Cautious margin guidance overshadows bumper cash returns at Lloyds

• Lloyds could return £3.8 billion to shareholders in 2023, or 11% of its market capitalisation
• Stock market prefers to focus on cautious guidance for net interest margins for 2023
• Shares could still be cheap if bank can meet target of sustained double-digit returns on tangible equity

“Add a forecast £1.8 billion dividend to a proposed £2.0 billion share buyback and Lloyds is, in effect, offering its shareholders an 11% cash yield on its £34.1 billion market capitalisation. That even beats inflation, let alone returns from cash in the bank or Government bonds, so patient investors may well be inclined to just sit and wait out any economic – or political – squalls,” says AJ Bell investment director Russ Mould. “But as was the case with Barclays and NatWest, investors are focusing instead on Lloyds’ cautious guidance for net interest margins in 2023, whereby chief executive Charlie Nunn is suggesting the full year for 2023 will exceed 3.05%, implying no progress on the 3.22% recorded in the fourth quarter of 2022.

Source: Company accounts

“This caution could reflect a view that the interest-rate cycle is about to peak and then see a return to cuts as the Bank of England responds to any signs of a recession. It could be the result of political pressure after the fury vented by a House of Commons Treasury Select Committee on the issue of banks’ profit margins earlier this month. It could be the result of competition for loans and deposits between rival banks. And if could be an acknowledgement that savers and borrowers are both looking for help at a time when Lloyds has just racked up a record annual pre-tax profit, a fraction above the prior record attained in 2021.

Source: Company accounts, Marketscreener, consensus analysts' forecasts

“Going into Tuesday’s full-year results, analysts believed profits would rise again in 2023, albeit marginally, although management’s forecast of a 13% return on tangible equity in the year just begun undershoots consensus forecasts of 13.5%, perhaps thanks in part to that guidance for the net interest margin, where the market had been looking for a further gain to 3.15%.

“Mr Nunn’s suggestion that sour loans will total around 0.30% of the average loan book for 2023 is better than markets’ expectation of 0.35%, even if the so-called asset quality ratio and the cost of loan impairments is rising, albeit from a very, very low base. This is a trend that central bankers, economists and politicians will be watching in 2023, as well as shareholders, as they try to gauge whether the UK economy is tipping into recession or not.

Source: Company accounts

“The combination of the cloudy economic outlook and political (and public) pressure on the issue of loan book margins helps to explain why Lloyds’ shares are optically cheap. The shares trade on barely seven times forward earnings and one times historic book value, despite the double-digit returns on equity, and now the planned buyback effectively doubles the 5.5% forward dividend yield for 2023.

Source: Company accounts, Marketscreener, consensus analysts’ forecasts

Source: Company accounts

Source: Company accounts

“Patient investors will argue that there lies the opportunity. Sentiment is against the sector, yet the cash returns mean they are being paid to wait until it changes, and a positive catalyst appears, whenever and whatever that may be. A better-than-expected showing from the UK economy could be one potential source of that positive surprise, especially as Lloyds looks well equipped to weather any downturn, judging by how it comfortably meets regulators’ capital requirements.”