The Lloyds Banking Group (LSE:LLOY) share price is still tumbling as fears about the UK economy rise. It’s down 3% over the past week, and the scale of investor nervousness means further weakness should be expected.
Having said that, the FTSE 100 share is attracting some strong interest from dip buyers. In fact it’s the fifth-most-popular buy among Hargreaves Lansdown customers during the past seven days.
On the one hand it’s not difficult to see why. Lloyds shares now trade on a forward price-to-earnings (P/E) ratio of 5.6 times. On top of this, its divided yield for this year stands at 6.5%.
But I’m not preparing to buy The Black Horse Bank for my portfolio. Here are several reasons why I’m avoiding it today.
1. Surging impairments
It’s clear the UK economy faces an uphill struggle in the short-to-medium term. The cost-of-living crisis looks set to last well into 2024 as high inflation continues, putting pressure on individuals and on businesses.
It’s no wonder that credit impairments have been soaring at UK retail banks. Lloyds has had to set aside around £1.8bn since the beginning of 2022 to cover bad loans. I’m expecting another round of profits-sapping defaults to be announced when half-year results are released on 26 July.
2. Weak loan growth
Soaring prices mean that interest rates are tipped to keep increasing. City analysts now expect rates to peak at 6.5%, up from 5% at present. So Lloyds can expect its net interest margin, or NIM — the difference between the interest it charges borrowers and pays savers — to keep rising.
However, higher interest rates also threaten demand for loans, credit cards and other financial products as they become more expensive. Mortgage product demand in particular might sink as the cost of servicing these high-value loans becomes unmanageable.
Mortgage approvals are weak and fell to their lowest level since the financial crisis in April. This is a big deal for Lloyds given its position as the country’s biggest home loan provider.
3. Rising regulatory pressure
Meanwhile, the pressure on banks to better pass on higher interest rates to savers is growing. Thus the impact of higher NIMs in offsetting more impairments and weak loan growth threatens to be much reduced looking ahead.
In recent days, MPs on the Treasury Select Committee have accused lenders of “profiteering” by raising loan costs more quickly than savings rates. The Financial Conduct Authority (FCA) has also called on high street banks to “accelerate” steps to boost saver benefits.
4. Huge competition
Lloyds and its peers may be forced to hike savers’ rates anyway given the high degree of competition they face. The FCA in recent weeks said it’s “increasingly seeing customers switching” in the quest for better returns on their cash.
Intense competition from challenger banks and building societies is also raising the pressure on banks to offer better lending rates, putting further strain on their margins.
As I say, Lloyds shares look extremely cheap on paper. But I believe this is a fair reflection of the huge array of risks it poses to investors. So I’m buying other FTSE 100 shares following recent market volatility.
