Lloyds profits drop 14% as it warns over mortgage loans default

A woman uses a cash machine at a Lloyds Bank branch in central London, Britain February 25, 2016. Lloyds Banking Group rewarded investors with a surprise 2 billion pound payout on Thursday, underlying its intent to be the biggest dividend payer among Britain's banks and its recovery after a state bailout.  REUTERS/Paul Hackett
Lloyds said soaring inflation has threatened the outlook. Photo:Paul Hackett/Reuters

Lloyds Banking Group (LLOY.L) warned that the cost of living crisis could result in higher defaults on its loans as it posted a 14% drop in quarterly profits.

The UK lender reported a first-quarter profit of £1.6bn, down from £1.9bn a year earlier. Revenue increased 12% to £4.1bn, on the back of rising interest rates and continued mortgage growth.

The lender, which is the UK’s largest mortgage provider, booked an impairment charge of £177m as it warned that the cost of living crisis could affect borrower disposable income.

“Whilst we are seeing continued recovery from the coronavirus pandemic, the outlook for the UK economy remains uncertain, particularly with regards to the persistency and impact of higher inflation,” said chief executive Charlie Nunn.

The bank said higher inflation, which hit a record high of 7% last month, is making it harder for borrowers to keep up with payments.

Read more: HSBC’s profits drop 28% amid Ukraine war fallout

“We are proactively contacting customers where we feel they may need assistance and will continue to help with financial health checks and other means of support.

“We encourage customers, where affected, to get advice early and talk to us.”

Lloyds chief financial officer William Chalmers said that, while borrowers’ arrears remains low and below levels seen before the pandemic, the bank is braced for these to rise.

“We’re likely to enter into a tougher environment and expect impairments to tick up a little bit,” he said.

Lloyds share price was up during early trading as investors reacted to the figures.

"The performance of the Lloyds Bank share price since the pandemic first broke across the shores of the UK economy has been one of life’s big mysteries, given it is still well below the levels seen pre-pandemic, and yet the bank continues to return numbers which are much improved on where they were pre-pandemic," Michael Hewson, chief market analyst at CMC markets, said.

"Of course as we look to Q2 the major risks to Lloyds prospects are higher prices across the board, with the bank warning about the persistency of higher inflation on its customers, going on to say that they are proactively engaging with customers who may be particularly vulnerable," he added.

The lender also cut its outlook for the UK economy as the Ukraine war compounds inflation pressures.

Lloyds does not have direct exposure to Russia but said the war in Ukraine was impacting costumers via higher energy and commodity prices.

The bank now expects the UK economy to grow by a lower than first forecast 3.6% in 2022, with expansion flatlining in the second quarter, but it said this will be offset by stable house prices and modest unemployment.

The group sees interest rates rising to 1% in the second quarter and increasing again to 1.25% in the following three months as the Bank of England battles to rein in rocketing inflation.

However, despite the economic uncertainty, Lloyds revised guidance for its return on tangible equity and net interest margin.

Read more: FTSE: UK dividends payout surges to £13bn

Its net margin, the difference between the cost of its funding and the price it charges for lending, is expected to be above 270 basis points, up from 260 basis points.

Tangible equity, a key measure of profitability, is expected to be greater than 11%, compared with a 10% target in February.

Lloyds' core capital buffer, a measure of financial strength, fell significantly to 14.2% from 16.3% in 2021, which the bank blamed on regulatory changes.

Costs were up about 3% to £2.1bn, which the bank said was primarily due to strategic investments.

Watch: How does inflation affect interest rates?