Lloyds [LLOY] share price fell as much as 5.6% in Friday’s morning trading as half-year results saw unexpected PPI claims and impairment charges weigh on the stock. The bank, which is seen as a bellwether for the UK economy, had been cutting costs to protect itself from the uncertainty in the wider economy. But the results showed that fault lines are starting to appear.
1. PPI drags on profits
In the run-up to the results, our analysis showed how the lingering PPI saga might hurt Lloyds earnings. Lloyds put aside an extra £550 million for PPI claims. The additional cash dragged on Lloyds pre-tax profits, which came in at £2.9 billion, a 9.1% year-on-year drop, and well below the expected £3.95 billion.
In total £20 billion was paid out in the first half of this year, with Lloyds receiving 200,000 information requests from potential PPI claimants each week. The PPI deadline can’t come soon enough for Lloyds.
Amount set aside for PPI claims
2. Brexit comes into focus
Newly installed Prime Minister Boris Johnson's combative approach to EU withdrawal negotiations has certainly raised the chances of a no-deal Brexit. Sterling has tumbled and lenders are bracing for the impact of a disorderly exit from the world's biggest trading bloc.
So far Lloyds has proved resilient to the ongoing spectre of Brexit. Although the facade has started to slip as net interest margin, one of the most important measures of a bank’s profitability, showed a continued decline. Net interest margin came in at 2.89% in Q2 and 2.91% in Q1. In the previous quarter, it had been 2.92% and the one before that 2.93%. The deterioration makes it a must-watch number in future earnings updates.
3. Cost-cutting continues
Cost-cutting continued with a 5% decline in total costs, which came in at £4 billion. This gives Lloyds a cost: income ratio of 45.9%, down from 49.3% a year earlier. Operating costs are on target to be below £8 billion for the full year. This cost-cutting is part of a deliberate strategy to make the bank as efficient as possible, while protecting profits. It will also please shareholders who saw the dividend hiked to 1.12p, despite a 7.1% dip in profits and a 3% decline in income.
4. Loan business is under pressure
Cost control, increased loans and exposure to higher-returning lending products have kept the money coming in at Lloyds no matter what. Yet this all came under pressure with a 21% increase in loan impairments in the first half of the year, up to £556 million.
Most of the damage was done by unsecured lending in the retail division, which includes credit cards and car insurance. With consumer credit growth slowing and rising bad loans, there is a danger that this will continue to hinder Lloyds’s profit-making ability.
Amount for loan impairments in first half of the year - a 21% increase
5. Uncertain outlook for H2
With all the charges and costs incurred, Lloyds expects full-year capital to come in at the lower end of guidance. The bank also cut its full-year forecast for return on tangible equity to around 12%, from a previous estimate of 14% to 15%.
Commenting on the results, Chief executive António Horta-Osório said: “Longer-term targets remain unchanged although continued economic uncertainty could impact outlook.”
“Longer-term targets remain unchanged although continued economic uncertainty could impact outlook” - Lloyds Chief executive António Horta-Osório
The phrase ‘economic uncertainty’ might be overused, but it’s truer now than it has ever been. On Thursday, the Bank of England forecast 1.3% growth in the UK economy if the country leaves the EU with a deal. This was down from its earlier 1.5% projection. The central bank did not say what would happen in the event of a no-deal.
Any further slowdown has the potential to deliver a sharp shock to Lloyds’s operations across the board, with the bank’s lending operations a prime target.
|PE ratio (TTM)||9.50|
|Quarterly Revenue Growth (YoY)||-12.60%|
Lloyds share price vitals, Yahoo Finance, 5 July 2019
Time to buy?
Following the results, Lloyds shares opened 2.7% lower and have yet to claw back the losses. Since a high of 66.70p in mid-April, the share price has been on a downward trajectory, shedding 23% in that time.
Despite the falls, analysts have pinned an average price target of 75.37p on Lloyds. If hit, this would represent a hefty 47% upside on the current share price. Yet, with the results sending the share price south, analysts might now be asking if they’ve really got Lloyds’s number.
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