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Bad debts weigh down Lloyds shares

The Black Horse puts in a decent performance but getting over the jumps is proving to be hard work
February 22, 2023
  • Asset quality marginally lower
  • £2bn share buyback mooted

Unpacking Lloyds Banking Group’s (LLOY) results was a challenge for investors as a combination of higher debt provisions, volatility charges and hedging reversals played havoc with the reported numbers. However, the inner workings of the bank seem to be performing well on the back of higher interest rates. The net interest margin rose by 40 basis points to 2.94 per cent, although return on tangible equity – a key measure for the banks – fell by 30 basis points to 13.5 per cent on an expanding loan book.

However, it stills seems strange that the UK market’s most traded share will not break, or stay above, the 50p level for a prolonged length of time. One interpretation might be that Lloyds, along with the rest of the sector, is seeing bad debt provisions rise, just as the interest margin boom brought on by rising rates appears to be running out of steam.

Lloyds had to set aside a further £465mn of provisions for bad debts. The clear downward leg in many economic indicators in the final quarter of 2022 – beginning with the disastrous impact of the mini-Budget – means that the bank's total expected credit loss (ECL) provision now stands at £4.9bn. Of course, these are simply provisions, rather than recognised balance sheet losses and relate to a tougher scenario for higher interest rates and inflation that the bank adopted in June last year.

There are some grounds for optimism. The uplift in the final quarter apparently related mainly to a single case in the commercial bank, while Lloyds is still banking the return of risk capital set aside for the duration of the pandemic. In other words, default rates are still based on modelled assumptions, rather than what has so far been observed, which gives some cause for comfort and explains why the forecast for the asset quality ratio for 2023 is only slightly lower at 30 basis points. However, Lloyds still seems to be struggling to get its operating costs ratio under control. Strategic investments meant that operating costs rose by 6 per cent £8.8bn, with the forecast that this will rise further to £9.1bn this year.  

On the back of the bank’s intention to implement a £2bn share buyback, Lloyds’ investors are seeing tangible returns of capital. While the interest margin outlook disappointed, the results themselves were in line, if broadly unexciting, reflected in a consensus price/earnings ratio of 6.8. That keeps our recommendation in place. Buy.

Last IC view: Buy, 42p, 6 Oct 2022

LLOYDS BANKING GROUP (LLOY)  
ORD PRICE:49.9pMARKET VALUE:£34bn
TOUCH:49-50p12-MONTH HIGH:54pLOW: 38.1p
DIVIDEND YIELD:4.8%PE RATIO:7
NET ASSET VALUE:70p*LEVERAGE:18
Year to 31 DecTotal operating income (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
201822.15.965.503.21
201942.44.393.501.12
202029.21.231.200.57
202137.46.907.502.00
20225.806.937.302.40
% change-84+0-3+20
Ex-div:13 Apr   
Payment:23 May   
*Includes intangible assets of £7.44bn, or 11p a share