Lloyds buys itself breathing space, but next few months are crucial

Mortgage lending is healthy, and the bank’s quick actions during the pandemic have paid off.

Lloyds (LSE:LLOY) has earned some breathing space by comfortably beating forecasts for the quarter on most fronts.

It is clear to see why the bank is often described as a barometer of the UK economy.

Performance for the first six months of the year was ravaged by the effects of the pandemic. The third quarter saw something of a return to form as restrictions were eased and some signs of a tentative recovery emerged. 

However, with lockdowns being reintroduced in an effort to prevent a real second wave, and with UK/EU Brexit negotiations reaching a conclusion, the outlook for the final quarter is highly uncertain. 

This in turn largely feeds into Lloyds’ prospects, which could see the third quarter as being an exception for the year as a whole.

Against this parlous backdrop the bank has battened down the hatches wherever possible.

Its balance sheet remains robust, with the capital cushion increasing to 15.2% from a previous 14.6% and access to liquidity is plentiful if required, with a coverage ratio of 138%.

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Meanwhile, the third quarter recovery was further underlined by an additional provision of £301 million, far lower than the £720 million expected, and taking the figure for the year to £4.1 billion. 

The impairment charge is also significantly lower than those booked in the first and second quarters of £1.4 billion and £2.4 billion respectively, with the projection for the year now expected to be at the lower end of the previously guided £4.5 to £5.5 billion.

Meanwhile, it has seen a spike of £3.5 billion in mortgage lending, which is significant given the fact that mortgages account for some 60% of its loan book and, by their nature, are seen as lower risk loans. 

This represents an additional boost given that customers generally have been saving rather than borrowing or spending, as evidenced by an increase of £35 billion to group deposits.

The bank’s focus on maintaining its leading digital position also continues apace, with selective investment continuing to increase its market share. The bank now has 17 million active users, which will be of increasing benefit to its cost line as this growth continues.

Alongside this growth, Lloyds is also part of a banking sector vying to be seen as part of the solution to this crisis, as opposed to being a large part of cause of the great financial crash of over a decade ago. 

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The group has allowed 1.2 million payment holidays, with £11 billion of lending through government schemes and stands ready to consider further measures if necessary.

The slight economic tailwind and Lloyds’ own measures have led to a pre-tax profit for the quarter of £1 billion, which compares to £50 million a year ago and far exceeds expectations of around £590 million. This was achieved despite a 19% decline in net income year on year, as historically low interest rates have taken a bite out of earnings.

Net interest margin remains under pressure, coming in at 2.5% for the quarter, while the cost/income ratio has suffered further, rising to 56.9% from a previous 52.3% and from 47.6% a year ago.

Despite its best efforts, there are any number of factors outside the bank’s control which continue to thwart its overall performance. As with many of its peers, share prices have seen a painful decline this year, which for Lloyds equates to a plunge of 56%. The performance over the last year is equally difficult reading, with a drop of 53% comparing to a loss of 23% for the wider FTSE 100 index.

It may well be that on valuation grounds alone, and with much of the bad news already in the price, the market consensus of the shares as a strong ‘buy’ has held firm. Even so, the next few months will doubtless provide another test of the bank’s mettle.

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