Lloyds Banking Group PLC (LON:LLOY) offers a “less attractive” risk/reward as there are still negative long-term earnings risks, Citigroup said on Tuesday as it downgraded the bank.

After hitting long-term lows in August, shares in the bank have risen around a quarter in the past week on Brexit deal hopes

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At the end of this month, Lloyds will report its third-quarter earnings, for which Citi is predicting underlying profit before tax of £2.1bn, stable compared to the Q2 and 4% above the average analyst consensus. 

With Lloyds guiding to £1.2-1.8bn of extra PPI charges, reported PBT will be somewhat lower, with Citi expecting £1.55bn on PPI so £0.5bn of PBT.

Lloyds net interest margin (NIM), the difference between its interest paid on savings and charged on loans, declined by two basis points in both the first and second quarters. 

“We foresee a further 3bps compression in 3Q19, due to ongoing asset margin pressure,” Citi said, though with Lloyds having £13bn of its ‘structural hedge’ available for investment, this could partly mitigate ongoing NIM pressure.

Citi expects to see further NIM compression and lower gilt gains, so is in line with other analysts on revenues, but believe this could be offset by cost saving.

Earnings risks

In the longer term, Citi’s analysts believe Lloyds earnings risks are “still to the downside”, with its forecasts 3% more bearish than the City for 2020 and 8% worse for 2021. 

“Previously the lowly valuation compensated investors for earnings risks, as well as the economic & political uncertainty, but post the recent bounce we believe the risk/reward is no longer as attractive.”

The analysts noted that Lloyds now trading on around nine times 2020 forecast earnings, closer to its 10x long-run average, and downgraded its rating to ‘neutral’ from ‘buy’, with an unchanged target price of 61p.