Lloyds Banking Group plc (LLOY) Ordinary 10p
HL comment (31 July 2019)
Second quarter underlying profit fell 9.1% year-on-year to £2bn, as a small decline in net income and higher impairments more than offset progress in reducing costs. That reflects softening business confidence, although the consumer environment is said to remain healthy.
At a reported level, the bank also suffered from an additional £550m PPI charge in the quarter as information requests increased ahead of the August deadline.
The interim dividend rose 5% to 1.12p per share.
Lloyds shares opened down 2.7%.
Antonio Horta-Osorio has built Lloyds into a retail banking powerhouse, capable of generating attractive returns for shareholders. However, those returns are dependent on the health of the UK economy, and since the 2016 EU referendum that's made investors nervous.
So far those nerves have been based more on fears than facts. Underlying profits have been ticking along nicely, driven by effective cost control, increased loans to customers and greater exposure to risker, but higher retuning, loans like auto-finance and credit cards. The bank is well capitalised and while PPI has been thorn in the side, the deadline for claims is fast approaching so we're reaching the end of that sorry saga.
The combination of nervous investors and strong operating performance has resulted in a bank trading on a 0.8 times book value, 20% below the five year average, and offering a prospective yield of 6.4%. That's despite a £1.75bn share buyback.
There are some signs the economy may be creaking in the most recent set of numbers however. Business customers are looking less confident, and the residual values of the cars the group finances have declined. Neither is a flashing red light, but they shouldn't be ignored either.
While there's no getting away from the fact that an economic downturn would be very painful for Lloyds, the bank has been taking steps to increase resilience.
Lloyds is already the UK's biggest digital bank, as well as operating the largest branch network. Further digitalisation aims to improve customer service and reduce costs, building on an already market leading cost:income ratio and supporting profit growth even if income stalls.
The group's making a land grab into Financial Planning and Retirement too. Horta-Osorio is aiming for £50bn+ of new assets by 2020 and has already added 1m new pension customers since 2018. The Scottish Widows business means the bank already has a foot in the door and early signs are good, with £12bn of inflows in the first half. A partnership with Schroders should provide extra impetus.
The plan is expected to cost around £3bn. But if Lloyds can pull it off, the rewards could be substantial. Investors could be on the receiving end of a sustainable and growing dividend, with potential for further returns of surplus capital through share buybacks from time to time. Unfortunately that depends on the state of the UK economy, and that's outside the bank's control.
Second Quarter Results
Net interest income fell 3.5% to £3.1bn, reflecting small declines in both loans to customers and net interest margin (the difference between what the bank charges on loans and pays on deposits).
Other income fell 6.9% to £1.6bn, with strong performance from Wealth and Insurance offset by lower automotive finance volumes, and lower commercial banking income amidst challenging market conditions. Operating lease depreciation increased 3.7% to -£254m.
A continued focus on improved efficiency saw operating costs fall 3.3% to £1.9bn, with remediation costs falling 37.6% to £123m. The group reported a cost:income ratio of 47.1% in the quarter (down from 47.7% a year earlier).
Impairments for bad loans rose by 53.5% in the quarter to £304m.
Pre-dividend payment, the group reported a CET1 ratio at the end of the half of 14.6%. That reflects capital generation of 0.7 percentage points during the half, held back by higher than expected PPI charges and accounting changes.
Lloyds expects to deliver a net interest margin of around 2.9% for the year as a whole, having achieved exactly 2.9% in the first half, with the cost-income ratio expected to fall. Impairments are expected to rise but remain below 0.3% of the total portfolio. Capital build is now expected to be at the lower end of 1.7-2 percentage point range due to increased PPI charges.
The author of this article holds shares in Lloyds Banking Group.
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