Lloyds (LSE:LLOY) shares haven’t been widely popular with investors for some time. That’s a shame as, in many respects, it’s one of the safest banking stocks.
To some investors, Lloyds’ operations might seem a little boring. It’s very focused on the UK market, and over the past decade, growth has been stunted by near-zero interest rates.
But things are changing. So, here’s why I’m buying more Lloyds stock for my portfolio.
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NIM tailwinds
Net interest margins (NIMs) are essentially the difference between savings and lending rates. The figure highlights the amount of money that a bank is earning in interest on loans compared to the amount it is paying in interest on deposits.
The NIM is a core indicator of a bank’s profitability and growth — this is especially true for banks that are focused on traditional lending.
And Lloyds is a bank that is heavily reliant on lending, rather than an investment arm or another business segment.
Mortgages make up around 65% of its loans to customers, and 95% of its assets are based in the UK. It is, therefore, dependent on movements with the UK housing market.
In the third quarter, interest income accounted for 74% of total income, coming in at £3.4bn. That’s 19% higher than the previous year and it’s because the bank’s NIM has been rising.
With central bank rates rising, Lloyds now expects its NIM to come in above 2.9% at the full-year mark. That’s up from 2.5% at the end of the last financial year.
In fact, the UK’s third-largest bank is even earning more interest on the money it leaves with the Bank of England (BoE). Lloyds had £145.9bn of eligible assets with £78.3bn held as central bank reserves at the end of the second quarter.
Analysts suggest that each 25 basis point hike in the BoE base rate will add close to £200m in treasury income solely from holdings with the central bank. So far, the base rate has increased 275 basis points this year.
Why isn’t Lloyds surging?
Lloyds is more exposed to the UK’s economic downturn than other banks. That’s why its impairment charges were approximately 75% higher than those of Barclays during the past quarter. Lloyds set aside £668m for bad debt caused by the impending recession — Barclays set aside £381m.
As noted, Lloyds is among the least diversified banks in the UK. It is attempting to generate new revenue streams, but for now it’s very exposed to a UK downturn and the mortgage market.
And this is why the bank’s share price isn’t surging. In fact, it trades with a price-to-earnings (P/E) ratio of just six.
The low P/E ratio reflects concerns about Lloyds’ lack of diversification. However, that won’t stop me buying more Lloyds shares. I’m backing a higher NIM to propel this bank’s profitability over the next year, and eventually the share price will follow.
