Profits and dividends at Lloyds (LSE: LLOY) have gone from strength to strength over the last few years. Meanwhile, the share price has gone nowhere. Indeed, it’s down 16% so far this year, and is 36% below its post-financial-crisis high made in the summer of 2015.
The FTSE 100 firm posted a forecast-beating profit in its Q3 results on Thursday. But the shares remain mired below 60p. I’ve been bearish on the stock for a good while, but has it become too cheap to ignore? Its price-to-tangible-net-assets ratio of 1.1 appears low for a thriving bank. Its forward price-to-earnings ratio of 7.5 is in the bargain basement. And its prospective dividend yield of 5.7% is appealingly high. What’s not to like?
Canaries in the mine
My main concern about Lloyds is the risk posed by the historically unprecedented UK consumer debt bubble. Wages have fallen in real terms since the financial crisis but consumers have continued to spend, helping to keep the economy ticking by running down their savings and racking up debt to staggering levels. I don’t see this as sustainable.
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In its Q3 results on Thursday, Lloyds said: “Credit quality across the portfolio remains strong with no deterioration in credit risk.” And this was echoed by Royal Bank of Scotland on Friday, which said: “Underlying credit conditions remained benign during the quarter.”
However, it’s the nature of bubbles that everything looks fine until they burst. But I do see some indications that the bubble may be getting stretched. The table below shows a rising trend in Lloyds’ rolling 12-month impairment of loans for each quarter since the start of 2017.
| Q1 2017 | Q2 2017 | Q3 2017 | Q4 2017 | Q1 2018 | Q2 2018 | Q3 2018 | |
| Impairment (£m) | 623 | 668 | 734 | 795 | 926 | 983 | 997 |
And I’m spotting canaries in the mine elsewhere. For example retailer Next, which has a £1.1bn customer debtor book, recently reported the emergence of “a leading indicator for increasing bad debt rates.”
Paragon of prudence
As Warren Buffett said when the last financial crisis hit: “You only learn who has been swimming naked when the tide goes out.” Close Brothers is a fine example of a conservatively-managed bank. It was able to maintain its dividend through the last crisis. How does Lloyds’ current positioning compare with that of this paragon of prudence?
In its quest for growth, Lloyds has upped its unsecured lending, notably with the acquisition of UK consumer credit card business MBNA last year. In the current year to date, the Black Horse has increased credit card lending by £600m to £18.5bn. At the same time, retail unsecured loans and ‘retail other’, which includes overdrafts, were each up £100m to £7.9bn and £9.5bn, respectively. Motor finance is also a current growth focus. Lending is up £900m since the start of the year to £14.4bn, with £500m of that coming in Q3.
In contrast, Close Brothers has recently reduced its exposure to unsecured lending, selling a business it had developed in the unsecured retail point-of-sale finance market. And while Lloyds is revving up UK motor financing, Close Brothers was recently content to report a small contraction in its car loans book, noting “we continue to prioritise margin and credit quality in a highly competitive market.”
On balance, I’m not quite persuaded that Lloyds’ cheap valuation is cheap enough for the potential risks ahead. As such, I’ll continue to avoid the stock at this stage.
