Lloyds Banking Group plc (LLOY) Ordinary 10p
HL comment (29 July 2021)
Lloyds reported net income for the first half of £7.6bn, up 2% year-on-year driven by improved used vehicle prices in the automotive finance business.
A 140% increase in the value of fines and compensation, meant total cost rose 7%. However, a huge £4.5bn swing in provisions for bad loans saw underlying first half profits rise from a £281m loss a year go to a £4.1bn profit.
The bank announced an interim dividend of 0.67p per share, with a progressive dividend policy going forwards.
The Lloyds share price rose 1.5% in early trading.
There is a change in the winds at Lloyds, and across the UK banking sector.
In 2020 the industry saw interest rates plummet, hitting the profitability of lending, while consumers repaid expensive unsecured borrowing and companies pulled down funding lines. In expectation of serious economic pain to come the industry set aside tens of billions to cover bad loans.
18 months on and the picture is very different.
Lloyds' credit card and overdraft lending is starting to creep back up now the economy has unlocked - more lucrative forms of borrowing from the bank's perspective. The housing boom is feeding the mortgage book too. Meanwhile corporate customers are paying back lending facilities as emergency cash balances are eased.
A symptom of those improving economic indicators is that the bank is releasing large chunks of the provisions it set aside to cover bad loans. That is infusing the bank's profits with a vim not seen for years. Such releases may be temporary, but they are likely to continue for the rest of this year - and are providing a lasting boost to capital levels.
Unfortunately one trend that does not look like it will unwind so quickly is the low interest rate environment.
Banks make money by lending money out at higher rates than they pay on deposits - the difference is known as the net interest margin. With interest rates on savings accounts already on the floor (and zero in many cases) they simply can't push the cost of funding much lower - whereas competition and regulatory action means lower interest rates get passed on to borrowers relatively quickly.
As a traditional high street bank without fee-based investment banking income, low interest rates are particularly painful for Lloyds. Net interest margins are expected to be around 2.5% this year, which would be manageable- but not highly profitable and could make revenue growth a challenge. As old mortgages and loans are paid off or renewed they will roll on to lower interest rates, offsetting growth elsewhere in the lending book.
Given that low interest rates look like they're here to stay, it's perhaps no surprise Lloyds is looking for growth outside traditional lending.
The 2021 strategy review includes 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. That should prove more resilient if rates remain lower for longer.
Deeper customer relationships with business owners could support growth in asset management, general insurance and pensions businesses too, another area which isn't closely linked to interest rates. It's early days in both areas, but the £390m acquisition of Embark at the half year shows the group is prepared to spend to support its ambitions.
The other weapon in Lloyds' arsenal when it comes to fighting low interest rates is an impressively low cost: income ratio. In particular, increased digitisation reduces the cost to serve customers and potentially boosting profitability of future revenue growth.
Finally there's the balance sheet to consider. The bank has some £6bn in surplus capital (even after the Embark deal). With regulatory restrictions lightening that may change at the full year. Special dividends and/or buybacks are both possibilities.
Overall, Lloyds has weathered the perfect storm in 2021, and done so in reasonably good shape. The bank's exposure to interest rates means it's likely to be less profitable for some time, but there are at least some efforts underway to diversify away from interest driven exposure.
Lloyds key facts
- Price/Book ratio: 0.67
- 10 year average Price/Book ratio: 0.88
- Prospective dividend yield (next 12 months): 5.1%
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.
Half Year Results
Net interest income fell 1% In the first half, to £5.4bn, despite continued growth in the bank's loan book (driven by mortgage lending). The bank's net interest margin (NIM), the difference between what it charges borrowers and pays for financing, fell to 2.50% from 2.59% a year ago. That reflects lower interest rates across the market, together with a decline in unsecured lending. However, those headwinds seem to be easing, with unsecured lending up and NIM rising to 2.51% in the second quarter.
Other income fell 2% to £2.4bn, with lower levels of insurance new business, a reduced automotive finance fleet size and fewer asset sales.
Impairment releases relating to bad loans resulted in a £656m boost to profits this year, rather than a£3.8bn hit last year. That was partially offset by £425m of fines and compensation - relating mainly to HBOS Reading and the communication of historical insurance renewals. The bank's cost:income ratio in the half rose 2.6 percentage points year-on-year to 54.9%.
The bank reported a CET1 ratio, a key measure of banking capitalisation, of 16.7%, up from 14.6% a year ago and 16.2% at the start of the year. Return on tangible equity (RoTE) for the half came in at 19.2%.
The bank has updated its full year guidance, based on the improved UK macroeconomic outlook. NIM is now expected to come in around 2.5%, operating costs to be below £7.6bn and underlying RoTE to be around 10%.
The author owns shares in Lloyds Banking Group.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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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