended payout. Given it is generating something like an additional 1.8 billion pounds of capital every six months, Lloyds’ dividend looks relatively safe.

Request a free trial of Breakingviews here.