Lloyds (LSE: LLOY) reported today its best quarterly results for some time, which showed the highest net interest income level, the lowest level of impairment and record underlying profit over the last five quarters. Mid-afternoon on Friday, its shares are giving up some 2.5% of the gains they had recorded in recent weeks, however.
Why is that?
Fundamentals
Net interest income stood at almost £2.9bn — the highest level since the quarter ended on 30 June 2014 (2Q14). Add to it some £1.6bn of “other income”, and its total income, or bank revenues, is £4.54bn in the second quarter 2015.
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Lloyds is a rather stable business, so the annualised figure of £18bn for 2015 revenues makes a lot of sense.
It would mean that Lloyds won’t disappoint investors, who have pencilled in a revenues target of £18.2bn for the year — its top-line will likely be flat year-on-year.
This is not ideal to back a Lloyds investment at 83p a share, based on its implied price to tangible book value ratio, which is way too high, I’d say.
Costs, Underlying Profit
Operating costs and lease depreciation stood at £2.3bn, but impairment charges, at £21m, plummeted to their lowest level since 2Q14 — the quarterly impairment average, excluding the current quarter, comes in at £213m, and shows a declining pattern from £300m during the period.
That’s the reason why, once all the costs are deducted, its underlying profit (at £2.2bn in this quarter) was better than in the previous quarter, at £2.06bn. It sends a mixed signal: Lloyds may need to cut costs, but it needs investment to grow — and this could be another problem in future.
Its second-quarter underlying profit, excluding the contribution of TSB‘s earnings, compares with:
- £2.06bn in 1Q15
- £1.67bn in 4Q14
- £2bn in 3Q14
- £1.9bn in 2Q14
Growth, Government Overhang & Provisions
It doesn’t take a financial guru to understand that Lloyds lacks growth, and it couldn’t be otherwise in a low-rate environment where the direction of interest rates remains highly uncertain. That combines with downwards pressure on the stock stemming from a meaningful stake that is stil being held by the government, which must sell about 16% of Lloyds stock in the market.
Its bottom line rose more than 30% on a comparable basis, but investors are not paying attention to its net income.
Rather, they are focused on the risk that the bank may have to set aside more capital for its bad behaviour in the past.
And this the biggest problem of all
(Its interim dividend came in line with expectations, and is below 1p a share; Lloyds also hinted at buybacks and special dividends to deliver shareholder value, both of which theoretically should help its stock price rise.)
Non-Recurring Items
“Statutory profit before tax up 38% £1,193m (2014: £863m), including charge of £1,400m for PPI and £660m charge relating to the disposal of TSB,” the bank said today.
Certain non-recurring items had a big impact on its financials today and, unfortunately, nobody knows whether these items will prevent the bank from returning excess capital to shareholders over time.
As it clearly emerged this week during several conference calls between analysts and chief executives at some of the major banks in the UK and Europe, the outlook for the second half of the year isn’t exactly easy to predict.
Litigation risk, and similar risks, are giving sleepless nights to the banks’ bosses.
In this context, Lloyds said today that “the additional (£1.4bn) provision for PPI is disappointing. It mostly reflects higher than expected reactive complaints with higher associated redress and is covered in more detail in the chief financial officer’s review of financial performance.“
Now, I don’t now if similar provisions will emerge again — but this quarter’s figure was by far the highest since 2Q14. (The average for the 2Q14-2Q15 period is about £775m.)
What I know, though, is that “conduct provisions” amounted to zero in the last quarter, when Lloyds’ share price surged 7% in a single day of trade. The market decided to bet on LLOY at the end of April, but was caught by surprise today — and if that happens again, talk of higher dividends and buybacks will be soon forgotten.
