Where to for VUK, page-8

"it’s a really good point that vmuk have seemed disciplined over the last couple of years. But while the loan book may be of superior quality to the average bank in the uk, a recession will still bite especially as their overall loans to equity ratio is relatively high 72:4bil (or 18x) so it doesn’t take a monstrous writeoff to wipe out the equity and the perceived discount to nta. Even the Aussie banks don’t have that much leverage! I can’t find any banks with such a high ratio…"


Yeah, that's the tricky gig of the bank investor - forming a view of capital adequacy in the context of what is happening in the world.

And none of us can have clear insight into the true quality of any bank's loan assets - all we can do is rely on precedent as to how the loan book has performed in the past under varying credit market conditions. And even doing so does not remove the uncertainty.

But it is that uncertainty that causes the share price to implicitly factor in the prospect of around half of VUK's equity capital being written off. (Incidentally, you quoted 4 billion pounds as VUK's Equity base. I get 5.5bn pounds based on the last published accounts.)

So, by applying a Price to Book value of 0.57 the market is effectively saying that around 40% of the equity base - so 40% of 5.5bn pounds, i.e., 2.2 bn pounds - is due to be wiped out.

2.2bn pounds is equivalent to 3.1% of VUK's 72 bn pounds of total loans and advances to customers; so viewed another way, the market is effectively saying that over 3% of VUK's loan book and by implication, at least 3% of the loans issued across the entire UK economy, are going to go bad.

If that happens, we've got far bigger things to worry about.

Because, for context, the 4 major Australian banks booked a total of around $27bn of loan losses during the three years of the GFC, 2008 to 2010. That $27bn figure represented 1.45% of the ~$1.9 trillion dollars of loans the banks held going into the GFC.

And while you are right in pointing out that VUK is more leveraged than Aussie banks, the distinction is not as sharp as it might first appear, given the Australian banks are all conducting buybacks, or increasing he size of buybacks, an indication that their directors view them as being overcapitalised anyway.

While we should really compare risk-weighted assets, I couldn't be arsed and a crude measure of the degree of capitalisation, namely Gross Loans-to-Equity, will give a good enough picture.

So here is VUK compared to the major Aussie banks on that measure:

VUK (in pounds):
Loans = 72 bn
Equity = 5.5bn
Ratio = 13.1x

NAB - Just completed $2.5bn buyback; announced further $2.5bn
Loans = 771 bn
Equity = 63bn
Ratio = 12.3x

CBA: - $2bn buyback just kicked off
Loans = 849 bn
Equity = 75bn
Ratio =11.3x

ANZ: - Just completed buyback; in Feb announced looking to increase buyback
Loans = 638 bn
Equity = 64bn
Ratio =10.0x

WBC: - Buyback ongoing
Loans = 710 bn
Equity = 72bn
Ratio =9.9x



So, yeah, VUK more leveraged than the Aussie banks but its not sheep stations of a difference, especially considering all the Aussie banks are in the process of tightening up their capital structures.

(But I have to admit to not being sure how VUK stacks up against its UK, or European, peers.)

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"im really struggling to figure out whether the current food/energy inflation is going to spill over into the economy (I think we are relatively insulated in aus but not so for the brits). Will this lead to recession? is this going to slow down any rate rises? Feel like it’s a tough investing environment at present. In a non recessionary environment I’ve no doubt vmuk share holders will do well, but I’m just not sure what the chance of hitting an iceberg is currently? And if there are wholesale writedowns it seems to me that vmuk will be disproportionately affected - although I’ve no doubt, if that happens, you’ll have your finger on that pulse and escape the pain before us mere mortals get the memo…"


Yeah, I also feel things are a bit tricky. To make money out of the stock market always requires second-order thinking, but more so now than is usually the case.

On that note, everyone's first-order mental focus is firmly stuck right here and now in the glare of inflation, but to make money from stocks always requires forming a view of how the conventional wisdom will have changed in 12 to 18 months' time.

My view is that we muddle along in fits and starts over the 12 to 18 months, but that there is no "iceberg" economic event. Two things inform this view:

1.) We humans - for some inexplicable reason - think in arbitrary 12-month time frames when it comes to business and economics. So before long, we start "cycling" the current very elevated CPI base which means that inflation figures at the end of this year are likely to appear comparatively muted.

For example, if Dec 2022' CPI print comes in at 5%, which remember is 5% up on the big 7% figure announced in Dec 2021, then cumulatively that's a very meaningful increase in the aggregate level of prices over the full two-year period, but because 5% is a smaller number than 7%, it means the inflation situation will be perceived to be getting "less bad", and when things get less bad then the market invariably tends to view that as a positive development.

It's a numerical optical illusion which everyone should understand but often the market commentariat barely gets beyond analysing anything deeper than just the headline figure that hits the media headline at the time.


2.) If I am wrong, and inflation becomes so embedded that it starts to seriously harm the real economy, well, the new normal mandate for governments around the world is to invoke populist fiscal policies to anesthetise any economic pain until things normalise.

I call it the Political Populism Call Option.
It's not quite a free option; to access it you need to be invested in the market and the price of the option is that you need to be happy to live with a bit more volatility than usual.


So, provided I can find undervalued businesses to buy, I'm quite sanguine about things.

I see a slow economic grind over the next 12 months, but no major economic dislocations in the vein of the GFC or the Greek debt default crisis, or Covid. I think the next 12 to 18 months will look and feel like 2002/03 where economies muddled along and equity markets ground sideways.

But even then, there were numerous investment opportunities during that sluggish, but steady, economic backdrop.

So I don't think I lose money on my VUK investment because in such a world, at some point the market wakes up to the realisation that the sky isn't about to fall on VUK's head, which is what is being implied by valuing the business at half-book.

But maybe I'm too sanguine: it's just that we are bumping against all-time low valuation metrics for VUK, so I feel that I've at least got some half-decent precedent on my side.

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