Lloyds Takes a Stumble

Horta-Osorio's revival is becoming a victim of expectations

Lloyds Banking Group's earnings, branded dull by one analyst, provided at least one surprise: it was the only big European bank reporting better-than-estimated quarterly earnings to experience a drop in its stock.

Turned Around

Lloyds shares have delivered gains over the past five years, unlike its peer group

Source: Bloomberg data

Boring banking just isn't what it used to be, even for Britain's biggest mortgage lender.

Scant Reward

Lloyds fell as much as 4.6% after posting earnings that beat estimates

Source: Bloomberg

Intraday times are displayed in ET.

While revenue slipped, a combination of cost cuts and shrinking loan impairments helped to mitigate the decline in pretax profit 1 . Capital ratios stayed above the industry average, while the bank's net interest margin widened to 2.74 percent.

The response from investors was to shrug and sell. What gives?

CEO Antonio Horta-Osorio has successfully turned around the lender after it was bailed out in 2008, allowing the government to cut its stake to less than 10 percent. He's now in the awkward position of having to preserve his reputation, something that's going to become more difficult as the tailwinds he enjoyed -- a growing economy and rising house prices -- start to reverse.

The bank's market value has swelled to overtake every big European bank bar HSBC and Santander. Based on book value, Lloyds has enjoyed a higher valuation than its peers -- in part because it wasn't heavily reliant on investment banking. That premium could now be at risk as the U.K. economy slows and lenders such as Barclays and Deutsche Bank start to deliver on their own turnarounds.

Premium Price

Lloyds trades at a higher price-to-book value than Europe's investment banks

Source: Bloomberg data

Crucially, Lloyds is suffering from increased competition in the mortgage market that has squeezed margins. The bank chose to throttle back on new lending to defend them: mortgage lending grew 1 percent in the quarter, well short of the 3 percent growth in overall U.K. mortgage stock in February alone.

That's forced the bank to chase other forms of consumer finance such as car loans. Historically, that's proved to be a minefield. Berenberg analysts estimate consumer credit has generated 92 percent of credit losses despite representing only 8 percent of household debt. Lloyds, while it has a below average market share, will need to be cautious to avoid taking losses.

Four years of solid consumer spending have started to raise the risk of fatigue -- and the looming Brexit vote won't help Lloyds, which is far more exposed to the British consumer than its more European peers.

Cost Control

Lloyds has a lower cost-income ratio than peers - and has promised to reduce it further

Source: Company reports

Horto Osorio is pulling the levers he can: he has bought back debt to reduce his cost of funding, and has sought to slash operating expenses. The bank's cost-income ratio of 47 percent is well below Deutsche Bank's 89 percent of Barclays's 76 percent -- and he plans to cut it further to 45 percent. That may be difficult given the bank is already cutting 9,000 jobs.

Small wonder he's given himself two extra years to achieve that target.

Thursday's earnings mark a turning point: Lloyds has been a bet that the British economy, more particularly its housing market, would rebound after the financial crisis of 2008. Now investors need to assess whether Horta-Osorio will over deliver on revenue and costs just as that engine of growth peters out. Whether they like it or not, British taxpayers will still be along for the ride. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Excluding one-time items and its former TSB banking division.

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net

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