Lloyds Banking Group PLC (LON:LLOY) is expected to be a “relative winner” in a rising interest rate environment, according to Credit Suisse.
Credit Suisse maintained an ‘outperform’ rating on Lloyds and raised its target price to 90p from 85p, saying the bank remains its top pick.
The Bank of England (BoE) raised interest rates by 25 basis points (bps) to 0.75% in August and said there would be further gradual and limited rate rises to come.
A low interest rates environment and tough competition in mortgage lending have put pressure on banks’ net interest margins (NIM), a measure of profitability.
Mortgage margins improving, says Credit Suisse
But Credit Suisse said mortgage margins, a key driver of UK NIM, are improving thanks to the trend towards five-year fixed interest rate products as consumers try to lock in low borrowing costs ahead of further expected rate rises.
The broker said its analysis shows Lloyds has the most rate-sensitive balance sheet, utilising the most internal hedging, supporting its NIM outperformance.
“Following our in-depth review of Lloyds’ NIM drivers, we are more confident in management’s ability to further surprise on the upside,” it said.
Credit Suisse revises estimates for Lloyds' NIM, earnings and dividends
Credit Suisse raised its forecast for NIM in the 2020 financial year by 5bps to 300bps, driving a 3% uplift in net interest income. It also raised its estimates for earnings per share (EPS) in fiscal years 2018-202 by 1-3%, supported by higher income and lower impairment assumptions.
However, Credit Suisse raised its expectations for payment protection insurance (PPI) costs by £0.5bn in aggregate for 2018-19, which will partly offset underlying EPS improvement.
In August Lloyds said it has set aside a further £460mln in costs for claims related to the PPI mis-selling scandal. The lender has allocated more than £19.2bn to settle claims.
READ: Lloyds first-half profits rise 23% despite extra £460mln provision for PPI claims
Credit Suisse said it has also revised its capital distribution forecasts to incorporate 5% annual growth in the ordinary dividend, supplemented with a special dividend per share and share buybacks.
READ: Lloyds completes £1bn share buyback programme
“Our buyback forecasts are unchanged at £1bn for 2018, rising to £1.5bn per annum thereafter. This gives an all-in yield of 10% in 2019/20.”
Lloyds a 'leading UK capital return story'
The broker said it sees Lloyds as the “leading UK capital return story”, supplemented by underappreciated growth potential in insurance
A 0.3% reduction in the bank’s Pillar 2 capital requirement in the second quarter gives Credit Suisse “more confidence in its ability to pass” the upcoming stress test by the BoE’s Prudential Regulation Authority and hence distribute capital above a common equity tier 1 ratio of 14%. Results from the stress test are due on December 5.
On insurance, which Credit Suisse sees as a strategic growth area, the first half results showed new business income up 75% year-on-year.
Credit Suisse also believes there is further upside potential to its estimates if Lloyds achieves its 2020 target for £50bn in assets under administration as the broker only assumes £40bn.
Risks for Lloyds include weaker UK economy and housing market, a so-called “hard Brexit” and higher capital requirements by the BoE.
In morning trading, shares in Lloyds were little changed at 61.69p each.