Bailed out by the UK government during the global financial crisis, Lloyds Banking Group has come a long way on a number of counts.
A host of restructuring and capital optimisation initiatives undertaken by management have certainly left the bank in better shape, as evidenced by a recent quarterly update. Meanwhile, the government’s presence on the share register is about come to an end.
The government came to the rescue of Lloyds to the tune of £20 billion during the crisis, and at the peak the UK taxpayer held 43 per cent of the share register. This has recently fallen to 0.25 per cent with the remaining shares currently being disposed of.
Opinions vary over the financial outcome (management claimed at the recent AGM that the taxpayer would make a £500 million profit from the bailout). In any event, the landscape of the UK banking sector would be no doubt very different if the government had not intervened.
The latest quarterly results from Lloyds highlighted the extent to which the ship has been turned.
While underlying earnings growth was only modest in 1Q17, earnings quality was high, with a higher NIM (net interest margin), positive operating jaws (income versus expenses growth), and a lower cost to income ratio all driving capital generation and return on equity higher.
The key point to note is the consistency of what the bank is delivering. While the reported underlying profit growth of 1 per cent year-on-year is by no means a standout result in isolation, it does represent a continuation of the earnings recovery trend over the last several years.
Taking a closer look at the key earnings drivers, perhaps most significant in our view was the 12 basis point increase in the net interest margin to 2.80 per cent. Management has attributed the increase to lower funding and deposit costs, with 1Q17 having benefited fully from deposit re-pricing actions taking in the prior period.
As a consequence of the 1Q17 run rate, management expects the net interest margin to be close to 2.8 per cent in the 2017 calendar year (and a modest improvement on previous guidance of “in excess of 2.7 per cent”).
Having delivered on strategic priorities, management has embarked on the next phase. Over the next three years, the focus will be on creating “the best” customer experience, becoming “simpler and more efficient”, and delivering “sustainable growth”.
While it will be interesting to see whether delivering sustainable growth will require Lloyds to re-enter higher risk markets or regions (ie,. emerging markets), the bank’s medium-term strategy does appear well suited to the current trajectory of the UK economy.
While the stock market’s appetite for bank stocks appears to be recovering, it is worth noting that Lloyds’ share price is still trading at pre-Brexit levels despite the ongoing improvements to its earnings quality. There is no doubt that a ‘hard’ Brexit will make the operating environment for UK banks more uncertain. However, this is not necessarily a bad thing, and as Lloyds’ latest results attest, the bank is more able to weather any potential near-term instability caused by a break from the EU.
Greg Smith is head of research at investment research and funds management house Fat Prophets. Interests associated with Fat Prophets declare a holding in Lloyds. For a free trial to Fat Prophets’ daily market commentary please click here.