Despite posting some of the biggest profits in years, Lloyds (LSE:LLOY) shares continue to sit below pre-pandemic levels. The near 6% dividend yield does provide some tasty income. But it seemingly pales in comparison to other companies in the FTSE 100 making more spectacular comebacks, such as Rolls-Royce.
So, should investors just pack their bags and move their capital to a different company? Or would selling now be a tragic mistake? Let’s investigate.
The bull and bear case
Rising interest rates may be causing havoc for mortgage owners. But lending institutions like Lloyds are breathing a sigh of relief after operating in a near-zero interest rate environment for over a decade. Subsequently, net interest margins are on the rise. And while profitability for the bank only improved by 27 basis points, that was enough to send the latest pre-tax profits surging to £3.87bn!
Obviously, that’s terrific news. More profit means bigger dividends for shareholders as well as more capital to issue new loans at higher rates. However, this is where problems may be emerging.
Many customers took on loans back when interest rates were significantly lower than they are today. And for those on a variable rate, the impact of such rapid rate hikes by the Bank of England is starting to be felt.
Loan defaults are on the rise. And while they seem to be relatively contained at this stage, there are fears of a domino effect eventually creeping in, especially if the UK falls into a recession.
What’s more, Lloyds’ profit margins may also be under fire. With other banks and fintech platforms offering higher rates on savings accounts, it’s starting to see its total deposits start to shrink. The bank may soon have to start offering higher rates to depositors to remain competitive. And that will most likely start to undo the recent progress made in expanding margins.
Time to sell?
Despite the impressive progress made by one of Britain’s leading banks, there seems to be an equal number of threats opposing its future potential. And that certainly creates a bit of a conundrum for investors.
In my experience, when faced with unclear outcomes for a business, it’s good to go back and review why I invested in the business to start with.
If I had bought Lloyds shares as a source of passive income, I don’t think there’d be any good reason to sell at this stage. After all, the bank remains critical to the functioning of the UK economy. And it seems to be more than capable of maintaining its current shareholder payout even if profitability stops improving.
On the other hand, if I’d bought shares as part of a turnaround strategy, then it may be worth exploring alternative opportunities. I’m cautiously optimistic that the bank will eventually recover to pre-pandemic levels. But there’s a giant question mark as to when this may happen. And it could take far longer than other top-notch firms in the midst of a turnaround.
