How will COVID-19 contingencies affect Lloyds' share price?

Lloyds Banking Group [LLOY] is setting aside huge sums of cash as its lending profits are squeezed by Brexit and COVID-19. How will this affect its share price going forward?

Lloyds’ first-quarter update, reported at the end of April, revealed a huge crash in profits, causing its share price to wobble. The effect of the coronavirus on the UK economy has been seismic, but consumer banks’ ability to weather the storm is only now becoming apparent. 

Since this time last year, Lloyds’ share price has dropped more than 50%. It has also fallen 46% lower since 20 February, when coronavirus-induced market sell-offs were at their peak, while its net interest margin (NIM – the amount of profit the bank makes on money it has lent) has narrowed. 

Lloyds isn’t the only UK bank to have seen its share price wrecked by pandemic induced havoc recently though, and despite some ongoing threats, Lloyds shares have shown some resilience, and may continue to do so.

Profit problems

Lloyds’ ability to turn a profit are a crucial reason for dampened share price valuations. Earnings for the last quarter showed a 95% year-on-year fall in pre-tax profits, from £1.6bn in Q1 2019 to £74m. Lloyds also took a large impairment charge of £1.43bn as it anticipates credit losses from bad loans will increase as the British economy struggles. This is five times the provision made in the first quarter of 2019, causing a far more severe drop in profits than many analysts tracking Lloyds, and its ailing share price, had expected. 

This provision does, however, tally with rival banks. Barclays [BARC] also logged a £2.1bn charge to cover losses, while HSBC [HSBC] has taken a £2.4bn charge to cover potential defaults.

Banks have been subjected this quarter to recent changes in accounting rules, which now require them to book expected losses further in advance. In the first quarter, increases have included Santander [SAN] upping its loan-loss provision by 80%, and a more than 1,000% increase at Standard Chartered [STAN].

Results-wise for Q1, Lloyds has fared relatively worse than Barclays, which reported a 38% drop in pre-tax profits to £913m. HSBC’s pre-tax profit also tumbled 48% to $3.23bn, below the average analyst forecast of £3bn.

Lloyds’ £4bn net income represented an 11% year-on-year decline, and its NIM of 2.79% was a reduction on the 2.91% it reported a year ago.

Like other lenders, the bank has scrapped its proposed 2019 dividend payout, saying its board will decide on any future distributions at the end of 2020.

The importance of recovery

Lloyds’ NIM has held up reasonably well considering recent circumstances and the wide-ranging stock market rout, putting it in a good position for when economic recovery does come. Its cost to income ratio remains sector-beating, at nearly 50%, showing its ability to keep a handle on costs despite ebbing income. 

The banking bellwether said its CET1 ratio of 14.2%, which measures its liquidity, “remains strong”.

Lloyds expects that the UK economy could shrink by 5% in 2020, before recouping some of those losses in 2021, where 3% growth is predicted. This reduction is anticipated to go hand-in-hand with a crash in housing prices and a rise in unemployment. It has also said that it expects the UK economy to recover to its pre-crisis size by 2022, though house prices would still be lower. 

Therefore, the bank expects credit losses will rise by another £1.8bn, £1bn of which would relate to mortgages. 

“Despite the outlook remaining challenging and uncertain, we are well placed to play our part and help Britain recover from this crisis,” Lloyds CEO Antonio Horta-Osorio said at the time of the Q1 report.

Analysts at Citi think Lloyds’ estimated credit losses “look optimistic”, particularly as the bank has not provided much indication on how it expects to perform for the rest of the year.  

Weathering the storm

Indeed, there are ongoing factors that present a threat to Lloyds. It is uncertain how the UK economy will recover after lockdown orders are lifted while Brexit negotiations, which dogged Lloyds last year, and are likely to be fraught in the wake of COVID-19. 

Despite recent turbulence, analysts at Barclays kept their 50p share price target for Lloyds unchanged, while cutting targets on HSBC to 410p from 420p. Barclays has kept both banks on 'underweight' ratings. 

Lloyds share price vitals, Yahoo Finance, 12 May 2020

Analysts at Hargreaves Lansdown believe that despite there being no prospect of a dividend in sight for Lloyds’ share price investors in the immediate future, the bank has proven its ability to weather a crisis such as this, providing some longer-term comfort. In spite of its lacklustre profit figures, the market consensus regarding Lloyds’ share price remains positive for the near future. 

Lloyds’ net interest margins are being squeezed from all directions — hopefully, it has banked enough capital to absorb any further economic shocks.