Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown – Lloyds Banking Group plc (NYSE:LYG)

Brexit bravado

The Conservative leadership contest rumbles on and won’t be decided until 23 July. Both contestants have been trying to strengthen their “no deal” Brexit credentials with Boris Johnson talking of “do or die” (article) and Jeremy Hunt saying the sacrifice is necessary (article).

Unsurprisingly, amidst the uncertainty, UK domestic economic conditions aren’t improving and the latest data point to ongoing weakness in a number of sectors that are crucial for Lloyds (NYSE:LYG).

Lloyds has lagged UK peers over the last quarter

Source: FT Markets

Consumer credit growth hits are lowest since 2014

The Bank of England released credit data for May a few days ago. The most notable feature was another slowdown in the rate of consumer credit growth to 5.6% year-on-year. This is the lowest pace of growth since April 2014 and compares to a peak of 10.9% in November 2016. Over the last twelve months, consumer credit growth has slowed every month but one.

Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown - Lloyds Banking Group plc (NYSE:LYG)

Source: Bank of England

In other lending segments, the data also point to a subdued if stable picture.

In mortgages, the pace of loan growth in May was 3.2% year-on-year and consistent with the 3% level it has been at since late 2016.

Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown - Lloyds Banking Group plc (NYSE:LYG)

Source: Bank of England

In the small business sector (SMEs), lending growth in May was 0.4% and has been plus or minus zero percent since late-2017.

Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown - Lloyds Banking Group plc (NYSE:LYG)

Source: Bank of England

A final data point this week that is worth flagging is the IHS Markit construction purchasing managers’ index, which is a survey of industry executives that aims to measure activity levels in the construction sector. It fell to 43.1 in June (anything below 50 signals contraction), its lowest level since April 2009. The reading for May had been 48.9.

UK construction activity falls at the steepest rate since 2009

Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown - Lloyds Banking Group plc (NYSE:LYG)

Source: IHS Markit

Lloyds is more dependent on economically-sensitive lending segments than peers

There are several reasons why the data are particularly relevant to Lloyds.

The first is simply that Lloyds is the most UK-focused of the UK banks with more or less 100% of its lending being within the UK. It doesn’t have the capital markets diversification of Barclays (NYSE:BCS) or the Asian diversification of HSBC (NYSE:HSBC).

The second, which I’ve discussed in a previous article, is that in recent years, Lloyds has consciously chased growth in these most economically-sensitive parts of the domestic lending market, especially consumer credit.

Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown - Lloyds Banking Group plc (NYSE:LYG)

Source: company disclosures

Credit card lending has been by far the fastest growing part of Lloyds’ loan book since 2015, aided by the 2017 acquisition of MBNA. Growth has averaged 22% p.a. This is closely followed by 16% p.a. growth in other unsecured consumer lending and 9% p.a. in auto finance. Lloyds has also grown faster than peers in the SME corporate market. These are precisely the segments that are now showing the greatest slowdown according to the Bank of England data.

The reasoning behind this strategy is Lloyds’ dominant share of the UK mortgage market (~20%) and its industry-leading margins, which give it relatively little incentive to chase growth here.

UK mortgages still make up the majority of Lloyds’ loan exposures, but the importance of these other higher margin, higher risk segments have increased materially. Motor finance, consumer credit, and small corporate lending now account for ~15% of the loan book.

Lloyds Banking Group: Latest U.K. Credit Data Point To A Further Slowdown - Lloyds Banking Group plc (NYSE:LYG)

Source: company disclosures

Lack of top-line growth will hold back the shares

Admittedly, UK slowdown is probably “in the price” at this stage. Lloyds is not valued as a high growth stock and Street estimates for revenues over the next two years show annual expected growth of only 0.2% (against a UK banking average of 3.3%). This would be consistent with the company continuing to prioritise margins over volumes and allowing the mortgage book to shrink while it pursues (slowing) growth in more profitable non-mortgage lending segments.

Nonetheless, weakening credit statistics are still unhelpful and there are very few banks that have managed to post durable share price gains while their top-line is flat or shrinking. There is always a limit to how far earnings growth can be propelled by other sources i.e. cost cutting or lower loan losses.

This is why I think Lloyds will continue to struggle, even in spite of its cheap multiples (7x PE, 1x P/TNAV, 14% expected ROTE for 2019, 6% dividend yield rising to 10% with buybacks).

For investors looking for exposure to cheap UK banking stocks, I’d continue to favour Barclays (recent article here) or HSBC (here).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.