Yesterday’s Newsletter pointed out that Lloyds’ current share price of 41.69p (LSE:LLOY) is only 9.9 times underlying earnings averaged over the last ten years. At face value, it therefore seems cheap if we assume merely that EPS over the next ten years will match those of the last ten. However, there are reasons to believe that Lloyds could do better in the future. If it does, and it checks out on financial stability and qualitative factors then it would seem exceptionally cheap.
Reasons we might see a significant growth in earnings per share:
At the same time investors in the long-term bond market currently earning 0.8% pa will worry that inflation is going to erode the real value of their savings. The result may well be a rise in long-term interest rates and a suppression of short-term rates.
This “steeping of the yield curve” is music to the ears of bankers because one of their key societal roles is “borrowing short and lending long”. In other words, depositors usually have access to their money within a few hours or days – banks borrow from them for short periods. These liabilities for banks therefore pay puny interest rates, if any at all.
On the bank asset side – mostly lending to businesses and home-owners – they lend for many years.
As long-term interest rates rise so will the gap between what banks have to pay to access money at the short end and what they receive by lending it out at the long end.
Even over the last ten years this gap, called the “net interest margin” has been respectable, generally in the range 2% to 3% - see table. Now we have reasons to believe that, at least for a while, NIM could exceed the top end of this range. Each 50 basis point (i.e. 0.5%) rise in the NIM should add roughly £2bn to Lloyds earnings before tax. That is around 2.8p per share.
Average EPS over the last ten years were 4.2p, so an uplift of 2.8p is considerable. How long the wider gap will last before short-term interest rates are raised is anybody’s guess, but at the moment central bankers seem really determined to hold rates down.
Net interest income, £bn Net interest margin Impairment, £bn
2020 10.8 2.52% 4.2
2019 12.4 2.88% 1.3
2018 12.7 2.93% 0.9
2017 12.3 2.86% 0.8
2016 11.4 2.71% 0.6
2015 11.5 2.63% 0.6
2014 11.0 2.40% 1.1
2013 10.9 2.12% 3.0
2012 10.3 1.93% 5.7
2011 12.2 2.07% 9.8The other major element in bank profitability is the “loan impairment” rate, i.e., a provision which estimates the hit caused by loans going bad. Loans are shifted into the impaired category when it becomes probable that not all of the related principal and interest payments will be collected.
During the Covid year the directors’ estimate of impairment rose to £4.2m or almost 1% of loans to customers. In more normal years the figure is under £1bn.
The directors are targeting impairments for 2021 to be below £2bn. If the economic recovery builds up steam that should be easy to accomplish.
Quote from a February FT article: “But this domestic retail and business lender is nevertheless a particularly useful window on the nation. The UK now expects to recover faster from the pandemic than most business planners recently imagined…Lloyds, whose emblem is a black horse, is cantering out of trouble at pace. Loan loss provisions of £4.2bn pushed full-year pre-tax profits down 70 per cent to £1.2bn. But fourth-quarter impairments of £128m were light…core tier one equity, therefore, rose to 16.2% of risk-weighted assets. Allow for software and accounting charges and that is still some way above the minimum target, equivalent to about 3.5p a share. No one suggests Lloyds will pay the lot back to shareholders as soon as the payout cap comes off. But there is plainly plenty of firepower for returns and for investment. Lloyds’s net interest margin is a stout 2.46 per cent. This suggests the pandemic has suppressed price competition, as well as consumer spending. A consequence of the latter is a flood of deposits. A stimulatory grassroots splurge is already apparent in soaring holiday bookings.”
It has the largest UK branch network and is the largest digital bank with 17.4m online active customers (12m are mobile app users). It concentrates in the geography where it has competitive advantage with 97% of revenue coming from the UK.
It claims a one-quarter share of UK consumer credit cards, slight less than one-quarter of share of personal current accounts and deposits, mortgages and small business len………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Prof. Glen Arnold
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