Worries over the British economy continue to sink the Lloyds Banking Group (LSE:LLOY) share price. But it’s not all bad news at the bank.
Sky-high inflation in the UK means the Bank of England (BoE) is tipped to keep hiking interest rates. So the profits the FTSE 100 firm makes on its lending activities could continue to surge.
As an investor I must weigh up these opposing tides and what these might mean to future profits. I also need to consider whether the risks facing the Black Horse bank are baked into its now-sunken share price.
On paper, Lloyds shares certainly look cheap. It trades on a forward-looking price-to-earnings (P/E) ratio of just 5.4 times, far below the FTSE average of 14.5 times.
It also offers plenty of value from an income perspective. Its 6.6% dividend yield for 2023 smashes the 3.8% average for FTSE 100 shares.
So is Lloyds the best UK blue-chip value stock for investors to buy?
Rate rises
As I mentioned, higher interest rates can be a boon to retail banks’ profits. They boost the difference between the interest firms offer to savers and what they charge to borrowers.
A series of sustained rate hikes by the BoE pushed Lloyds’ metric (known as the net interest margin, or NIM) to 3.22% in quarter one. This was up more than half a percentage point from the same 2022 period. And it pushed net income 15% higher year on year, to £4.7bn.
With domestic inflation still running hot, the City currently expects interest rates to hit 6.25%. That’s up from current 15-year highs of 5%. I think there’s a good chance this borrowing benchmark could end up exceeding these levels, though. The current BoE rate sits above what forecasters were expecting at the start of the year, after all.
Bad loans
But of course higher rates can cause other significant problems for Lloyds. They mean that demand for loans and credit cards could slump should consumers and businesses scale back spending and the economy weakens.
Economists at Bloomberg have predicted a year-long recession should the BoE lift rates even as high as 5.75%. In this scenario, the volume of bad loans at the banks (which rose an extra £243m at Lloyds in quarter one) could soar.
NIM pressure
It’s also possible that retail banks’ NIMs will not rise as strongly as some hope as rates rise. This is because the pressure on them to better pass the benefits of higher interest rates onto their savers is growing.
Last week Chancellor of the Exchequer Jeremy Hunt said banks are “taking too long” to boost savings rates. The Financial Conduct Authority has also launched an investigation into how the sector “is supporting savers”.
The traditional high street banks are also under duress to offer better savings rates as customers vote with their feet and take their money to one of the UK’s many building societies or challenger banks. The likes of Lloyds currently sit well below these rivals in the ‘best buy’ tables.
As I say, Lloyds shares look cheap on paper. But on balance I believe the bank’s low rating is a fair reflection of the colossal risks it faces.
