Lloyds Bank Q3 results: big profits but guidance static

With provisions for the motor finance investigation all but buried and with higher income flowing through, Lloyds Banking Group (LSE:LLOY) has enjoyed a bumper third quarter which puts the bank in prime position to meet its full-year targets.

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Some of the clouds which have been overhanging the sector leading up to the Budget, and the domestic banks in particular, have now partially parted. The increase to the bank surcharge was less than feared, manageable and temporary and led to a small relief rally in Lloyds shares yesterday.

Other concerns also remain on the back burner, with the level of defaults and arrears low and stable, although in typically conservative fashion Lloyds has increased impairment provisions for the quarter to £313 million, or £930 million in the year to date.

This of course anticipates potential rather than actual losses, such that releases are possible in the future should the bad debts fail to materialise. The higher figure is based on several scenarios, such as the inflationary impact of the Middle East crisis, lower GDP growth in the UK, a rise in unemployment and limited gains in residential and commercial property prices. Even so, at the moment, there are few if any signs of deterioration across its lending book.

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Both income and the Net Interest Margin (NIM) are much stronger, boosted by both volume growth and the benefit of structural hedge income. The structural hedge contribution, which is designed exactly to mitigate the group’s susceptibility to changes in the interest rate environment, has resulted in £5.2 billion of income so far this year, which is expected to translate to more than £7 billion for the year as a whole, and then over £8 billion in 2027.

Alongside the prudent provisions, higher income and lower operating costs have kept the engine running smoothly. Overall income for the quarter increased by 9% to £5.07 billion, while pre-tax profit spiked by 99% to £2.33 billion given the non-recurrence of the third quarter £800 million motor provision from last year.

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Contributing to these numbers were 10% growth in underlying Net Interest Income (NII) to £3.8 billion, enabling a Return on Tangible Equity (ROTE) of 19.5%, compared to just 7.5% in the corresponding period. The cost/income ratio also markedly improved to 47.2% from 68.4%, while the capital cushion, or CET1 ratio remained stable at 13.3%. NIM improved to 3.25% from 3.06% despite the headwinds of mortgage margin compression and a competitive deposit market.

Guidance on all metrics as announced in the interim results at the end of July has been maintained, including but not limited to NII of £14.9 billion, a cost/income ratio below 50% and a ROTE in excess of 16%, which has resulted in disappointment that the figures have not been raised.

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In any event, this will set the scene for the imminent “Accelerate 2030” programme which is broadly based on three areas of growth, namely the increasing use of intelligent AI, cross group connectivity and increasing productivity, the latter of which is expected to result in an additional £2 billion of cost savings by the end of the plan.

An early sign is that Lloyds expects some £100 million of benefits from GenAI this year alone in UK Retail before the efforts have been ratcheted up. Alongside this, the increasing use of its digital strength, where costs have been reduced such as by the closure of branches where customer activity has changed (the bank currently has more than 22 million mobile app users) aims to reduce the cost/income ratio to below 45%, a sector-beating target.

In addition, and coming slowly up on the rails, are those units which provide alternative sources of income such as insurance, credit cards and the UK private bank (previously called 'Wealth') and incorporating the recent acquisition of Schroders Personal Wealth (now Lloyds Wealth), where the integration is all but complete. The likely concentration of growth in these areas over the coming years will lessen the reliance on the more traditional income streams and in any event will increase the depth and breadth of revenues in due course.

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This update is a reassuring vindication of the current and future strategy and, given that Lloyds is often seen as a barometer for the UK economy, this progress has been hard-won. So far this earnings season, reaction to bank sector updates have tended towards extreme, and the slight income miss and lack of profit upgrades have been leapt upon by investors in early trade, sending the shares markedly lower at the open.

However, this could also be a pause for breath as investors digest the new strategic aims and maybe bank some profits, following a share price which has risen by 18% over the last year, as compared to a gain of 9.6% for the wider FTSE100, and by 80% over the last two years. While such strength may be lifting the valuation into more expensive territory, this performance validates the current market consensus, where the general view of the shares as a buy will no doubt hold firm.