Last week, billionaire hedge fund manager Crispin Odey proclaimed in his quarterly letter to investors that the FTSE 100 could lose as much as 80% over the next few years as the UK pulls itself away from the EU.
Such a broad-based sell-off would catch all of the FTSE 100’s constituents, including retail banking giant Lloyds (LSE: LLOY). But is this scenario really likely to play out, or is it just scaremongering?
Truth or scare?
If shares in Lloyds were to fall by 80% the bank’s market capitalisation would collapse to less than £10bn and the financial stability of the group would be called into question. In reality however, this scenario is extremely unlikely. Indeed, even during the darkest days of the financial crisis, shares in Lloyds never fell below 10p — an 80% drop from current levels. Before the bank’s market value dropped to this level (a level which might spark fears of insolvency) the government stepped in to help with a bailout.
Compared to 2008, today Lloyds’ financial position is a world apart. We will never be 100% informed on what assets the bank does and doesn’t hold on its balance sheet although, with a Tier 1 capital ratio of 13.4% of the end of Q3, the bank is well placed to weather any economic turbulence that may come as a result of Brexit.
That being said, Lloyds is the UK’s largest mortgage lender, and due to the leveraged nature of mortgages, the bank is highly sensitive to any changes in the UK property market. A small fall in home values could have a large adverse impact on Lloyds’ balance sheet.
Still, the European banking sector stress tests conducted earlier this year showed that under stressed conditions, which includes a substantial fall in home prices, Lloyds’ Tier 1 capital ratio would only decline to 10.1%, comfortably above management’s minimum capital requirements.
Highly unlikely
Considering the above then, on a fundamental basis, it’s very unlikely that shares in Lloyds could fall by 80%. The bank’s fundamentals are some of the strongest in the European banking sector, so if anything were the wider FTSE 100 to take a tumble, Lloyds should attract buyers as a haven in an uncertain market.
It seems that a lot of bad news is already baked into Lloyds’ share price. City analysts expect the bank’s earnings per share to fall by 16% this year and a further 8% during 2017 as low interest rates and increasing competition eat away at profitability. Thanks to these downbeat forecasts, the shares have been marked down and currently trade at a depressed multiple of 8 times forward earnings making Lloyds one of the cheapest stocks in the FTSE 100.
What’s more, the shares offer a dividend yield of 4%, and the payout is covered 3.8 times by earnings per share. Looking at these figures, if anything now is the time to buy not sell Lloyds.
