Lloyds fearing the worst as default charge soars

On another grim day for Lloyds shareholders, our head of markets checks the bank's results for positives.

The current environment is proving to be a hard slog for Lloyds Banking Group (LSE:LLOY), and the difficulties are unfortunately set to continue.

Since its last update, Lloyds estimates that the economic outlook has deteriorated further, partly because of the immediate impact of the pandemic in its second quarter, but also due to the likelihood of significantly higher defaults on loans in the next few months as various government support schemes subside.

As such, its additional impairment charge takes the half-yearly figure to £3.8 billion, with the bank guiding that the full-year number will total somewhere between £4.5 and £5.5 billion.

The wider challenges are exacerbated given the bank’s perceived status as a barometer of the UK economy. With GDP growth remaining under pressure and the unemployment rate potentially yet to peak, the uncertainty around Brexit negotiations takes on additional significance given an already faltering economy.

Meanwhile, historically low interest rates are set to hold firm for some considerable time to come, putting pressure on the traditionally lucrative Net Interest Margin, as evidenced by a decline from 2.9% to 2.6% in the period.

In addition, the consumer has where possible been paying down loans and reducing spending on credit, both of which are normally steady income lines for the banks, with the result that there has been an increase in retail deposits as any spare cash is put to one side.

These factors have inevitably dented net income, which declined 16% in the reporting period. This in turn has increased Lloyds’ cost/income ratio, where lower costs (down 4%) have been more than offset by the income decline.

The figure has risen from 45.9% in the first half of 2019 currently to stand at 52.3%, although in context the figure remains the best in the sector when compared to its peers.

Other metrics have also suffered, such as the Return on Tangible equity, which has plunged to just 0.1% from 11.5%, and the overall pre-tax loss of £602 million is testament to the parlous environment in which Lloyds is operating.

There may be some glimmers of hope in the release, although they are unfortunately few and far between.

In what seems to be a combined effort by the banks to both encourage economic recovery and consign their chequered reputation to the history books following the Great Financial Crisis, for this economic downturn they are aiming to be part of the solution rather than a large part of the problem.

For Lloyds, around £9 billion has been lent through government-backed lending schemes, alongside an additional 1.1 million payment holidays and 33,000 capital repayment holidays.

In terms of the balance sheet, the capital cushion has risen further to a comfortable 14.6% and an as yet unused PPI provision of £745 million could be released in part or in full after all claims have been settled, providing a boost to the numbers.

The bank’s major presence in the digital space, where a 4% increase in users took the overall number to over 17 million, positions Lloyds well both in terms of the likely future direction of banking, while also enabling further expansion at a lower cost.

In all, the results make for difficult reading.

Even prior to today’s share price decline, a loss of 50% over the last year, as compared to a drop of 20% for the wider FTSE 100, was indicative of the market trying to price in the sheer scale of the challenge which Lloyds faces.

Reasons for optimism on shorter-term prospects, it appears, will need to wait for another day. In the meantime, it remains to be seen whether the market consensus of the shares as a buy, and indeed having recently moved to being the preferred play in the sector, will come under some serious review.