The bank is cheap, but could it become cheaper?
As an investor I am, by my nature, a contrarian. I look for shares which have been beaten up, trashed and generally talked down. If a stock is out of favour and the background noise from investors is overwhelmingly pessimistic, I take an interest.
Bombed out
I can't think of a sector which is more bombed out currently than banking. In particular, Lloyds Banking Group (LSE: LLOY) has caught my attention.
We all know the story of the devastation that the credit crunch and the collapse of Lehman Brothers wreaked on the UK's banking sector. Before the crisis the then Lloyds TSB traded at around 260p. At the bottom of the stock market crash, it fell to 20p. It then gradually recovered to a high of 77p in September 2010.
At that point you might have thought that the worst was past and that banking stocks would steadily increase in value. In fact many people felt that the banks would be one of the big recovery plays of 2011.
Another setback
How wrong they were. Instead, there has been a torrent of bad news. In particular, Lloyds reported a loss of £3.5bn for the first quarter of 2011 after making a £3.2bn provision for mis-selling claims by customers who took out payment protection insurance.
Having made a profit of £2.2bn in 2010, this loss looked like a backward step for the company. This clearly was the market's view, as the share price took a pounding, falling from 77p to 48p, where it currently languishes as I write this article.
The stock now trades below book value. However, I am wondering whether the rather bipolar Mr Market has fallen into one of his depressive moods.
Certainly I suspect that there is more than an element of 'kitchen sinking' by new chief executive Antonio Horta-Osorio, who took over from Eric Daniels on 1 March.
And other numbers indicate a more optimistic picture. The bank's core business showed growth as customer loans and deposits rose from £842bn to £848bn. According to Ralph Silva, banking analyst at SRN, "The bank as a whole appears to be getting better and appears to be taking a larger market share".
Yes, it is true, the bank will have to dispose of over 600 branches, but we have known this for some time. And there has been talk of ring fencing retail banks from 'casino banking', but as Lloyds does not have a major investment banking arm it won't be affected by this increased regulation.
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The elephant in the room
However, having discussed all these possible negatives, the one elephant in the room is Europe's sovereign debt crisis. Greece seems to be heading inexorably to a default of some description, even if it is euphemistically termed a 'restructuring' or 'reprofiling'.
When this happens, the secondary effects will be hard to predict. Even if Lloyds does not have a big exposure to Greek debt, there is the possibility of contagion spreading through the markets. If this happens, all bets are off.
So if you do buy into Lloyds, you need to do so with your eyes wide open. This is a risky play, but could potentially be very rewarding.
My personal view is that there will be no 'Lehmans moment' which causes stocks to come crashing down as they did in 2009. Greece's problems have been too well signposted for the markets to be shocked.
Instead, I suspect Europe will muddle through with a limited, managed restructuring. Until this is done stocks will continue to edge downwards as they have been doing recently, and buying opportunities, such as the one for Lloyds, will start to appear.
Could Lloyds fall further? Well, undoubtedly. But the fact that the share price has held firm in the past couple of weeks as rumours of a Greek Tragedy have swirled round the markets suggests that we may be close to the bottom. And if there is better news from the 30 June update, the stock could even start an upward climb. However, timing the market is as much a matter of luck as judgement.
Looking at the big picture, the optimist in me sees the future potential of this group, with huge market shares in the UK in current accounts, savings, investments and mortgages. This company will, eventually, become one of the UK's biggest and, dare I say it, most profitable banks.
As for myself, I have put my money where my mouth is by buying into Lloyds. I see this as a long term play, and I hope to reap the rewards in several long years rather than in a few short months.
More from Prabhat Sakya:
> Prabhat owns shares in Lloyds Banking Group.
