Lloyds Banking Group (LYG) , the U.K.'s third-largest bank by assets, posted decent results Wednesday morning. Earnings per share were bang in line with expectations, at £0.02, and net interest income even delivered a beat. However, a closer look at the results and at the general conditions for U.K. financial institutions shows that this could be the end, not the beginning, of the improvement in banks' fortunes.
Lloyds posted net interest income of £3.19 billion ($4.18 billion) in the third quarter versus expectations of £3.1 billion, according to FactSet, and were up 12% from the same period a year ago. Net interest income is the bread and butter for retail banks as it is the main way they make money.
Net interest margin (NIM) -- net interest income as a percentage of average gross interest-earning assets for the period -- increased to 2.90% from 2.69% year on year in the third quarter. This result looks good, but it is hardly the bank's merit.
"The improvement in margin continues to be driven by lower deposit and wholesale funding costs, which more than offset continued pressure on asset margins," Lloyds said in its statement.
Congratulations to the Bank of England, then, for its continuing success in keeping interest rates at historically depressed levels in face of rising inflation, thus making it easy for banks to obtain financing in the wholesale markets and pay no interest to depositors. This policy has helped prevent an economic downturn after last year's Brexit vote, but its risks are starting to show up.
Lloyds' statement said the bank now expects NIM to remain stable at 2.9% in the fourth quarter and at 2.85% for the whole year. That amounts to an admission that Lloyds does not expect the central bank to increase interest rates in any meaningful way; if it did, it would have expected rising NIM, as commercial banks normally increase lending rates first, and only afterwards, with a lag, the rates they offer depositors.
Almost everyone in the market knows that the Bank of England's hands are now tied. Even if inflation exceeds the current 3% level, which is a full percentage point above its 2% target, the central bank will not be able to manage more than a symbolic rate hike.
Credit has been increasing so rapidly in Britain that any interest rate rise will put people in difficulty. A survey by the Financial Conduct Authority (FCA) released last week shows that half of U.K. adults present one or more characteristics of potential financial vulnerability.
A quarter of all U.K. adults, or 12.9 million, have been overdrawn in the last 12 months; 4.1 million are already in financial difficulty because they already have failed to pay domestic bills or meet credit commitments in three or more of the last six months.
But, if consumers cannot pay higher interest rates, perhaps banks could profit from increasing the volume of loans they extend? That would be tricky, too.
Rating agency S&P warned in a report released on Tuesday that "high credit growth in 2018 could negatively affect some U.K. bank and non-bank financial institutions' ratings." The annual growth rate of almost 10% for consumer credit since the beginning of 2016 has "significantly outpaced" both U.K. GDP growth and the rise in household income.
To achieve such a high loan growth rate, lenders must have been competing on pricing and underwriting standards, the rating agency said. "Lower credit quality and poorly seasoned portfolios could in time be revealed in higher loss rates and higher net consumer credit charge-offs, particularly if economic conditions deteriorate," it added.
U.K. bank investors, beware.