My firm sold Lloyds TSB Group (LYG) a couple of weeks ago. I still think it’s one of the best run banks in the world, but its exposure to loans underwritten by other banks made us pause and rethink our thesis.
LYG has a securitization conduit called Cancara. It uses the conduit to securitize some of the loans it generates. There’s no problem there. LYG has proven to be very conservative in its underwriting and that’s why it sports a very rare AAA rating by S&P.
However, about two thirds of the $25 billion Cancara conduit are loans that have been generated by other banks. For a fee, LYG allowed other banks to fold their loans into Cancara and LYG basically insured those loans by its own balance sheet. Call me paranoid, but other banks have little incentive to care about the quality of the loans. Now, LYG is on the hook, not them.
This was my reasoning to sell the company I praised for a very long time. Again, there’s a good chance this may end up being nothing. We’ll monitor the performance of Cancara loans for awhile and may buy LYG back at some point in time.
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