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Lloyds Banking Group - impairment charges sink profits

Third quarter underlying net interest income rose 19% to £3.4bn

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Third quarter underlying net interest income rose 19% to £3.4bn, as net interest margins (the difference between what a bank earns in interest and pays on deposits) rose to 2.98% from 2.55%, because of higher interest rates. Underlying other income was down 4% at £1.3bn.

Costs only increased slightly, so underlying profit rose 22% to £2.4bn. But after including a £668m impairment charge in anticipation of more customers defaulting on their loans because of a weaker economic outlook, profit fell 17%.

Total loans and advances to customers were broadly flat at £456.3bn, with almost £300bn of this coming from the open mortgage book.

The CET1 ratio - an important measure of a bank's capital position - fell to 15% from 16.3%, partly reflecting regulatory changes.

Lloyds expects full year net interest margins to be higher than 2.9%.

The shares fell 1.5% following the announcement.

View the latest Lloyds share price and how to deal

Our view

Lloyds has taken a hit to the tune of £700m as it prepares for more customers to default on their loan repayments. That was a heftier charge than analysts were expecting and is driven by the rapidly weakening economic outlook. We can't rule out further charges coming through if things are worse than predicted.

All banks are affected by the economic cycle, but Lloyds' particular reliance on traditional banking and lending, especially mortgages, means it will feel more pain than others when the tide turns.

That said, that very operating model means rising interest rates are good news. The difference between what Lloyds earns in interest on loans and the amount it pays in interest on deposits, is moving in its favour. A net interest margin knocking on the door of 3% is no mean feat, but still isn't enormously profitable. As further interest rate rises come through, Lloyds is in a good spot, and this should feed through directly to growth. But Lloyds is also doing the right thing by looking for alternative ways to grow.

The new strategy plans to build out the bank's small business offer as well as increasing the focus on larger corporate and institutional clients. Both groups have potential to generate fees, rather than interest income.

The group's also looking to grow its Wealth Management options, across asset management, general insurance and pensions businesses, another area which isn't closely linked to interest rates. It's early days, but the billions being invested over 5 years means Lloyds is taking this strategy shift seriously. These plans have merit, but we're a long way off knowing if that hefty investment will pay off. This is an especially precarious time to bulk out this area - volatile markets and low consumer confidence aren't accommodating for wealth management.

The other weapon in Lloyds' arsenal when it comes to fighting low interest rates is an impressively low cost: income ratio.

Finally, there's the balance sheet to consider. The group's streets above the capital ratio set by regulators, which means there's hordes of uninvested excess capital - arguably - going to waste. Cash that could be returned to shareholders.

Overall, we commend the efforts to diversify, but these are far from being the main event. In the meantime, Lloyds looks set to benefit from incremental interest rate hikes - but investors should be prepared for ups and downs (such as higher default rates on loans) given economic uncertainty.

Lloyds key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 27th October 2022