Lloyds Earnings: Operating Costs Missing Expectations While Guidance on Loan Losses Was Enhanced

Lloyds posted a good second quarter, slightly ahead of company-compiled consensus expectations. Net interest margin declined marginally to 293 basis points from 295 basis points a quarter ago on weaker lending margins driven by competition as well as deposit mix shifts. We are yet to see what deposit mix shift dynamics peers will have in the quarter, but the dynamics were well within what we have seen over recent quarters already. In the second half of the year, the structural hedge should begin to outweigh these headwind dynamics. Mortgage demand was good with further growth flagged for the second half of the year. Other income continued its good progression from the first quarter of the year, supported by a larger fleet in motor, higher client activity in commercial, and a good trading performance in insurance and pensions. Operating costs were 2% higher than consensus. Lloyds will have to keep its focus on costs in the second half of the year. Guidance on operating costs was unchanged; however, we believe that its investment story is centered on its ability to drive costs back below 50% of income. Any chances that guidance will not be met or will have to be adjusted upward could support negative sentiment around the stock. We maintain our GBX 78 per-share fair value estimate and narrow moat rating.