Lloyds Banking's first-quarter profits sink but beat forecasts

First-quarter results from Lloyds Banking Group revealed a 6% fall in underlying profit to £2.05bn due to the sale of TSB, but this was largely better than forecast as a reduction in impairment charges, PPI provisions and lower costs counterbalanced a small decline in income.

A statutory profit before tax of £0.65bn for the three months to 31 March, down 46% on the same period last year, reflected the expected £0.79bn charge relating to the redemption of enhanced capital notes (ECNs).

Total income fell 1% to £4.38bn after a 3% increase in net interest income was blotted by a 7% decline in other income stemming from lower insurance income and continued pressure on fees and commissions that Lloyds said was a resilient performance in current market conditions. Management have guided to a similar run rate for the rest of the year, which is slightly weaker than analyst forecasts.

Lloyds left its full year guidance for 2.70% net interest margin unchanged after a further improvement in net interest margin to 2.74% in the period, which led to the increase in net interest income.

The improved margin more than offset the impact of a 2% reduction in average interest-earning banking assets, which was largely due to lower run-off assets.

The FTSE 100 bank said the improvement in net interest margin was due to improved deposit pricing and mix, lower wholesale funding costs and a benefit, as expected, from the recent ECN redemptions.

Lloyds maintained its strong balance sheet, with a CET1 ratio of 13.0% after a 0.4% impact of the ECNs redemption, while for the full year management still expect to generate around 2% of CET1 capital per year.

Management has previously signalled that it would return surplus capital to shareholders, broadly equating to anything over 13% of CET1.

The underlying return on required equity was 13.8%, down from 16.0% in the first three months of 2015 largely reflecting the disposal of TSB and a higher assumed underlying tax rate.

The statutory return on required equity was 4.4 per cent (2015: 8.3 per cent).

Chief executive António Horta-Osório, who still has the UK government as 9.2% shareholder, said Lloyds "continued to make good progress" and that the relatively stable results "demonstrate the strength of our differentiated, simple, low risk business model and reflect our ability to actively respond to the challenging operating environment".

He was proud of the 1% reducion in costs and continued to guide to lower full year costs, with medium-term guidance for a cost-to-income ratio of 45% remaining unchanged.

Analyst impressions

Lloyds' shares moved down 4% to 66.39p after an hour's trading on Thursday, which was put down to the figures being somewhat spoiled in the short-term by the large ECN bond redemption and market volatility writedowns that led to the postponement of the government’s retail share sale, while some analysts commented that Brexit worries could also weigh on sentiment, given that Lloyds is increasingly viewed as a proxy for the UK economy.

Analysts at Shore Capital said the results were "solid if unexciting...not necessarily a bad thing for a bank", adding that "the key to the Lloyds investment case is the strength of its underlying capital generation which, as noted above, should support strong dividend paying capacity in the medium term".

Richard Hunter at Wilson King said many of the financial metrics provided "reasons for cheer": a robust capital cushion, a strong return on equity, lower operating costs, no further PPI provisions and net interest margin and impairment figures which are both travelling in the right direction.

"In addition, the projected dividend yield for the stock exceeds 6%, which tends to set it apart from its UK peers and is of particular attraction in the current interest rate backdrop."

Laith Khalaf at Hargreaves Lansdown said the quarter was "most notable for the absence of any charges for PPI claims" and that other banks are likely to be jealous of Lloyds.

"Capital ratios are strong and there is little need to build ratios up any more, so in future, the bank can give the rest back to investors. Lloyds has been assiduously cutting costs for years and is now reaping the benefit," he added, which combined with low levels of bad debt, was good news for earnings.

"Investors will have to bide their time for the share sale, shelved during the market weakness around the start of the year. The stock is still below the level the government paid for its stake (c.74p) so we do not expect that situation to change in the near term.”