Lloyds Bank makes more than expected despite Q3 profit drop

This has turned out to be something of a quarter to forget for Lloyds Banking Group (LSE:LLOY), with the additional motor finance redress provision playing havoc with many of its key metrics. Of course, the motor provision is not life-threatening and without that distraction the underlying progress remains strong.

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For the year to date, the impact is evened out somewhat, but even so the additional £800 million provision, taking the current total to £1.95 billion, is a thorn in the side. A potentially deteriorating economic backdrop and lower house price forecasts have increased impairments elsewhere also, although to a minor extent in comparison to the motor finance hit. For the most part, the UK consumer is alive and well, with defaults stable and the previous small number of individual cases moving into default territory within Commercial Banking appearing to have stabilised.

The key metrics are unsurprisingly a mixed bag this quarter. The motor provision reduced the Return on Tangible Equity (ROTE) to 7.5% for the three months ended 30 September, or 11.9% so far this year, without which the cumulative number would have been a more palatable 14.6% and increased the cost/income ratio to 68.4% for the quarter compared to 53.4% in the corresponding period last year. Meanwhile, the capital cushion, or CET1 ratio remains at a robust 13.8%, and the outlook is upbeat with expectations for £13.6 billion in Net Interest Income (NII) and around 12% for ROTE.

There was some positive news in terms of the group’s more traditional business, with growth in both loans and deposits. Loans increased by 4%, or £18 billion to £477 billion over the first nine months, with UK mortgages a highlight. Meanwhile, the customer deposit exodus which had been in place with higher rates being sought elsewhere seems to have steadied for the time being, with an increase of 3%, or £14 billion in deposits to £497 billion, driven largely by Commercial Banking.

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Although pre-tax profit of £1.17 billion for the quarter represented a 36% decline from last year, the number was ahead of the expected £1.04 billion and is mitigated by a more manageable 9% decline in the year to date to £4.68 billion. Net income, which is obviously unaffected by the provision, grew by 7% in the quarter to £4.64 billion and was 6% higher in the year so far at £13.56 billion. NII of £3.45 billion represented an increase of 7% (6% in the year to date to £10.1 billion), underpinned by growth in the Net Interest Margin to 3.06%.

Despite some pressure on mortgage margins, the NIM saw the benefit of a growing structural hedge contribution, which is designed exactly to mitigate the group’s susceptibility to changes in a falling interest rate environment, and which should provide a further revenue boost this year.

Given the backdrop of this particular quarter, it may have been a step too far to have expected any progress in terms of shareholder returns. Nonetheless, a dividend yield of 3.9% remains attractive, and increases for this as well as the buyback programme should still be on the table for future updates.

Overall, Lloyds is pursuing its refocused strategy, especially on the digital front where at the last count the total number of banking app users of 20.9 million provides a springboard for further capital light growth. The group is also prioritising higher value areas, such as what it describes as the Mass Affluent segment, deepening customer relationships and separately expecting in excess of £1.5 billion of annualised additional revenues from strategic initiatives from next year. The recent acquisition of Schroders Personal Wealth, previously run as a joint venture, is a statement of intent.

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Aside from the overhang of the motor finance redress provision, and while there is little doubt that Lloyds runs a tight ship, there is a concern of potentially choppier waters ahead. Often seen as a barometer for the UK economy, a worsening of the backdrop could further squeeze an already pressed consumer and would leave Lloyds as one of the first domestic banks to feel the heat.

That being said, the threat is manageable and being monitored closely which provides comfort for the group and investors alike. The sector has been rerated and the strongest players recognised. For Lloyds, an increase in the share price of 36% over the last year compares to a hike of 15% for the wider FTSE100 and has taken the increase to 103% over the last two years. The attractions remain clear and the market consensus of the shares as a buy is a reflection that the group is still on track, with solid growth prospects.