Lloyds’ share price could start to rise after delivering a solid financial performance in Q1. But the FTSE 100 bank may be overexposed to the UK's domestic economy.
Lloyds (LON: LLOY) is consistently one of the most popular shares on the FTSE 100. There are two simple reasons for this: first, the bank has no international operations and is therefore a reliable bellwether for the UK’s financial sector.
And second, Lloyds’ share price has been trading within a range of circa 40p-50p since April 2021, despite the bank regularly topping the index volume chart. This can make it a popular choice for active traders.
Now after reporting solid Q1 results, investors are questioning whether the FTSE 100 bank can finally see sizeable capital returns.
FTSE 100: Lloyds Q1 results
Lloyds reported headline statutory profit after tax of £1.6 billion, £500 million more than in the same quarter last year, with higher net income partly offset by expected higher operating costs. It also reported a strong return on tangible equity of 19.1%, with net income up 15% to £4.7 billion, ‘reflecting ongoing recovery and the higher rate environment.’
For perspective, underlying net interest income rose by 20% on net interest margins of 3.22%. However, the FTSE 100 bank expects full-year net interest margins to average at ‘above 3.05%,’ suggesting that this crucial figure is expected to dip in Q2 and beyond.
Investors might have been expecting net interest margins to rise. The base rate has risen again, to 4.5%, and according to Goldman Sachs analysts it could increase to 5% during the summer. But with stiff competition from challengers and the other FTSE 100 banks, profitability will likely be squeezed for the rest of the year.
For context, while Nunn mentioned competition from Chase UK in full-year results a few months ago, Nationwide plans to pay out £340 million — or £100 each — in profits directly to most customers. MPs have also criticised several FTSE 100 banks including Lloyds for failing to pass along enough interest to customers — with the Treasury Committee calling out them out for offering ‘measly’ rates.
Banks hoping to avoid a windfall tax may prefer to become more generous with their accounts.
Importantly, Lloyds only set aside £243 million for impairment charges, down from £465 million last quarter. This implies that the bank thinks that the worst of the economic pain could be behind us, despite deposits falling by £2.2 billion partially due to seasonal tax withdrawals. Lloyds currently has a respectable CET1 ratio of 14.1%, while it anticipates that return on tangible equity — a key metric — will be circa 13% across FY23.
Analysts expect CPI inflation to fall from the current 10.1% to under 9% imminently given the extremely sharp month-on-month spike last year and falling energy bills. But Governor Andrew Bailey’s recent wage price spiral admission — after recent figures showed that private sector wages grew by 7% in Q1 — could make getting inflation down to the Bank’s official 2% target harder than first appears.
The Bank now expects inflation to fall to 5% by the end of the year, up from its previous prediction of 3.9%, and only to hit 2% by 2025. And speaking at the British Chambers of Commerce’s annual conference, Bailey warned the Bank thinks the likelihood of inflation topping its projections is ‘skewed significantly to the upside.’
Lloyds CEO Charlie Nunn enthuses that ‘the Group has delivered a solid financial performance in the first quarter of 2023, with strong net income and capital generation, alongside resilient observed asset quality. The macroeconomic outlook remains uncertain. We know that this is challenging for many people.’
Lloyds shares: housing market dependence
Lloyds is by far the UK’s largest mortgage lender; its open mortgage book rose by £3.6 billion over the last year to £298.6 billion, and it’s investing heavily into its Citra Living rental project.
The FTSE 100 bank is still predicting that UK house prices will fall by 7% in 2023 in nominal terms, and further in real terms. Simultaneously, 200,000 mortgages customers will be exiting their fixed rate this year to a hostile market seeing their monthly payment increase by hundreds of pounds.
Predicting where UK house prices will go is an art rather than a science — almost every analyst expected the market to crater when the pandemic struck — and then a combination of ultraloose monetary policy and stamp duty holidays saw prices rise to record highs. But if you believe that house prices are primarily a function of credit, and that the cost-of-living crisis is yet to fully bite, then the £243 million set aside for impairment charges may be too optimistic.
Positively, Lloyds is offering a trailing dividend yield of 5.1% over the past year, compared to just 3.7% for the wider FTSE 100. And the 2.4p dividend pay-out in 2022 is currently expected to rise to circa 2.8p in 2023, and then to 3.1p in 2024. With a price-to-earnings ratio of just 6.5, the bank is even engaged in a £2 billion share buyback, on a market cap of just over £30 billion.
This could make Lloyds shares an excellent FTSE 100 dividend choice — though its concentration on the UK economy, and in particular the housing market, could mean that would-be investors pay for the likely rewards with a reasonably sized risk. On the other hand, this feature also leaves it comparatively protected from any potential wider financial crisis.