Lloyds Banking Group PLC (LON:LLOY) is facing a near “perfect storm” of challenges, according to analysts, and glimmers of hope are “few and far between”.

Heading into the results, the consensus forecast had been for a negligible loss of £13mln, having announced an adjusted £558mln profit in the first quarter.

But Britain’s biggest mortgage lender swung to an underlying loss before tax of £839mln in the first half of the year, which was worse than investors and the City expected.

“This is primarily due to much higher than expected impairments as the group has adjusted its macro-economic assumptions to reflect a more challenging outlook,” said analyst Gary Greenwood at Shore Capital, with Lloyds lifting bad loan impairment charges by £2.4bn to £3.8bn.

A statutory loss before tax of £676mln, which compared to expectations of a £31mln loss, saw a further drag from £70m of restructuring charges and £233mln of gains related to market volatility and other items.

Greenwood added that Lloyds earlier assumptions “seemed optimistic” and pointed out that much of the additional provision obtain transitional relief “so there is a delayed impact to capital”.

Richard Hunter, head of markets at Interactive Investor, said: “The current environment is proving to be a hard slog for Lloyds, and the difficulties are unfortunately set to continue.

“Since its last update, Lloyds estimates that the economic outlook has deteriorated further, partly because of the immediate impact of the pandemic in its second quarter, but also due to the likelihood of significantly higher defaults on loans in the next few months as various government support schemes subside.

“The wider challenges are exacerbated given the bank’s perceived status as a barometer of the UK economy. With GDP growth remaining under pressure and the unemployment rate potentially yet to peak, the uncertainty around Brexit negotiations takes on additional significance given an already faltering economy.”

More cautious than Barclays

UBS analyst Jason Napier said Lloyds’ new guidance “looks cautious when compared with Barclays”, which released results a day earlier.

FTSE 100 rival Barclays had issued what felt like a cautious outlook for the second half of the year, stressing its dependence on a strong recovery in developed economies such as the US and the UK, where unemployment remains a major concern.

Barclays said the second half of the year is expected to continue to be challenging, but said impairments were expected to be below those in the first half, which were increased by £1.6bn in the second quarter to £3.7bn, and that its investment banking arm was “well positioned”.

Lloyds, on the other hand, which does not have an investment bank, said investors should not expect a near term recovery for income.

Like Barclays, it expects loan losses will also be less than the first half, guiding to a total of £4.5bn-£5.5bn, with stable net interest margin, costs below £7.6bn and risk-weighted assets flat to “slightly up” on the first half. 

“Lloyds is, by and large, a bread and butter bank,” said Nicholas Hyett, equity analyst at Hargreaves Lansdown.

“It takes deposits and makes loans – cross selling wealth management, pension and insurance products on the side. Unfortunately it’s the core lending business which has been hit hardest by the current crisis.”

With lower Bank of England interest rates squeezing loan profitability, together with a massive shift in the loan book away from profitable consumer lending and towards less lucrative commercial lending through government support schemes, Lloyds has little elbow room.

“While some of the headwinds elsewhere in the bank, such as insurance sales, look set to diminish as lockdowns come to an end, and consumer borrowing should pick up too, the long term challenges of low interest rates and anaemic economic growth are probably here to stay for some time,” Hyett said.

“These are hardly ideal conditions for Lloyds, in fact they’re pretty close to the perfect storm.”

Glimmers of hope?

Hunter said any glimmers of hope “are unfortunately few and far between” – pointing to the increased adoption of digital banking during lockdown plus the combined effort by the banks, government and Bank of England to encourage economic recovery, “and consign their chequered reputation to the history books” following their ignominious role in the global financial crisis, with banks are positioning themselves to be part of the solution rather than a large part of the problem. 

Lloyds itself has lent around £9bn through government-backed lending schemes, giving an additional 1.1mln payment holidays and 33,000 capital repayment holidays standing alongside.

While the bank has a comfortable CET1 capital ratio of 14.6% and an as-yet unused PPI provision of £745mln, which could be released in part or in full after all claims have been settled, Hunter the results make for difficult reading. 

With an 8% fall to 26p on Thursday, Lloyds shares are down 59% so far in 2020, compared to a 45% fall for other mainstream UK banks and a 22% drop for the wider FTSE 100.

This is indicative of the market trying to price in the sheer scale of the challenge which Lloyds faces, says Hunter. 

“Reasons for optimism on shorter-term prospects, it appears, will need to wait for another day. In the meantime, it remains to be seen whether the market consensus of the shares as a buy, and indeed having recently moved to being the preferred play in the sector, will come under some serious review.”

Shore Cap’s Greenwood offered a more optimistic view, suggesting the second quarter “represents an awful set of results, [but] we think this is could be a nadir in terms of quarterly profitability (excluding bank levy) with economic activity starting to improve and significant forward-looking provisions already set aside”.

At the previous day’s closing price of 28p, Lloyds traded on 0.54 times trailing tangible net asset value per share of 51.6p.

Greenwood said he sees fair value at 43p, offering a potential 54% upside.

“We would encourage investors to look through a very disappointing set of Q2 results and reflect on the strength of the balance sheet and scope for profits to improve materially in future as the economy recovers.

“We think much of the bad news is already in the numbers and, more importantly, the share price.”