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Lloyds share price rally cools, but has capital easing burnished the bank’s image?

Going into the first quarterly earnings of 2019 on 2 May, a cloud of uncertainty hung over the Lloyds [LLOY] share price. Disappointing Q4 numbers did not bode well for the new year, and peer Royal Bank of Scotland [RBS] had just given a very bearish outlook in its own Q1 results a week earlier.

Lloyds' share price was not the only indicator of shaky performance. Sure enough, industry pressures had taken their toll on earnings. Lloyds reported £4.4bn in revenue, which, while up 2% from the same quarter the previous year, was still some £200m short of forecasts. Meanwhile, net interest income neared 3%. Chief executive Antonio Horta-Osorio blamed the same factors as his RBS counterpart Ross McEwan: competitive market pressures, particularly in mortgages, and hesitancy toward business investment ahead of Brexit. 

1.2%

Lloyds share price dip throughout the day, post earnings

Whereas RBS shares had plummeted 4.3% overnight in the wake of disappointing results, Lloyds’ share price held up remarkably well, limiting the fall to 1.2% throughout the day after earnings, and to 2.8% since. At a P/E (TTM) ratio of just under 11, the stock remains substantially cheaper than RBS’s 18 – and the relaxation of capital requirements have burnished Lloyds’ image, in analysts’ eyes, as a solid and profitable bank.Lloyds 1-year share price performance, CMC Markets, 14 May 2019

 

Fortunately, the news 24 hours ahead of the earnings update that regulators had lowered capital buffer requirements at the bank, potentially freeing up extra cash for payouts, had provided a tailwind for an otherwise mixed report. 

Investors’ and analysts’ sentiment was buoyed by the Prudential Regulation Authority (PRA)’s decision to cut the amount of capital Lloyds’ ‘ring-fenced’ retail bank needs to hold as a “systemic risk buffer”, which in turn now allows the board to target a lower capital ratio at group level, of 12.5%, from the original 13%.

 

Extra buybacks on the way?

CFO George Culmer kept deliberately vague when asked what the bank would do with the surplus capital. “That will be a decision for the board that they will take at the end of the year,” he said. He did, however, rule out a change in ordinary dividends policy.

The common expectation among analysts is that the cash will be directed at another round of share buybacks, continuing the £1.75bn repurchase programme launched in March. Estimates vary on size and timing; Investec’s Ian Gordon wrote in a note that he expects a £1bn buyback to be announced in February 2020, while Gary Greenwood of Shore Capital put total extra capital release at £1.9-2.4bn, and predicted £1.5bn to go toward buybacks in 2020.

 

Market cap£42.66bn
PE ratio (TTM)10.97
EPS (TTM)5.50
Operating margin (TTM)34.50%

Lloyds share price vitals, Yahoo finance, 14 May 2019

 

Beyond the immediate windfall, there’s also the boost to Lloyds’ image in the face of uncertain macro-economic prospects for Britain. “This is the first example we can think of where one of the large quoted UK banks has actually reduced its capital requirement, after a number of years of upward revisions,” wrote Shore’s Greenwood.

Culmer was keen to note as much during the Q1 conference call: “The only route for capital changes have been ever upwards, so it is important unto itself as an amount but also [as] symbolism that says actually if you manage your business you can invert that direction.”

“This is the first example we can think of where one of the large quoted UK banks has actually reduced its capital requirement, after a number of years of upward revisions” - Gary Greenwood, investment analyst at Shore Capital

 

“Not in our lifetime”

Lloyds’ share price was 61.15p as of 10 May, down 8% from the year-to-date high, but still up over 17% since the start of January. Dividends and buybacks keep the stock a “cash-cow” in the words of Hargreaves Lansdown’s Laith Khalaf, despite the “familiar story” of a “solid performance, slightly marred by some one-off items”.

The board has kept full-year targets unchanged, and analysts believe they are not far-fetched, despite macro headwinds and the periodic drag from one-off items. “It’s difficult to see rivals matching its combination of thin markets risk and structured UK exposure,” wrote Ken Odeluga of City Index. Meanwhile, Investec’s Gordon wrote: “We do not believe that any other existing FTSE 100 bank will achieve a 14.6% return on tangible equity in our lifetime”, as Lloyds aims to do this year.

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