The Lloyds Banking Group (LSE:LLOY) share price has dropped 10% in just three months. Its a fall that reflects fears over how the stalling economy will hit the FTSE 100 firm’s profits.
At current prices, the Black Horse Bank seems to offer unmissable value though, at least on paper. It trades on a forward price-to-earnings (P/E) ratio of 6.1 times. Meanwhile, its dividend yield for 2023 sits at 6%.
So should I buy cheap Lloyds shares to boost my passive income?
Growing pressure
Retail banks like Lloyds have long been havens for investors seeking extra income. The products they provide are essential in keeping the economy ticking over. This gives them the ability to pay decent dividends in normal times.
But in extraordinary economic periods like today, their profits can sink. And this can have a big impact on the level of dividends they’re able to shell out.
I worry about investing in Lloyds because it faces a steady rise in loan impairments over the short-to-medium term. The Financial Conduct Authority (FCA) said this week that a staggering 10.9m Britons were struggling to pay bills in January. That was an increase of 3.1m from eight months earlier.
It’s likely that the number of people struggling has kept rising since the start of the year too. Inflation remains in double digits and the Bank of England has kept hiking interest rates.
The burden on Lloyds — which racked up another £242m of charges related to bad loans in quarter one to help cash-strapped customers — is growing as well. The FCA also announced: “We’ve told lenders that they should provide support tailored to your needs“, and the body has rapped 32 lenders over the knuckles so far and told them to change the way they treat customers.
Interest rates
In better news for Lloyds, the Bank of England (BoE) looks poised to keep hiking interest rates long into 2023. Higher rates are good for banks as they raise the difference between the interest they offer to savers and charge borrowers.
Consistent policy tightening by the BoE pushed Lloyds’ net income 15% higher in quarter one, to £4.7bn. The market currently expects interest rates to rise to 5% from current levels of 4.5%. Though if inflation remains ‘sticky’, there’s a chance they could even beat these lofty predictions.
The trouble is that retail banks could struggle to grow revenues once the central bank’s rate-tightening cycle ends. As the UK economy flails, demand for loans, mortgages, credit cards and other financial products is likely to remain weak.
There’s also mounting pressure from the FCA, consumer groups and MPs for banks to pass on the benefits of higher rates to savers. Even if the BoE keeps raising its benchmark the benefits to Lloyds and its peers may be limited compared to what we’ve already seen.
The verdict
As I say, Lloyds shares offer excellent value at first glance. But I still believe the risks of investing in the FTSE firm remain too high. I’d rather buy other cheap UK shares for my portfolio.
