Lloyds Bank Q3 results offer large element of comfort

Lloyds Banking Group (LSE:LLOY) has kicked off the quarterly reporting season in unspectacular fashion, although there are signs of improving momentum as the year progresses.

Most of the key metrics echo a similar theme – improving third-quarter numbers compared to the previous, but with the cumulative performance in the nine months so far significantly shy of the corresponding period last year. This will not come as a major shock to investors given the strength of last year’s results, and there are some mitigating circumstances which account for most of the shortfall.

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Statutory pre-tax profit of £5.15 billion represents a 10% decline from the corresponding period in the year to date, with the third-quarter number slipping just 2% to £1.8 billion. Underlying Net Interest Income (NII) fell by 8% to £9.6 billion and by 6% to £3.2 billion in the latest quarter, although this figure was a 2% improvement from the second quarter. Net income in the third quarter decreased by 4% to £4.35 billion, while operating costs have risen by 5% to £7 billion, mainly driven by ongoing strategic investment and inflationary pressure.

As a result, the cost/income ratio currently stands at 55.9%, although there was an improvement to 53.4% in the last three months. This is one of the areas where investors have been taking a longer-term view. The push towards an increasingly digital business will undoubtedly reap rewards in the coming years, but the associated costs such as branch closures and severance packages are currently resulting in something of a slog until the ultimate aim can be achieved.

In the meantime, the group is targeting a cost/income ratio of below 50% in the next two years, with this strand of the business growing apace, previously having reported more than 19 million active users of its mobile apps for example.

The lower NII and higher operating cost figures have largely led to the drop in profit, although some of this has been offset by a lower impairment charge. Lloyds continues to take a conservative view of potential customer defaults – despite there being no discernible trend of increasing bad loans at present – and set aside a further £172 million in the quarter. This brings the figure in the year to date to £273 million, significantly lower than the £849 million this time last year.

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More positively, the momentum seen at the half-year results has continued with regard to the crucial metric of Net Interest Margin (NIM). The figure has held steady at 2.94%, with the bank still guiding for a figure in excess of 2.9% for the year as a whole and indeed NIM rose to 2.95% in the third quarter, compared to 2.93% in the second. At the same time, the so-called structural hedge, which lessens the group’s susceptibility to changes in interest rates, should also provide further income to offset pressures elsewhere.

Although the mortgage lending business, which is a significant contributor to the group, is presently under pressure as customers begin to refinance in a lower margin environment, this is already being partly offset by a rise in structural hedge earnings. In the background, it is worthy of consideration that the previous £450 million set aside for potential motor finance mis-selling will remain a concern until the full results (and monetary value) of the investigation become clear, with an update expected from the Financial Conduct Authority in May next year.

The other key metrics reveal that the group remains in good shape, with a capital cushion, or CET1 ratio of 14% (and 15.2% in the latest quarter) comfortably in excess of the group’s 13% target. Indeed, the group intends to pay down the ratio to around 13.5% by the end of the year, which could augur well for further shareholder distributions, such as a new buyback programme as well as an improvement to the dividend, where the yield is currently an attractive 4.7%.

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Overall, these results do not shoot the lights out, but they do provide a large element of comfort that Lloyds continues on its positive direction of travel towards a more streamlined and digital business, underpinned by a healthy financial position. Moves into other income streams such as credit cards and insurance could well bolster its major mortgage revenue, and the group’s confirmation of its year-end targets is proof that the bank remains on track.

The shares have reacted reasonably warmly to the results, adding to the gain of 50% seen over the last year, which compares to a hike of 12.6% for the wider FTSE100. As a longer-term play bolstered in the meantime by the potential for generous shareholder returns, the market consensus of the shares as a buy is likely to remain intact.