Equity Research; Lloyds Banking Group
Lloyds recovery on track
- Lloyds reported FY2016 statutory profits of £4.2bn (more than double the £1.6bn in 2015) largely derived from lower operating costs (£8.1bn v £8.3bn) and lower PPI provisions (£1bn v £4bn).
- Pre-tax profits of £4.238bn narrowly missed consensus forecasts of £4.38bn.
- The total PPI (protection payment insurance) provision remains at £17bn (as at Q3 2017) meaning the board believe the existing provision should capture the total liability up to the FCA’s June 2019 PPI claims deadline. The total provision in respect of FY2016 was £1bn v £4bn in FY2015. As provisions drop out entirely in FY17 it should add 1.12p to EPS or £800m to post tax profits.
- Lloyds provided clarity on net interest margins, “expected to be greater than 2.7% in 2017” due to the MBNA acquisition adding 0.1% to net interest margins. The margin positive comes at a time of pressured industry margins due to the reality of 0.25% Base rates.
- There were a few negatives, both loans and deposits declined; average interest earning assets declined 1% to £435.9bn. This suggests organic credit growth has gone, hence Lloyds needs to acquire to grow. The recent acquisition of credit card business MBNA, expected to complete end Q1 2017 adds just £7bn in new assets. Looking ahead Lloyds will need to return to organic growth.
- Scottish Widows, Lloyds’ insurance unit was also weaker, with a 13% profit decline due to a 6% decline in life and pensions sales to £8.92bn.
- The board heeded investor demands for capital returns. Lloyds is paying a 0.5p special dividend plus 2.55p (FY16 interim + final dividend) hence a total 3.05p which exceeds EPS (2.9p) by 0.15p. The special dividend recognizes that capital levels of 13.8% are extremely high providing room for Lloyds to pay more than it earns.
Conclusion
The strong reception to FY16 (LLOY 69p+2.2p) results will encourage the UK government to reduce its remaining 4.99% Lloyds holding. We expect the UK government to fully exit soon. Our expectation is half of the holding could go in the next fortnight.
As “digitization” (the banking industry move online) increases, banks are well placed to cut their High Street footprint and personnel costs. As long as I.T. spend is managed, there should be lower operating expenses. Lloyds is a major beneficiary of digitization, operating costs fell 3% during 2016 – there should be substantial savings in branch rationalization in the next decade.
Lloyds are below their 72.5p on June 23rd 2016, having spent 8 months recovering the Brexit aftermath losses. They are now 126% of tangible net assets per share of 54.8p a premium to its peer group. But 2017 is seeing property slowing down and a more cautious consumer with subdued credit demand. In the short term Lloyds are up with events.