Should you invest in TSB?

Last year 700,000 private investors made a nice little profit when they bought shares in the Royal Mail privatisation.

Nine months later, TSB is floating on the stock market and private investors can buy shares – as long as they apply by next Tuesday.

So is this another opportunity to make easy money? Do TSB shares look cheap?

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Hi, you've probably heard that TSB is about to float on the stock market, so I thought it would be worth taking a look and seeing whether you should invest in it or not. We'll start with a bit of background. TSB is being sold off by Lloyds Banking Group – Lloyds is being forced to do this by the EU because it's just too big, too dominant a player in the UK banking market. In this flotation they're going to sell around 25% of the shares in TSB now, and they'll have sold all the shares by the end of 2015.

You, as a retail investor, can invest in the TSB flotation right at the offer price. You can't buy the shares directly from Lloyds or TSB, but you will be able to buy the shares from most of the well-known stock brokers out there including Hargreaves Lansdown. If you wanted to buy shares, you can go to the Hargreaves Lansdown website. If you get your application in by 5pm on June 20th, that's next Tuesday, you should get shares. The minimum possible investment is £750. If you buy, for every 20 shares that you buy, you'll get one extra free share as a retail investor. That's as long as you hold the shares for a year.

TSB have just announced what the flotation price will be, what the range will be for that price, so the shares will almost certainly float somewhere between £2.20 and £2.90. Halfway through that range, that's £2.55. If £2.55 is the actual float price, the valuation for TSB will come in at just below £1.3bn. The big question is, is £1.3bn a good price? Should you invest in the TSB?

Well, there are certainly some good arguments for saying TSB looks cheap and probably the best one is the price/book ratio. What does that mean? Basically it's at 0.8, and what that's saying is the TSB share price is actually lower than the TSB's net asset value. If you add up all TSB's assets, they're worth more than this £1.275bn market price for the IPO. For every 80p, when you buy 80ps worth of shares you're getting £1 worth of assets. That does sound really cheap and it's cheaper than a lot of the other major banks. Lloyds’ price/book ratio these days is 1.4, so the share price is higher than the net asset value.

Another big plus point, I think, for TSB is it's a UK based bank. It's pulling in money from UK depositors, UK savers, and it's going to be lending money out to UK borrowers, mostly mortgage borrowers. That should reduce the risk of it. You know that TSB won't be going off and buying high-risk assets in Germany or whereever else.

Another plus point is it has a very high tier one ratio at 17%. What does that mean? Well, tier one ratio, or tier one equity, is the really safe asset that TSB have, those really safe core assets. If TSB gets into trouble, if some of its borrower's default, it's still got a really nice big buffer zone of assets it can use to ensure it survives.

Back before the crisis there were banks with tier one ratios below 5%, so TSB is way safer with that nice big buffer. It's got a bigger buffer than any of the other big UK banks. In second place HSBC has a tier one ratio of around 13%, so really nice and safe. However, there is a downside of such a high tier one ratio. It means it's going to make it tougher for TSB to deliver really strong returns for shareholders. If you think about it, let's just imagine TSB has got a billion pounds worth of assets and it makes profits of 100 million. It's then delivering a 10% return on equity.

If it wants to bump up that return on equity, it's either going to bump up the profits or cut the equity. If it cuts the equity from a billion to 500 million but still makes 100 million in profit, its return on equity goes up to 20%. That's why a lot of banks like to push down their tier one ratio so they can do . . . so that they have strong returns for investors, but TSB probably can't do that because it wants to stay safe. To boost its returns it needs to grow and get more customers, and if it's going to grow and get more customers, it's going to have to offer high interest rates to savers and high interest rates for current account customers.

TSB has already launched a really nice current account paying 5% interest on your current account balance, which is great for customers and it will bring in new people into the TSB, but TSB is probably going to have to sustain those rates over the long-term and that's going to be a big cost. Another downside is TSB has said, it won't pay a dividend until May 2018 at the earliest. A lot of people invest in banks to get income, to get a dividend; they can't get that from TSB for another four years.

Also, even though I said TSB is low-risk with that tier one ratio, there is one factor that makes it more risky and that's in its mortgage loan book. Forty-five percent of TSB's mortgage books are interest-only loans where people aren't paying back the principal mortgage debt. Those interest-only loans are historically higher risk. There's a higher chance that the borrowers will default on their loans. That's a definite minus point on the risk side of things.

What am I going to do? Am I going to buy? Well, I admit, I'm sort of kind of sitting on the fence here. I know that in some ways TSB is cheap. I think there's a decent chance the share price will go up after the flotation, not certain but a decent chance. For me, the whole thing isn't exciting enough for me to get involved. I can see we're not going to see dividends for four years. I'm worried about the mortgage book, and I also just think TSB is a bit old fashioned.

TSB's style itself is a young thrusting challenger bank, but basically it's an old fashioned branch based bank with 600 branches doing current accounts and mortgages. The really sexy, exciting part of the banking sector is on the internet with the new peer to peer lenders, people like Zopa and RateSetter. You got all the Crowdfunding people like Kick Starter and Seedrs; all sorts of other innovation going on. The new E Payment systems, people like PayPal and Monetize, and all the rest of it. TSB isn't in those sexy, great sectors and that's where the future is in the long-term.

TSB, it's fine, it's a bit old fashioned, it looks cheap in some ways, but I'm not going to buy, but you've got to make your own decision. Hopefully I've made that decision a bit easier for you with this video. I'll be back with another video soon. Until then, good luck with your investing.

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