Lloyds Banking Group, formerly known as Lloyds of London during its heights as an elite global insurance giant, has fallen on relatively less jubilant times, as its long-term shareholders will attest. In 1999, when the stock was peaking at 976 British pounds per share, it was the toast of London. Today, with its share price rummaging around the 69 level, investors can only dream of the lost glory. Despite having risen significantly since the fall of 2016, the stock is a “conviction short” according to Bernstein analysts Chirantan Barua and Mark Burrows.
Lloyds – Peak margins with “no rabbits left in the hat”
On April 18 the investors in Lloyds noted the stock forming a short term trend bottom near 62.20 and were likely cheering as the trend since has turned higher, since climbing more than 10% in less than a month.
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Short this trend, say Barua and Burrows, focusing on three primary risk factors: Margins, one directional risk exposure and excess capital concerns.
Saying Lloyds is at “peak margins” with “no rabbits left in the hat,” Barua and Burrows tackle the fact Lloyd’s has worst loan to deposit ratio and related highest deposit costs among major banks. Saying the bank of overextended on commercial deposits, they point out the bank could be exposed in a downturn as they give the stock an underperform rating with a 40 price target.
Lloyds is experiencing significant customer churn, with UK residents, squeezed by the economic situation, shopping for better rates at the drop of a hat. They are playing in a market that is the most competitive in Europe, and that’s not changing anytime soon.
“We don’t see price competition letting up anytime in the near-term either – banks continue to bring mortgage pricing down helped by the Government creation of the ‘Term Funding Scheme’ that offers continued access to low-cost deposits,” they write. “With that glut of free money in the system, we estimate that competition pressures will shave another ~12bps off the NIM in the coming years.”
UK consumer “resilience” is nothing more than a debt-based spending frenzy
There is only one direction to go with Lloyd’s risk and that is up, says Bernstein. The UK consumer, a market in which Lloyds is dependent, is fraught with problems. This one directional risk exposure can turn against the bank in a big way from many directions.
The much ballyhooed “resilience” is nothing more than a debt filled spending spree that has reached its peak and is likely to come unwound over the remainder of the year with a Bank of England move against unsecured lending leading the charge.
As inflation rears its ugly head, this will “eat into disposable earnings” for middle-class UK residents, who could reduce consumer activities as Bernstein feels they will ‘overshoot the ‘return to normalcy.’”
As interest only mortgages start to mature into real loans, there is a repayment risk that Lloyds could bear. “In such a scenario, we expect provisions to tick up from current levels,” the report stated. “A deteriorating UK housing market will also naturally give way to rising risk,” with mortgage risk rising from 4bps in 2016 to 25bps in 2018.
And then there are capital concerns.
Saying that Lloyds capital position is “massively flattered by a 7-year bull run in UK asset prices and historical low delinquencies,” they go on to describe current CET1 capital ratios as “deceptive.”
“We estimate a move up today to a 15% risk weight across their IRB mortgages would reduce CET1 by some 100bps as risk weighted assets are inflated,” they wrote, noting model changes are only starting to put through regulatory pressures and “could get much worse when the real economy takes a hit.”
In a downturn, Lloyds could get hit and hit hard, with a dividend cut being a potential causality, the report says.