Lloyds Banking Group plc Q1 profits fall by 50%

Shares in Lloyds (LSE: LLOY) fell this morning after the company reported a dismal set of first quarter results. For the three months ended 31 March 2016, Lloyds reported a statutory profit before tax of £654m, down around 46% from the figure of £1.2bn reported for the same period last year. Analysts were expecting the bank to report a statutory profit of £1bn.

However, Lloyds’ surprise profits slump isn’t as worrying as it first appears. Indeed, the bank’s profit hit is largely a result of its decision to buy back so-called enhanced capital notes leading to an initial cost of about £800m. These notes were redeemed during the reported period and under accounting rules, Lloyds has to book any losses or additional charges related to the transaction. Redeeming the £3bn in bonds will give the lender a £900m cash injection over the next four and a half years.

Stripping out costs

Stripping out the one-off bond redemption costs, Lloyds’ underlying profit decreased slightly to £2.1bn from £2.2bn last year, but once again these figures are mildly misleading as during the first quarter of 2015, Lloyds still owned a stake in challenger bank TSB, which contributed to earnings. Excluding any profit from TSB, Lloyds’ underlying profit was relatively stable at £2.05m down from £2.06m.

Broadly speaking, Lloyds’ Q1 results show that the bank is still growing, although the pace of growth has slowed.  Net interest income, a measure of earnings from loans minus deposit costs, increased by 3% to £2.9bn. The bank’s net interest margin, the difference between interest income generated and the amount of interest paid out to depositors, ticked higher by 10 bps to 2.75% from 2.64% as reported last quarter. Moreover, Lloyds’ cost-to-income ratio fell to 47.4%, down from 47.7% a year ago. Return on equity dropped to 13.8%. Lloyds’ capital reserves expanded to 13%, from 12.8% at the end of last year.

What’s next for the bank?

Lloyds’ first quarter results may have missed City expectations but the bank is still heading in the right direction. One bad quarter shouldn’t hold the bank back for the rest of the year and now the group has redeemed its costly capital notes, net income should tick higher as funding costs fall.

Overall, the investment case for Lloyds remains intact after today’s results. The bank’s capital ratio of 13% is one of the best in the industry and a reduced return on equity is still at the high end of the banking sector.  Even if interest rates remain where they are today for the next decade, Lloyds will continue to churn out around £8bn per annum in profit. As the bank already has a fortress balance sheet, the majority of the profits generated going forward will be returned to investors.

According to City analysts, over the next 24 months, Lloyds could pay 10p per share to investors via dividends, excluding any special payouts — that’s a return of around 15% at current prices.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.