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Lloyds - Declining PPI charges boost profits

Nicholas Hyett | 25 April 2018 | A A A
Lloyds - Declining PPI charges boost profits

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Lloyds Banking Group plc Ordinary 10p

Sell: 55.14 | Buy: 55.19 | Change 1.45 (2.68%)
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Underlying profit before tax was up 6% in the first quarter, hitting £2bn, reflecting increased net interest income and lower conduct charges. Lower PPI charges meant reported profits rose 23% to £1.6bn.

The shares were broadly flat in early trading.

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Our View

Exciting Lloyds is not. But steady growth and a chunky dividend - analysts are forecasting a prospective yield of 5.5% - are not to be sniffed at.

Performance has been driven by more loans to customers, at higher margins and with lower operating costs - in essence doing simple banking well. CEO Antonio Horta-Osorio's plan for the next three years calls for more of the same.

Lloyds is already the UK's biggest digital bank, as well as operating the largest branch network. Further digitalisation aims to improve customer service and reduce costs.

The group is making a land grab into Financial Planning and Retirement as well - aiming for £50bn+ of new assets and 1m new clients by 2020. The Scottish Widows business means it already has a foot in the door, but expansion will still require significant investment.

Small business lending is also getting a shot in the arm, with management targeting an extra £6bn of net lending by 2020.

All this, together with a significant increase in investment in staff, is expected to cost around £3bn. But if Lloyds can pull it off, the rewards could be substantial.

The bank's cost to income ratio should continue to fall, reaching the low 40s by 2020, with improvements every year. Loan defaults are also expected to remain low.

If all goes to plan, return on equity should hit 14-15% (versus 8.9% in 2017) with capital generation of 1.7-2 percentage points a year. For shareholders that should mean a sustainable and growing dividend, with potential for further returns of surplus capital.

It's worth bearing in mind there's always scope for regulatory or economic curveballs to upset the apple cart with banks. Lloyds is also particularly exposed to the fortunes of the UK economy, with increasing exposure to more volatile credit card and car finance markets. With concerns about a painful Brexit weighing on the economy that's not ideal - and might explain the group's undemanding valuation.

However, it's difficult to see where the bank has put a foot wrong so far. Horta-Osorio's two previous three year plans have taken the bank from financial crisis pariah to one of the strongest players on the high street.

It might lack fireworks, but if his next offering deliver more of the same there won't be many complaints.

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First Quarter Results

First quarter net interest income was 8% above the previous year, at £3.2bn. That reflects a small increase in loans to customers and 0.13 percentage point improvement in net interest margin, which rose to 2.93%.

However, this was partially offset by a 5% decline in other income, which stood at £1.4bn. That reflects increased weather-related insurance claims, less activity in bulk annuities, fewer transactions in commercial banking and changes to overdraft charging. Lex Autolease continued to deliver growth.

Despite a 2% increase in operating costs, reflecting the acquisition of the MBNA credit card business, the bank's cost:income ratio continued to improve, now standing at 47.8%.

Impairments for bad loans more than doubled to £258m, with the increased impairments reflecting the purchase of MBNA credit cards last year. Quarter-on-quarter, the asset quality ratio (bad loans as a percentage of total loans) remained flat.

Lloyds generated 0.5 percentage points of CET1 capital (a standard measure of banking capitalisation) in the quarter, closing the period with a CET1 ratio of 14.4%, or 14.1% after accounting for dividends.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.