DBRS: Lloyds’ 1H15 Profits Up Despite Significant PPI Charge

Summary:
• Underlying profit before tax (PBT) of GBP 4.4 billion in 1H15, up 15% year-on-year (YoY), driven by income growth and lower impairments.
• Statutory PBT of GBP 1.2 billion reflecting ongoing legacy items, including a further PPI charge of GBP 1.4 billion.
• Balance sheet continues to strengthen, with improvements in capital and funding positions.
• DBRS rates Lloyds Bank plc at AA (low) – Under Review with Negative Implications for Senior Unsecured Debt & Deposits due to the review of European banks’ support assumptions.

DBRS Ratings Limited (DBRS) considers Lloyds Banking Group plc’s (Lloyds or the Group) 1H15 results demonstrate the strength of its franchise. The Group’s profitability, however, continues to be weighed down by legacy issues, most notably in the form of conduct provision, such as for Payment Protection Insurance (PPI).

On an underlying basis, Lloyds reported a PBT of GBP 4.4 billion in 1H15 (up 15% YoY), with the Banking net interest margin, excluding TSB, up 27 basis points (bps) YoY, to 2.62%, as a result of improved deposit pricing and lower funding costs. Impairment charges were also 75% lower YoY, at GBP 179 million, indicating the Group’s continued risk reduction. This is also evident in the continued downward trajectory of impaired loans, with the pro-forma impaired loan ratio reaching a low of 2.2% following the announced sale of a portfolio of Irish commercial loans at end-July 2015 (2.9% at end-2014).

Statutory profit, however, continued to be negatively affected by a number of legacy items, including the loss on sale of TSB, and conduct provisions, most notably related to PPI. As a result, Lloyds reported statutory PBT of GBP 1.2 billion in 1H15 (1H14: GBP 863 million) and a net profit of GBP 925 million (1H14: GBP 699 million).

Following higher than expected average redress, a change in the scope of the Group’s remediation programme, and revisions in the Group’s forecast of complaint volumes and associated costs, Lloyds took a further GBP 1.4 billion charge in 1H15 (1H14: GBP 600 million), taking the total charge for PPI to date to GBP 13.4 billion, of which GBP 2.2 billion remains unutilised. The provision taken in 1H15 assumes a significant decrease in reactive complaint volumes over the next 18 months, compared with recent quarters. If, however, complaint volumes remain unchanged from 1H15, DBRS notes that the Group could take a further provision of approximately GBP 1 billion in 2H15.

Underlying performance was good across all divisions in 1H15. Insurance was a highlight in the period, given its improving underlying profit as growth in new business income outpaced increased investment costs, reflecting the Group’s strategic growth initiatives. Retail and Commercial Banking also performed strongly in 1H15, with underlying profit increasing 8% and 3% YoY respectively, as a result of increased income generation. Consumer Finance had a more moderate period, with underlying profit up 1% YoY, as income growth and reduced impairments offset an increase in costs, principally related to investment in the business.

Lloyds has continued to strengthen the balance sheet, and posted strong capital ratios at end-1H15. The fully loaded Basel 3 Common Equity Tier 1 (CET1) ratio, post dividend, was 13.3%, up 50 bps from end-2014, and the Basel 3 leverage ratio was 4.9%, unchanged from end-2014. The UK Government’s shareholding also reduced to less than 14% as of 31 July 2015. Funding and liquidity also remains solid with loan-to-deposit ratio of 109% at end-1H15, and a primary liquid asset portfolio of GBP 109 billion, against wholesale funding maturing within one year of GBP 39 billion.

DBRS rates Lloyds at AA (low) – Under Review with Negative Implications for Senior Unsecured Debt & Deposits. The URN reflects DBRS’s view that recent developments in European regulation and legislation, including the Bank Recovery & Resolution Directive (BRRD), means that there is less certainty about the likelihood of timely systemic support for systemically important banks (SIBs). Currently DBRS’s support assessment for Lloyds is SA-2, which results in a one-notch uplift from Lloyds’s IA of A (high) to the final rating of AA (low).

Note:
All figures are in British Pounds (GBP) unless otherwise noted.