Up 22% in a year, here are 2 risks I now see for the Lloyds share price

On common valuation metrics, the Lloyds share price looks like a potential bargain. Christopher Ruane explains some risks that hold him back from buying.

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It has been a rewarding 12 months for shareholders in banking giant Lloyds (LSE: LLOY). Not only has the Lloyds share price moved up 22%, the FTSE 100 share currently offers a 5.5% dividend yield to boot.

Over five years, however, the share is down 13%. Over the longer term, well… Lloyds shareholders may not care to be reminded of the value destruction wrought since the millennium, when Lloyds shares changed hands for well over £3 apiece.

Cheap-looking valuation

Still, while it has been a rocky few decades, the current share price looks cheap on some metrics.

The price-to-earnings ratio of under eight looks like a possible bargain, in my view. For bank shares, a more common valuation metric is price-to-book value. Here again, Lloyds shares look cheap.

With the country’s largest mortgage book, a collection of well-known brands, and a strong recent track record of profitability, there is an argument that the Lloyds share price ought justifiably to be higher than it is.

I think that is potentially true. However, I see risks – and not managing risks properly has hurt Lloyds badly in the past.

Here are two that stop me from buying the bank share right now despite the possible value on offer.

Motor finance commissions review adds risks

The FCA has been conducting a review of commissions that were historically charged in the motor finance industry.

In the first nine months of this year, Lloyds recognised remediation costs of £124m in respect of this. That is not an insignificant amount, but is comfortably manageable for Lloyds.

Since its third-quarter update in September, however, a further court ruling has raised the spectre that banks including Lloyds could potentially face far higher costs in relation to this review than had previously been expected.

To some extent, we have been here before with British banks and the mis-selling of PPI (payment protection insurance). For now, there is no specific reason to expect that the scale of motor finance commission remediation costs will be anything like as high as was for PPI.

But we do not know what the final cost will be – and if the court ruling sticks on appeal, that may mean that the cost may be much higher than previously expected.

That could be bad for the black horse bank’s earnings – and helps explain why the Lloyds share price has tumbled 15% in little over a month.

Property market concerns

How is the property market doing – and what may happen next?

That is a question that is rarely far from the minds of some Lloyds shareholders, given the bank’s exposure to the sector through its large mortgage book.

Earnings and book value both rely on that book’s valuation assumptions being correct. If either is revised downwards, because property prices fall or mortgage delinquency increases (or both), the apparent bargain offered by the current Lloyds share price may be less of a bargain than it first seems.

For now, the property market continues to perform fairly well despite higher interest rates. But if that changes for the worse, I see a risk to the investment case for Lloyds.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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