Lloyds Banking Group plc (LLOY) Ordinary 10p

Lloyds reported first-half net income of £8.4bn, down 9% driven by lower net interest income. Banking net interest margin fell from 3.18% to 2.94%, in line with expectations.

Underlying profit of £3.5bn was down 13%, but better than the £3.4bn markets were expecting due to lower impairment charges as the economic outlook improved.

Both loans and deposits grew 1% over the period, driven by new mortgages and retail savings accounts, respectively. The group’s CET1 ratio, a key measure of financial strength, is 14.1% - well ahead of its target minimum of 13.0%.

Full-year guidance is unchanged, with banking net interest margin expected to exceed 2.90%.

The shares were down 1.5% in early trading.

Our view

Lloyds put in a decent second quarter to wrap up a good first half. Investors should look past the headline year-on-year numbers; they don't make for great reading. It's long been expected that performance will lag the record levels seen over 2023. That doesn't mean it's time to turn away.

Lloyds has a focus on traditional lending, so net interest margin (NIM - a measure of profitability in borrowing/lending) is key. There’s been a marginal decline over the first couple of quarters this year, but things look to have stabilised.

Mortgages issued during the pandemic are coming up for renewal at less profitable levels. This will remain a headwind over 2024, but should start to tail off as we move into 2025. It was good to see loan book growth over the second quarter, something that’s expected to continue into the second half. There’s also an ongoing impact from consumers shifting to longer-term savings accounts in search of better rates. But the pace of switching is easing, which is good news for Lloyds.

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 – to the tune of £700mn over 2024.

The flip side of the business model is higher exposure to potential loan defaults. For now, UK borrowers are remaining resilient to pressures, and Lloyds has one of the higher-quality asset portfolios. But this remains a risk to monitor.

Very aware of its reliance on traditional financing, Lloyds has invested heavily in its other income plays (credit card fees, insurance, investment management). This should provide an income tailwind when rates aren’t as supportive, and progress has been good.

The key risk in the short term is the FCA’s investigation into the misselling of motor finance. Lloyds is more exposed than peers and has already set aside £450mn in preparation for potential costs. At this stage, it’s hard to say if that figure is enough, so it’s a risk to be aware of.

Lloyds remains one of our preferred names in the sector, with strong capital levels that support returns to shareholders over the next few years. That said, there has been a positive change in sentiment since the start of the year and the valuation isn’t as attractive as it once was. The overhang from the FCA investigation could also act as a brake on any further rerating.

Environmental, social and governance (ESG) risk

The financials sector is medium-risk in terms of ESG. Product governance is the largest risk for most companies, especially those in the US and Europe with enhanced regulatory scrutiny. Data privacy and security is also an increasingly important risk for banks and diversified financial firms. Business ethics, ESG integration and labour relations are also worth monitoring.

According to Sustainalytics, Lloyds’ management of material ESG issues is strong.

The FCA’s investigation into historical auto-lending practices between 2007 and 2021 is a risk for Lloyds. Provisions have been taken but the scale of the potential impact is still largely unknown, more details should come later in the year. There’s room for improvement in product governance and responsible marketing, though it demonstrates strong progress in integrating ESG factors into asset management and corporate financing.

ESG data sourced from Sustainalytics.

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.

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