Interactive Investor

Lloyds Banking: Third-quarter results preview

25th October 2016 10:56

Lee Wild from interactive investor

Record low interest rates guarantee paper thin margins at UK banks these days, and concerns over what a Brexit might do to the local economy has made many investors think twice about backing our mortgage lenders. A trio of the high street's biggest banks - Lloyds, Barclays and Royal Bank of Scotland - will this week use third-quarter results to try and change their minds.

Three weeks after chancellor of the exchequer Philip Hammond scrapped a £2 billion retail share offer, Lloyds, the biggest of the three, kicks things off on Wednesday. Predictably, opinion in the City remains divided.

In the past few days, Deutsche Bank analyst David Lock has said he expects a "relatively quiet set of results".

Margins will continue to be supported in the near term but this tailwind will begin to fade by mid-2017"Credit quality appears to have been robust in third-quarter 2016, margins we expect to fall slightly quarter-on-quarter (but continue tracking to guidance of around 270 basis points (bps) for 2016), while the movement in pension deficit (and therefore equity and common equity tier one [CET1]) offers the most potential for uncertainty (a PPI charge should not be surprising given time-bar expansion)."

It's the outlook for 2017 and beyond that the market will really focus on this time, reckons Lock. Of particular interest will be margins, which he thinks will deteriorate from the middle of 2017.

Look for net interest margin (NIM) of 268 basis points for the third-quarter, a halving of reported profit year-on-year to £471 million, and underlying pre-tax profit little changed from second-quarter, but up slightly on a year ago at around £2 billion.

"We expect management will wait until  fourth-quarter 2016 before updating the market on margin outlook for 2017," adds Lock.

"Our view is that margins will continue to be supported in the near term (aided by liability compression), but that this tailwind will begin to fade by mid-2017 as asset pricing pressure & hedging headwinds begin to impact.

Since resuming dividend payments last year, Lloyds has returned 4.35p to shareholders"Our forecasts reduce 2-4% for 2016-18 on lower net interest income (NII) and higher costs.

"This leaves Lloyds trading at 11.5x 2017, for an underlying return on tangible equity (RoTE) of 11.9% in 2017, 1x tangible net asset value (TNAV) and a dividend yield of 5.6%."

Lock trimmed his price target from 59p to 57p, but David Goldman, one of a trio of managers running the successful £355 million BlackRock UK Income fund, continues to speak highly of Lloyds. In fact, it's one of his fund's top six holdings. At a dinner recently he told me:

"We own it because it's doing good work on the cost base and impairments are lower. And the yield it will generate over the next few years is pretty impressive."

Since resuming dividend payments last year, Lloyds has returned 4.35p to shareholders.

We've already reported how UBS analyst and Lloyds fan Jason Napier worried that capital generation in the second half, among the main drivers of sentiment, could disappoint. He also trimmed his dividend estimate for 2016 from 3.8p to 3p.

Napier still tipped the shares up to 65p, however, arguing that, while risks around near-term capital returns have risen materially, longer term prospects are "undervalued at 9.2 times trough earnings per share (EPS)"

"In four of the last five UK recessions it paid to buy the banks early. We also see LBG as well positioned for a down-turn: capital levels are good, the loan portfolio defensive, liquidity is high and there is significant room to cut deposit and branch-distribution costs."

JPM believes Lloyds will take a £1.5 billion provision for Payment Protection Insurance (PPI)In the opposite camp are Stephen Bailey and Jamie Clark who run the Liontrust Macro Equity Income fund. "Lloyds will not return to the days of being a dividend cash cow," Bailey told me. They're under-capitalised, he says, pointing to the simple leverage ratio rather than CET1.

The banks team at JP Morgan remained largely unmoved following half-year results released over the summer. It did trim estimates for adjusted EPS for 2016 to 8.2p, although it still thinks 16.3p is achievable next year.

But JPM also believes Lloyds will take a £1.5 billion provision for Payment Protection Insurance (PPI) in its third-quarter results. That explains the cut in dividend forecasts for 2016 to 2.25p, rising to 2.5p next year and 3p in 2018. The price target was also cut to 62p.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.