After a disappointing start to the summer, Lloyds Banking Group (LSE:LLOY) shares revved up again in July to four-and-a-half-year highs above 61p.
The Black Horse Bank rose 8% over the course of the month, boosted by a broader rise in the FTSE 100 and a better-than-expected set of interim results.
But it’s reversed during early August’s stock market washout. Does this represent an opportunity for me to grab a bargain?
I feel the answer is no. I’m not tempted to dip my toe in, even though the share price looks dirt cheap. It trades on a forward price-to-earnings (P/E) ratio of 9.1 times, making it one of the Footsie’s cheapest shares on this metric.
It also carries a 5.5% dividend yield for this year, far above the index average of 3.6%.
From a long-term perspective, I still think the bank has the makings of a potential investor trap. Here are three reasons why I’m avoiding its shares right now.
1. Falling NIMs
Falling interest rates could significantly massage loan growth at retail banks. It would also likely reduce the number of bad loans that roll in.
However, this would also limit the profits that the likes of Lloyds make on their lending activities. Net interest margins (NIMs) have been falling across the sector and look set to continue dropping if — as expected — the Bank of England keeps cutting interest rates.
In fact, the central bank may be forced to slash more sharply than expected if the UK economy struggles. This could be reminiscent of the 2010s when banks struggled to grow profits following the financial crisis.
2. Mortgage arrears
Improving conditions in the UK’s housing market have given banks something to cheer in recent months. Latest data from building society Nationwide, in fact, showed average home price growth hit 18-month highs in July.
This is good news for Lloyds. It is Britain’s biggest home loan provider and controls around a fifth of the market.
However, things aren’t all rosy for the mortgage market mammoth. This large exposure also leaves it hugely vulnerable to further significant loan impairments as homeowners move off low fixed-rate products and onto more expensive ones.
There were 96,580 homeowner mortgages in arrears in the first quarter, latest UK Finance data shows. That was up 26% from the same 2023 period and is a troubling omen for the country’s major lenders.
3. Rising competition
Margin pressures and loan defaults have been regular threats to Lloyds down the years. But unlike in previous decades, the banking sector is facing an unprecedented level of disruption from challenger and digital banks, putting revenues under even further strain.
Revolut’s receipt of a UK banking licence in July could alone provide a huge challenge for the incumbent banks. It has built a customer base of 9m people in less than a decade.
Lloyds still has significant brand power. But the market-leading customer scores of new players like Starling and Monzo suggests that high street operators like Lloyds are in a bloody fight to retain borrowers and savers and recruit new ones.
All things considered, I’m happy to leave Lloyds shares on the shelf. I’d rather look for other cheap UK shares to buy.
