I’m admitting it. I’m flip-flopping over the Lloyds Banking Group (LSE: LLOY) share price. On the one hand, it’s really cheap right now. At only 26p per share at the time of writing, it’s very attractive.
On the other hand, London-based hedge fund Marshall Wace has taken out a huge £100m short position on it.
This means the fund is speculating a large amount of money on the Lloyds share price going even lower. And it’s quite a statement.
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Lloyds certainly has its challenges. But, for an investor looking for bargain shares, the best time to buy them to maximise returns is when the market is bearish on them. Like it is now.
So, what to do?
Lloyds share price factors
Lloyds stock started this year around 60p. It halved in value over the first quarter and isn’t yet showing any signs of recovery.
But actually, for banking shares this isn’t unusual right now. Higher loan losses and interest rate cuts have hit the sector hard. Indeed, bank peers HSBC and NatWest are also struggling with similar capital problems.
Moreover, with the economy threatening potential rises in unemployment figures, capital gains are unlikely to occur anytime soon. This is true especially for Lloyds, which, as the UK’s biggest mortgage lender, will not want to see a housing market crash.
However, some economists believe that these fears are overstated. If they’re right, the Lloyds share price at 26p, priced at only half the bank’s net tangible asset value, may become very desirable.
And even if it doesn’t, if the bank ‘goes under’, shareholders could claim some cash back. Incidentally, the 0.5 price-to-net tangible asset per share ratio is similar to the bank’s position after the financial crash in 2009. And, notably, it recovered.
But I think this fear is groundless at the moment. The vast majority of Lloyds’ loans are backed by assets, its capital levels are good, and it’s set aside £3.8bn for bad debts. Moreover, at 6.1%, its return on equity (ROE) is higher than both Barclays and HSBC. This indicates its management is using its assets wisely.
The bank and Brexit
Curiously, one of the macroeconomic factors in Lloyds favour may be Brexit. Whereas there’s been much discussion of the negative impact of Brexit on financial services generally, its notable that Lloyds’ chair, Norman Blackwell, is a vocal Brexiter. Indeed, it was pretty clear to Blackwell that a free trade agreement would be on the cards pretty early on. And no doubt, the bank is planning for one.
Moreover, depending on what is agreed between the UK and the EU, banks with operations inside the EU will be affected to at least some extent. But Lloyds, with 97% of its revenues coming from within the UK, has far less to worry about. Consequently, a ‘no-deal Brexit’ may be less of a problem for the bank than for its peers.
So, despite the risks, it’s unsurprising that other hedge funds, such as Chicago-based Harris Associates, are building their stakes in the bank. Lloyds, after all, is a cautious lender with a big market share and is in one of the better positions to ride out Brexit.
Lloyds stock is not without its risks. But, at 26p per share, I think they’re affordable. So, on balance, I’m buying.
