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Lloyds - net interest margin guidance remains intact

Lloyds reported a 1% rise in net income over the third quarter to £4.5bn.

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Lloyds reported a 1% rise in net income over the third quarter to £4.5bn. There was a small uptick in net interest income and a larger gain from the smaller other income line (fees).

Net interest margin (NIM, a measure of profitability in borrowing/lending) fell quarter-on-quarter, to 3.08%, lower than markets were expecting. But management remains confident enough to reiterate full-year guidance, of NIM over more than 3.1%.

Deposits increased £500m quarter-on-quarter, as a dip in retail current accounts was more than offset by an increase in longer-term retail savings.

Arrears were broadly stable, remaining at or below pre-pandemic levels, and an impairment charge of £187m was taken over the quarter in expectations for future defaults. Underlying profit rose 22% to £2.0bn.

At 30 June, the CET1 ratio, a key measure of financial resilience, was 14.6%.

The shares fell 1.7% in early trading.

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Our view

Lloyds continues to benefit from the high-rate environment. A focus on traditional banking makes it more exposed to the interest rate cycle than others, 73% of total income is interest related.

Third quarter results were solid in our eyes. Net interest income was sightly lower than expected but softness is to be expected. We were pleasantly surprised to see positive movement in deposit levels, new mortgage business and capital generation.

Net interest margin (a measure of profitability in borrowing/lending) looks to have peaked, and was a little weaker than expected over the quarter. But importantly, management kept full-year guidance in tact.

There are headwinds, and from a few angles too - but we expect some to ease over the medium term.

Mortgages issued over the pandemic are coming up for renewal at less profitable levels. This will be a headwind into 2024, but should start to tail off toward the end of the year. There's also increased pressure on banks to offer more in the way of interest on deposits, and depositors are shifting from higher-margin current accounts to less profitable longer-term savings accounts that offer better rates.

Lloyds has done well over the recent quarter to attract business into its savings products, offsetting a dip in current account balances. But whether that's a trend that can continue, and where balances settle remains to be seen.

The structural hedge has the potential to be a key driver of income over the medium term. This can be thought of as a bond portfolio, and as the bank rolls from low yielding contracts written over the past few years onto higher yielding ones, income is expected to get a significant boost.

The flip side of the business model is higher exposure to potential loan defaults. Lloyds has set aside an additional £0.8bn in preparation for defaults so far this year. That's a big figure, but lower than 2022 and with resilient arrears levels and an improved economic outlook the charge taken over the recent quarter was lower than expected.

Very aware of its reliance on traditional financing, there are plans to build out the bank's non-interest income. Building out areas like asset management, general insurance and pensions businesses are on the cards. Investment is expected to peak in 2023 and benefits are slowly coming through - sustained growth over 2024 is the next hurdle.

Finally, there's the balance sheet to consider. Capital levels are strong, backing up the dividend and paving the way for a decent return of excess capital at the full year. As ever, no returns are guaranteed.

With a longer term investment horizon, and valuations that sit at severely discounted levels, Lloyds is one of our preferred plays in the sector. But we'd warn the near term is uncertain, so prepare for some ups and downs along the way.

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
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 25th October 2023