Credit Update: Lloyds Banking Group maintains strong performance amid lower rate

The group offers a broad range of financial services, with a dominant mortgage business and a strong market share across credit cards, unsecured lending and commercial banking.

As of 15 August 2025, Lloyds remains the third-largest bank in the UK, with a market capitalisation of approximately £49.47 billion.

Chart 1: Market cap of top 5 banks in the UK (in £ billion)

Industry Outlook

UK economic growth (gauged by real GDP growth) is expected to be around 1.0% YoY in 2025, reflecting persistent headwinds such as high unemployment and elevated interest rates, which continue to weigh on housing activity and corporate investment.

That said, house prices have shown signs of stabilisation in 2025 after softening through 2023–2024.

Major UK banks anticipate the possibility of further rate cuts during the remainder of 2025 and we expect lower interest rates to provide some relief to the economy by supporting employment and boosting lending activities. However, the magnitude of rate cuts will be limited as a more accommodative monetary stance could risk reigniting inflationary pressures.

Nonetheless, we expect Lloyds’ asset quality to improve in FY25/FY26, supported by an easing monetary backdrop, given its significant exposure to the UK mortgages market.

Chart 2: UK macro data (as of June 2025)

As shown in Chart 3, the UK household debt to disposable income ratio saw significant improvement as of March 2025, indicating that on average, overall households are generally in a stronger financial position with a better balance sheet. 

Chart 3: UK household debt to disposable income ratio (%)

Slightly higher NIM in 1HFY25 despite lower rate environment

Operating costs rose slightly by 4% YoY to approximately £4,900 million, reflecting inflationary pressures, strategic investment and business growth expenditure. However, the group managed to reduce its cost-to-income ratio to 55.10% (1HFY2024: 57.10%), as income growth outpaced the rise in operating costs.

Considering the Bank of England’s aggressive rate cuts in 2025 (including a further reduction on 7 August 2025 to 4.0%), and with the market expecting two additional cuts during the remainder of the year, we expect the group’s net interest margin to moderate slightly in FY2025.

Table 1: Profitability indicators (£m, unless otherwise stated)

Source: Company’s Reports, iFAST Compilations. Data as of 30 June 2025.

In 1H2025, the group has reaffirmed its 2025 guidance:

• Underlying net interest income of c.£13.5 billion (1H25: £6.7 billion)

• Operating costs of c.£9.7 billion (1H25: £4.9 billion)

• Asset quality ratio of c.25 basis points (1H25: 19 basis points)

• Return on tangible equity of c.13.5% (1H25: 14.1%)

• Capital generation to be c.175 basis points (1H25: 86bps)

Considering the group’s growing structural hedge contribution and solid loan growth, we believe it remains on track to meet its target, despite our expectation of a moderation in net interest margin in FY2025

Lloyds has consistently maintained stable asset quality and capital position

Lloyds Banking Group’s asset quality ratio* remains healthy despite a slight increase to 0.19% in 1HFY2025. This was mainly because the ratio is doubled to present the annualised figure as required. Without this adjustment, the group’s asset quality ratio would have remained at 0.10% in 1HFY2025. Additionally, the group has consistently maintained stable non-performing loan ratio of around 1.80% area in the past.

_{*Asset quality ratio = (underlying impairment charge / average gross loans and advances). The ratio measures the overall quality within a bank’s asset portfolio.}

The group’s Stage 3 coverage ratio has declined in recent years; however, this does not imply that it has reduced its cushion against bad loans. In fact, most of these loans are secured by collateral (such as properties), which allows the group to recover funds in the event of borrower default. As a result, the group does not need to set aside as much additional provision.

As shown in Table 2 below, the group has maintained a healthy asset quality ratio over the past few years. The negative figures in FY2021 were mainly due to a change in reporting standards, while the higher ratio of 0.32% in FY2022 reflected a temporary deterioration.

Investors should also be aware that about 70% of the total loan book comprises mortgages, highlighting the group’s significant concentration risk in the UK mortgage market. Despite its higher exposure to the mortgage book, the group’s expected credit loss (ECL) allowance remained broadly stable in the first half of 2025 at £3,545 million (31 December 2024: £3,651 million).

Furthermore, the group’s mortgage portfolio holds a moderate loan-to-value (LTV) ratio of around 45%, which provides additional comfort and suggests a decent recoverable value in the event of borrower defaults.

Chart 4: Non-performing ratio and Stage 3 coverage ratio (%)

Chart 5: Loan portfolio

In terms of capital, Lloyds recorded a slightly lower CET1 ratio of 13.80% compared with 14.20% in FY2024, staying on track with its ongoing target to reduce its CET1 ratio to around 13.0%. While CET1 ratio will moderate from 13.80%, the ratio remains above the regulatory requirement of 12% (even with additional 1% management buffer). The group intends to reduce its CET1 ratio to 13% as it aims to return more capital to shareholders through higher dividends and we do not see it as a sign of weaker capital base.

When compared with peers, Lloyds and Barclays have the lowest CET1 ratio buffer (CET1 minus regulatory requirement); however, we believe the group has the ability to withstand any unfavourable economic events.

Table 2: Capital and asset quality metrics (in %)

Source: Company’s Reports, iFAST Compilations. Data as of 30 June 2025.

Table 3: CET1 ratio comparison

Source: Company’s Reports, iFAST Compilations. Data as of 30 June 2025

Balance sheet underpinned by stable deposit and funding base

The group’s loans and advances have increased steadily over the past few years, and its loan-to-deposit ratio (“LTD” ratio) has been consistently maintained above 95%, indicating that the group is effectively utilising available deposits through lending activities to clients. However, a high LTD ratio may sometimes suggest liquidity risk, as bank relies more on deposits to fund loans which may create liquidity issues if there is a surge in withdrawal.

In Lloyds’ case, we think the high LTD ratio is a reflection of efficient balance sheet utilisation, rather than liquidity risk. The group has a proven track record of maintaining a high LTD ratio historically without facing material liquidity issues while having a resilient liquidity coverage

The Group continued to maintain a stable solvency profile during the period, with a liquidity coverage ratio (LCR) of 145%, well above the regulatory requirement of 100%.

Despite having the lowest net stable funding ratio (NSFR) of 127% among its peers, we view the group’s funding base as stable, given that it predominantly comprised of retail deposits. 

Table 4: Liquidity Coverage ratio comparison (LCR – in %)

Source: Company’s Reports, iFAST Compilations. Data as of 30 June 2025

Table 5: Net Stable Funding Ratio comparison (NSFR – in %)

Source: Company’s Reports, iFAST Compilations. Data as of 30 June 2025

Chart 6: Loans and advances to clients and loan to deposit ratio

Lloyds is very likely to reverse part of its provisions in the mis-selling case

The motor commission scandal involves several banks, including Lloyds, Santander and more, together with car dealers accused of charging unfair or misleading fees related to car loans and financing deals, which caused customers to pay more than they should have.

In 2024, Lloyds recognised a £450 million provision for the potential impact of the FCA review into historical motor finance commission arrangements, and a further £700 million was recognised in 4Q2024.

In August 2025, the Supreme Court overturned the ruling on car finance commissions and ruled that car dealers do not owe fiduciary duties to customers when arranging car loans. This means that the banks are less likely to face massive compensation claims related to the commissions paid to dealers even though the banks are still likely to face claims for overcharging in some cases. At this juncture, the FCA is working on a plan to compensate customers who were treated unfairly, but banks might not have to pay as much as feared.

In this context, Lloyds could potentially reverse part of its provision, as it is now less likely to face large-scale compensation claims.

Risks to consider

Highly concentration in UK market: Unlike many of its peers, Lloyds Banking Group has limited geographical diversification, with its business largely concentrated in the UK. As a result, the group’s performance is heavily tied to the performance of the UK economy, making it less competitive compared to internationally diversified peers such as HSBC

Liquidity risk: Lloyds’ loan-to-deposit ratio is relatively high. While this reflects efficient use of deposits, it also indicates a potential vulnerability: in the event of significant deposit withdrawals or a bank run, the Group could face financial strain.

Our view

Lloyds Banking Group continues to demonstrate resilient operating performance, underpinned by higher average interest-earning assets, improved margins, and stable asset quality. The Group’s capital and liquidity positions remain resilient, providing sufficient buffers to absorb potential headwinds (like residual impact from the motor finance commission review). However, we remain optimistic on this case as the recent Supreme Court ruling has largely reduced the likelihood of large-scale compensation payouts. 

That said, investors should remain mindful of certain risks. Lloyds’ heavy concentration in the UK market leaves it more sensitive to shifts in the UK economy compared with more diversified peers. In addition, its relatively high loan-to-deposit ratio, while reflecting efficient use of deposits, could expose the Group to liquidity pressures in the event of sudden funding outflows.

On balance, despite exposure to certain risks, we view that Lloyds’ overall performance remains resilient. We advocate investors to consider its medium-to-long term issuances.

Investors may consider Lloyds’ existing issuances — LLOYDS 7.086% 31Aug2033 Corp (AUD) and LLOYDS 5.189% 28May2031 Corp (AUD) — as the yield offered is relatively appealing, at around 4.99% and 4.76% respectively.

For investors who prefer USD, you may consider LLOYDS 3.574% 07Nov2028 Corp (USD), which is yielding around 4.2%.

For GBP investors, you may include LLOYDS 2.000% 12Apr2028 Corp (GBP), with a yield to call of 4.48%. Additionally, LLOYDS 7.500% Perpetual Corp (GBP) could also be a good choice, as we believe the risk–reward profile is justified with yield to call of approximately 7%. However, investors should be aware of the risks associated with perpetual bonds (e.g., interest deferral).

Table 6: Bonds*

*Liquidity subject to market conditions

Source: BSM, iFAST Compilations. Data as of 28 Aug 2025

Investors have to note that LLOYDS 7.086% 31Aug2033 Corp (AUD) is a Tier 2 bond, the seniority is 1 rank higher than AT1 securities.

There are few things that investors should also be aware of:

1)      We would like to highlight that, due to the loss absorption feature inherent in Tier 2 bonds, these instruments may not be suitable for risk-averse investors.

2)      Issuer has the right to call back the bond in 3Y later, otherwise there will be a reset rate at 3M BBSW + 290bps.  In short, if Australia’s interest falls, the yield will be lower

Nevertheless, we expect the issuer to call back its Tier 2 securities on the first call date. Under the Basel III framework, Tier 2 securities that remain uncalled after this date are subject to amortisation. As a result, banks are incentivised to redeem their Tier 2 securities promptly.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.