Earnings

Lloyds’ share price: what Q1 earnings reveal about UK economic outlook

Lloyds’ share price has tumbled this year. But while the bank’s Q1 earnings saw a severe drop in profits, they also offered clues on the future of the UK economy.

Lloyds’ [LLOY] share price has plummeted as the coronavirus takes its toll on the UK economy. A severe drop in consumer demand, businesses folding and jobs being lost are just some of the challenges facing the country.

As the UK’s biggest lender, Lloyds felt the effects sharply in its first-quarter results. Profits missed expectations, revenue was down and more than a billion was earmarked to cover loan losses, dismal reading for Lloyds share price investors.

Yet, among the stark numbers were the bank’s own forecasts for the UK economy post-coronavirus. And with Lloyds being the most UK-focussed of the big banks, their forecasts are a must-read for anyone interested in the country’s economic future.

 

 

 

What's happening with Lloyds’ share price?

Lloyds’ share price is down over 50% since the start of the year. The stock briefly rallied last week as promising test data for a coronavirus treatment was released. However, the share price gains were short-lived as Q1 results saw a bigger-than-expected drop in profits.

 

What happened in Lloyds’ Q1 results?

Pre-tax profits came in at £74 million, down a huge 95% from the £1.6 billion in the same quarter last year. Analysts had been expecting £863 million. The severity of the decline can be put down to Lloyds putting aside £1.4 billion to deal with expected bad loans as a result of the coronavirus.

£74million

Lloyds' pre-tax profits - a 95% drop from same quarter last year

  

Net revenue came in at £3.95 billion, down 11% from last year and again missing expectations. Net interest income slipped by 4% to £2.95 billion, while the net interest margin rate dropped to 2.79% from 2.91%. The cut in revenue Lloyds makes on interest can be put down to the Bank of England slashing its own interest rates.

CET1 ratio - a key indicator for just how robust the bank’s balance sheet is - actually improved, coming in at 14.2%, up from 13.8%. This is largely the result of Lloyds scrapping its dividend payouts.

It's clearly a challenging time ahead. Something that António Horta-Osório, Group Chief Executive acknowledges:

“The economic outlook is clearly challenging with the longer-term outcome dependent on the severity and length of the pandemic and the mitigating impact of Government and other measures in the UK and across the world."

“The economic outlook is clearly challenging with the longer-term outcome dependent on the severity and length of the pandemic and the mitigating impact of Government and other measures in the UK and across the world” - António Horta-Osório, Group Chief Executive

 

How exposed is Lloyds to loan losses?

According to Reuters, Lloyds has a relationship with almost a quarter of small business borrowers. While the government is underwriting new loans, it's not guaranteeing old ones. That means Lloyds is vulnerable to any spike in bad loans.

Lloyds own best-case scenario would see £4.9 billion in credit losses. The bank gives this a 30% chance of happening. Its most severe scenario would see £7 billion in credit losses. Lloyds gives this a 10% chance of happening.

 

Lloyds’ expected credit loss forecasts

ScenarioExpected Credit Loss (£m)Profitability
Base£4,92930%
Upside£4,58130%
Downside£5,48330%
Severe£7,00410%

Source: Lloyds Q1 interim management statement presentation to analysts

 

As Lloyds makes up the bulk of its business from lending, repayment holidays and slashed interest rates are likely to hurt revenue in the next quarter - if not beyond. Lloyds best case scenario sees the Bank of England’s interest rate climbing to 1.08% by 2022. Worryingly, the worst-case scenario is a big fat 0 until 2022.

 

Lloyds’ interest rate forecasts

 202020212022
Base0.10%0.25%0.25%
Upside0.26%1.03%1.08%
Downside0.00%0.03%0.06%
Severe0.00%0.00%0.00%

Source: Lloyds Q1 interim management statement presentation to analysts

 

What is Lloyds’ outlook for the UK economy?

So where does Lloyds think the UK economy will go next? Lloyds’ most optimistic scenario sees GDP shrinking 5% in 2020, before bouncing back to 3.8% in 2020 and 3.7% in 2022. The worst-case sees a recession until 2021, with an expansion not happening until 2022.

 

Lloyds forecasts for UK GDP

Scenario202020212022
Base-5%3.0%3.5%
Upside-5%3.8%3.7%
Downside-6.5%1.8%3.6%
Severe-7.8%-0.1%3.1%

Source: Lloyds Q1 interim management statement presentation to analysts

 

Any prolonged recessions will have an inevitable impact on  businesses, and therefore jobs. Lloyds reckons a 5.9% unemployment rate for 2020 is the best the country can hope for, reducing to 4.3% in 2022. In 2019 it was 3.8%.

According to Lloyds' own estimates, its customers' total debit and credit card spend dived at the end of the quarter. Unsurprisingly, spending on food and drink spiked in February but has since returned to normal levels. While spending on holidays took a substantial hit, plummeting almost 80%. Clearly there’s a long way to go before the British public, or at least Lloyds customers, are spending at the rate they did just a few months ago.

 

Time to 'buy' Lloyds?

Lloyds carries an average share price target of 75.37p. Hitting this would represent an 143% upside on the current share price. Back in March, HSBC upgraded their rating from Hold to Buy. Of the 24 analysts tracking the stock on Yahoo Finance, 16 rate it a Strong Buy or a Buy.

Given how much it has fallen, Lloyds’ share price might represent a bargain. Yet that will depend on how fast the UK economy recovers. Right now, and as Lloyds’ own forecasts show, that’s still a big unknown.

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