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Lloyds profits are below expectations, but costs fall and it is ready for Brexit

Lloyds Banking Group PLC CEO Antonio Horta-Osorio said the bank had reshaped its loan book ahead of Brexit and announced it would meet cost-cutting targets sooner than planned.

Horta-Osorio was speaking on a Feb. 20 earnings call after the lender reported profit below expectations. He said the the bank will buy back £1.75 billion of shares, slightly below the £2.00 billion that had been expected but ahead of last year's £1.00 billion program. Combined with a 5% increase in its dividend for the year to 3.21 pence per share, this added up to a £4 billion boost to investors. Lloyds' net profit rose 24% to £4.4 billion but this was below the company-provided average of analysts' forecasts of £4.6 billion.

Nevertheless, the bank's share price rose sharply 3.76% in late morning trading in London and was up 4.95% in mid-afternoon trade.

'The $1 million question'

Horta-Osorio said the bank made no change in its assumptions of bad loans ahead of Brexit. The U.K. is on course to quit the European Union on March 29 without an agreement on the terms of its withdrawal with potentially serious implications for the economy.

He called the uncertain cost implications surrounding Brexit the "$1 million question" but said the bank was well-prepared. It worked on the assumption that there would be an orderly Brexit, with the U.K. leaving under the terms of a withdrawal agreement, though he also said the bank was ready for a no-deal Brexit, too.

"If you are a retail and commercial bank the preparations for the event of a hard Brexit cannot be done in three, six or nine months because we are an accrual bank. When we look at our core loan book it is £444 billion, the same amount as eight years ago. But we have less large corporate [loans], less large mortgages in London and we have more credit cards, more car finance, more small and medium-sized enterprise loans," he said.

Horta-Osorio said Lloyds increased its loans to startups and SMEs by £3 billion in 2018.

The bank did not make any additional impairments in expectation of a post-Brexit downturn, unlike rival banks HSBC Holdings PLC and Royal Bank of Scotland Group PLC. Nevertheless, impairments for the year also increased to £937 million from £795 million, mainly due to the inclusion of the MBNA credit card book it bought in 2017.

Horta-Osorio said the British economy remained fundamentally strong, with record employment, eight years of GDP growth and pay growth, too, which would support the bank's business.

'Success is intertwined with the prosperity of the UK'

"We are the largest retail and commercial bank in the U.K. and our success is intertwined with the prosperity of the U.K. Our support to the U.K. economy is unwavering and we have committed to lend £18 billion to U.K. businesses in 2019," Horta-Osorio said.

Nevertheless, he said business investment was falling as uncertainty over Brexit increased as the deadline for the U.K.'s exit from the EU approached, echoing comments made by other U.K.-based banks such as RBS.

The bank said operating expenditure was expected to come in at £8.00 billion for full year 2019, compared with £8.17 billion for 2018. Lloyds said its return on tangible equity stood at 11.7% and it was on target for a rate of 14% to 15% in 2019.

The bank made a £1 billion strategic investment in digitizing its business last year, which Horta-Osorio said would continue. "These are not one-off costs, the digital world is a reality," he said.

Lloyds is the U.K.'s largest digital bank with 15.7 million digital customers, and digital channels now account for 74% of sales.

Payouts and whistleblowers

The group set aside a further £750 million for Payment Protection Insurance costs, of which £200 million was in the fourth quarter. This brings Lloyd's total PPI payout provision pot to £19.43 billion.

Banks have to repay customers who did not want, need or understand loan insurance taken out in previous years. Lloyds has sold about 16 million PPI policies since 2000 and said it had settled or provided for about 53% of the policies sold.

During 2018, Lloyds paid compensation to a whistleblower, Sally Masterton, who was forced out of the bank after her internal report in 2013 heavily criticized the bank's handling of a fraud at its HBOS PLC branch in Reading. Six people were jailed for a total of 47 years after scores of small businesses were ruined.

The fraud, corruption and money laundering took place before the acquisition of HBOS by Lloyds in 2008. However, the report warned that the lender had received but failed to act on information about the fraud from customers and from internal investigations. This allegedly occurred while Horta-Osorio, who took over at Lloyds in 2011, was CEO.

Lloyds said it had completed its compensation assessment program for 71 businesses of its HBOS branch in Reading and more than 96% of the offers had been accepted. In total, more than £96 million has been offered in compensation of which £78 million has been accepted, in addition to £9 million of ex-gratia payments and £5 million for the reimbursement of legal fees.

In December 2018, members of Parliament called for the resignation of Horta-Osorio over the bank's handling of the fraud, accusing it of mistreating the whistleblower and for creating a biased compensation scheme that MP Kevin Hollinrake called "an affront to any notion of natural justice." He called on the Financial Conduct Authority to investigate Horta-Osorio over his handling of the case.