UK Mortgage Risks And Rising IT Costs Will Hamper Outlook

Key Takeaways

• Heavy reliance on UK retail banking and mortgages exposes Lloyds to domestic economic downturns and limits loan growth and revenue resilience.
  
• Rising technology, compliance, and regulatory costs threaten profitability and put pressure on future earnings and operational efficiency.
  
• Broad-based income growth, digital transformation, capital strength, strategic diversification, and favorable UK conditions collectively position Lloyds for sustained profit and earnings resilience.

Catalysts

Provides a range of banking and financial products and services in the United Kingdom and internationally.

• The accelerating digitization of financial services and growing competition from agile fintechs and digital-only banks threaten Lloyds' ability to retain market share without significantly higher technology investment, resulting in escalating IT and compliance costs that are likely to constrain future net margin expansion.
  
• Lloyds' overreliance on the UK mortgage and retail banking market leaves the group highly vulnerable to a domestic economic downturn or a sharp correction in property values, which would directly impair loan growth, revenue generation, and asset quality, particularly as the back book mortgage spread advantage dissipates over the coming quarters.
  
• Ongoing and increasing UK and EU regulatory scrutiny-particularly related to climate risk, sustainable finance, and consumer protection-will necessitate stricter lending criteria and higher compliance expenditures, eating into profitability and placing downward pressure on both earnings growth and return on tangible equity.
  
• Continued dependence on legacy IT infrastructure and the need to accelerate digital transformation to keep pace with industry innovation will require substantial ongoing capital expenditures; these operational challenges heighten execution risk and threaten to erode efficiency gains, limiting future cost-to-income improvements.
  
• Structural industry headwinds, including demographic shifts such as an aging UK population that is less likely to increase borrowing and more likely to require costly wealth deaccumulation solutions, pose long-term threats to loan demand and top-line revenue growth for Lloyds, challenging its strategy to outpace sector growth and undermining future earnings visibility.

Lloyds Banking Group Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Lloyds Banking Group compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Lloyds Banking Group's revenue will grow by 7.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 22.9% today to 22.1% in 3 years time.
• The bearish analysts expect earnings to reach £4.9 billion (and earnings per share of £0.09) by about August 2028, up from £4.1 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 8.8x on those 2028 earnings, down from 11.8x today. This future PE is greater than the current PE for the GB Banks industry at 8.7x.
• Analysts expect the number of shares outstanding to decline by 3.85% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.33%, as per the Simply Wall St company report.

Lloyds Banking Group Future Earnings Per Share Growth

Risks

• Lloyds is delivering robust and broad-based income growth, with a 6% increase in net income and 9% growth in other operating income, supported by strong performance in both retail and commercial divisions, leading to improved revenue and profit potential.
  
• The company's ongoing digital transformation, efficiency programs, and investment in AI have resulted in significant cost reductions and productivity gains, allowing for a flattening cost base and improved operating leverage, supporting higher net margins over time.
  
• Lloyds maintains a strong capital position, with substantial capital generation (86 basis points in H1) and a CET1 ratio of 13.8%, enabling consistent dividend growth and share buybacks, directly benefitting shareholder returns and earnings per share.
  
• Strategic diversification into insurance, pensions, and wealth management, combined with continued innovation in bancassurance and protection products, is driving recurring fee-based revenue growth and stability in earnings, lessening reliance on net interest margins alone.
  
• Positive UK macroeconomic fundamentals, including resilient household and business finances, supportive government policy, and an attractive backdrop for the housing market, underpin opportunities for Lloyds to outpace wider UK economic growth, supporting top-line growth and long-term earnings resilience.

Valuation

• The assumed bearish price target for Lloyds Banking Group is £0.65, which represents two standard deviations below the consensus price target of £0.89. This valuation is based on what can be assumed as the expectations of Lloyds Banking Group's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £1.0, and the most bearish reporting a price target of just £0.53.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £22.1 billion, earnings will come to £4.9 billion, and it would be trading on a PE ratio of 8.8x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of £0.81, the bearish analyst price target of £0.65 is 25.0% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.