Lloyds Banking Group plc (LLOY) Ordinary 10p
HL comment (24 February 2021)
Lloyds reported full year net income of £14.4bn, down 16% year-on-year as payment holidays, low interest rates and a shift from higher interest rate unsecured lending all impacted performance.
Together with a big step up in provisions for bad loans meant that profit before tax fell 72% to £1.2bn.
The bank declared a final dividend 0.57p per share, the maximum allowed under current regulatory guidance. The group intends to resume a progressive dividend policy in 2021.
Lloyds shares rose 2.6% in early trading.
Lloyds is a 'bread and butter' bank. It takes deposits and lends the money out to borrowers. It's overwhelmingly UK centric and most of its business is typical high street banking - mortgages, credit cards and smaller companies.
Unfortunately it's this core banking activity that's been hardest hit by the current crisis.
A relatively pessimistic outlook on the UK's economic recovery meant a massive increase in bad loan provisions. Meanwhile a shift in the loan book from higher value unsecured lending to government-backed coronavirus funding schemes and mortgages has dented loan profitability - although reduced overall risk levels too.
However, the real challenge lies in the interest rate environment. Banks make money by lending money out at higher rates than they pay on deposits. With interest rates on bank 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.
Having said that, loan rates don't have much further to fall and Lloyds' deposits have actually grown despite the interest rate cuts. If a net interest margin of around 2.40% is sustainable, that should be manageable for Lloyds - even if it's not highly profitable.
Given that low interest rates look like they're here to stay, and could even turn negative, it's perhaps no surprise Lloyds is looking elsewhere for growth.
The 2021 startegy 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, based income - which would prove more resilient if rates remain lower for longer. Meanwhile deeper customer relationships could support growth in asset management, general insurance and pensions, another area which isn't closely linked to interest rates. It's early days in both areas, but we're watching the Schroders Personal Wealth partnership with particular attention.
Operating costs are also in the spotlight, having fallen again despite one-off coronavirus-related spend. A market leading cost: income ratio could be key in the months ahead, with increased digitisation reducing the cost to serve customers and potentially boosting profitability of future revenue growth.
Like most of the UK banking sectors Lloyds' balance sheet also looks in pretty good shape, despite the significant writedowns in loan value. The cancellation of 2019's final dividend, following pressure from regulators, played a large part in that. However, shareholder returns are now back on the menu - albeit modest for the moment.
The bank hit the new regulatory cap for the full year dividend, but we doubt it would have wanted to push much higher in any case. Investment in digitisation and expansion into new markets will make extra demands on the group's capital and we suspect management will use the crisis as an opportunity to permanently shrink the dividend.
Overall Lloyds has weathered the perfect storm in 2021, and done so in reasonably good shape. The bank's exposure to interest rates mean it is likely to be less profitable for some time, but there are at least some efforts underway to diversify away from interest driven exposure. In the meantime a low cost base and healthy looking balance sheet should give Lloyds what it needs to ride out the economic weather.
Lloyds key facts
- Price/Book ratio: 0.58
- 10 year average Price/Book ratio: 0.89
- Prospective dividend yield (next 12 months): 4.4%
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.
Full Year Results
Net interest income fell 13% in the year to £10.8bn. Loans and advances were unchanged year-on-year at £440bn, while the bank's net interest margin fell from 2.88% to 2.52%.That reflects the effect of lower interest rates, loan holidays provided to support customers though the coronavirus crisis and the switch in lending from unsecured to mortgage loans.
Other income fell 21% to £4.5bn. That reflects reduced customer activity across both retail and commercial banking - impacting fee growth.
Lloyds reported an impairment related to bad loans of £4.2bn during the year, up 229% year-on-year, the vast majority of which was recognised in the first half.
Operating costs fell 4% year-on-year to £7.6bn, reflecting the benefits of ongoing digitisation. However, lower income meant the bank's cost:income ratio increased to 55.3%.
Lloyds finished the year with a CET1 ratio of 16.2%, up from 13.8% a year ago. The key measure of banking capitalisation benefitted from the non-payment of dividends last year, as well as lower risk weighted assets and changes to certain accounting rules.
The bank reported a return on tangible equity of 2.3% during the year, down from 6.6% a year ago.
The bank's guidance for 2021 includes; a net interest margin greater than 2.40%, operating costs of around £7.5bn, bad loans to more than halve and a return on tangible equity of 5-7%.
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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