When it published its first quarter results at the end of April, Lloyds Banking Group (LLOY) joined the growing chorus of major financial institutions issuing their sombre outlooks for the UK economy. Acknowledging that Covid-19 had added “significant uncertainty” to its projections, it estimated UK GDP would contract by 5 per cent this year, before returning to growth in 2021 and 2022.
Though Lloyds had modelled for four economic scenarios, this central projection reflected its so-called ‘base case’, in which unemployment would spike to 5.9 per cent this year, house prices would also drop by 5 per cent, and bank rate would hold at 0.1 per cent.
Even then, the bank’s estimate looked positively bullish next to the forecasts of some of its peers. Though it predicted a larger bounce-back in 2021, Barclays’ (BARC) baseline scenario was that the UK’s economic output could contract by 51.5 per cent at its second-quarter peak, and decline by 8 per cent year-on-year. Royal Bank of Scotland (RBS), whose UK-focus makes it Lloyds’ closest peer, did not make an explicit prediction on the economic fallout from the virus, but cited “multiple external forecasts” in referencing a 6.5 per cent annual decline in output.
That figure was then equal to the International Monetary Fund’s forecast, but around half the hit modelled by the Office for Budget Responsibility. The public body’s “coronavirus reference scenario” had pegged a 35 per cent contraction for the second quarter, followed by a huge rebound in economic activity in the second half of the year.
However, by the time Lloyds had released its projection, the signs on the ground were already looking grim. Data from the Office for National Statistics has subsequently shown that GDP dropped 20.4 per cent in April, following a 5.8 per cent decline in March. This means that the UK economy has shrunk by a quarter in the first quarter of the year, and suggests an enormous recovery is required for Lloyds’ projection of a 5 per cent decline to hold.
Of course, the final impact of the pandemic and its economic effects are scarcely better known two months further into the crisis. But forecasts matter to profits. Updates to Lloyds’ economic outlook following the coronavirus outbreak were cited as the primary driver of the more-than 400 per cent increase in first-quarter impairment charges to £1.4bn, to cover expected credit losses. Total losses from the pandemic are currently expected to hit £4.9bn, most of which analysts predict will be booked in the first half (see chart).
The first quarter update also described underlying credit quality as robust. Given Lloyds’ weighting to low-risk mortgage lending – a bias which underpins a loan book that is 80 per cent secured – this is unlikely to have changed dramatically. Then again, it remains a huge challenge for banks to calculate credit quality until furlough schemes unwind, and the impact on employment is revealed.
Compounding this, independent forecasts for the UK economy are ever more bleak. Assuming there are no further waves of the pandemic, the OECD now thinks the UK economy will shrink 11.5 per cent this year, and that unemployment will climb to 10 per cent and persist at this level throughout 2021. Lloyds’ ‘severe’ economic scenario, which would result in a £7bn credit loss this year, merely models for unemployment of 6.7 per cent this year and 8 per cent beyond.
Meanwhile, consensus earnings forecasts continue to drop. Analysts now predict a statutory loss in the second quarter, and full-year earnings of just 1.54p. The latter represents a downward revision of 80 per cent in the last three months alone, and yet the shares now trade at 31.7p, just shy of their level at the end of April.
