Lloyds profits and capital surge but consumer credit concerns grow

Lloyds Banking Group continued to steadily grow income, profits and capital in the third quarter to raise hopes for increased dividends - but rising loan impairments sparked renewed worries about its exposure to unsecured consumer lending.

For the three months to 30 September, income increased 8% to £4.62bn and profits were boosted by a reflecting a 12% increase in net interest income as the net interest margin increased to 2.85% from 2.82% in the first half.

Underlying profit before tax grew 9% to £2.08bn, which was in line with the consensus City forecast, and with no more uncomfortable PPI provisions made in the quarter but £270m of impairment charges to loans, it means statutory pre-tax profits for the first nine months of the year were up 38% to £4.5bn.

Income and profits both benefited from the acquisition of the MBNA credit card business in the first half, which added £186m of income and five basis points to group margins. Earnings per share of 1.9p was well ahead of the consensus 1.3p.

For 2017 as a whole, management now expects the net interest margin to be around 2.85%, with the fourth quarter at around 2.90%.

Capital generation improved in the quarter and for the full year chief executive Antonio Horta-Osorio said now expects a range of 225-240 basis points, which will help mitigate upward pressure on capital requirements from the regulator.

The CET1 regulatory capital ratio strengthened to 14.9% in the quarter, above the bank's preferred 13% and the 13.8% from the end of last year, and Lloyds said it was awaiting the Prudential Regulation Authority's guidance on any increase to the buffer it wishes banks to maintain, which is expected by the time of full year results.

"The group however still expects to deliver a progressive and sustainable ordinary dividend for the full year and the board will give due consideration at the year end to the distribution of surplus capital through the use of special dividends or share buy backs."

ASSETS AND IMPAIRMENTS

Management remained happy with asset quality, despite loan impairments rising to £270m in quarter from £204m a year ago due to a 'single large corporate impairment.

While no further PPI charges were taken during the quarter, Lloyds said claim levels increased following the FCA advertising campaign and setting of an August 2019 deadline, reaching around 16,000 per week but since reducing to roughly 11,000 a week, still above the bank’s expected weekly run-rate of 9,000.

The possible PRA buffer reflected Lloyds sizeable exposure to consumer risk, with the addition of MBNA on top of what is the largest unsecured car finance portfolio among the high street banks.

Credit agency S&P warned on Tuesday that the pace of consumer credit growth is a major risk to banks if the economy deteriorates. The Bank of England has also lately warned on the risks of double-digit expansion in unsecured credit, saying banks need to increase capital buffers by £10bn.

INVESTORS DISAPPOINTED, ANALYSTS DIVIDED

Shares in Lloyds fell 1.3% to 66.51p in early trading on Wednesday and since topping 73p in late May have lost more than 8%.

Analysts were somewhat divided.

Mike van Dulken at Accendo Markets, said investors seemed to be ignoring the lack of new PPI provisions and upgraded full year guidance to focus on increased loan impairments.

"Having to wait until next Feb for news of any more capital returns (special dividends/buybacks) may also be playing its part, putting off those who’ve been waiting patiently for confirmation of more. As much as the headlines make for attractive reading in terms of many improved financial metrics, the devil is, as always, in the detail."

While Lloyds has been making solid progress, it now faces some headwinds, said Neil Wilson at ETX Capital.

"After a strong stretch of profit growth it was definitely the star of the UK banking show, but as we have been flagging there are mounting risks from its growing exposure to unsecured lending at a time when the economy looks more likely to hit the skids than deliver a marked improvement."

Wilson added that as well as a hangover from the HBOS scandal, the "big spectre" that hangs over Lloyds is the rapid growth in unsecured debt, plus more PPI provisions "seem likely, although it the lack of new provision in Q3 arguably suggests the worst may be over".

Amid warnings from credit agencies and the Bank of England about consumer credit, Wilson said Lloyds’ acquisition of MBNA increased its exposure to UK unsecured credit, adding to its risks.

"This has taken its market share of credit cards to 26%, rivalling Barclaycard. The problem is that with inflation rising faster than wages it is hard to see how consumers can significantly pay down debt without producing a serious hit to private consumption and GDP. There are also worrying signs that consumers are using debt for essentials. If a hike in interest rates coincides with an economic downturn lenders like Lloyds could be in trouble. Just as well Lloyds is generating so much capital – it may need it.”

For Ian Gordon at Investec, the trading update exceeded his own expectations and, he thought, "deals a hammer-blow to the Lloyds bear case".

He noted that the scale of the EPS consensus beat primarily reflected an absence of any conduct charges in the quarter, which drove the step-up in capital generation, while dismissing the impairment charge as "only" £274m versus consensus of £277m, and noting that it was mainly due to a large single item in the quarter.

With consensus expectations for impairment having been steadily correcting, with the current year declining from £1.76m in September 2016 to £817m now, Gordon expected there to be fresh impairment-led consensus upgrades in coming days.

With 2017 full-year capital guidance raised he believes there is "ample cover" to absorb a potential 50 basis point increase in target CET1 to 13.5% and still pay our his forecast dividend of 4.5p.

Shore Capital's Gary Greenwood agreed that better capital generation "should give the market confidence around dividend expectations".