Here’s why the Lloyds share price continues to tumble

Interest rates are on the rise, yet the Lloyds share price continues to drop. Zaven Boyrazian explains what’s going on with the banking stock.

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The Lloyds (LSE:LLOY) share price hasn’t exactly been on a great run of late. In fact, despite rising interest rates (which are beneficial to banks), the stock has dropped by almost 15% since the start of 2022.

This disappointing performance has brought the 12-month return to a lacklustre -8%. But why is this happening? And should I be looking at this fall as a buying opportunity or a sign to stay away?

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Investigating the potential problem

Lloyds has a lot of moving parts, so there are undoubtedly plenty of factors influencing its share price. However, the main catalyst behind its recent decline seems to stem from inflation.

UK inflation currently stands at around 6.2%, with the Bank of England predicting it could go as high as 10%! That’s obviously bad news for consumers. But for banks, the subsequent rise in interest rates allows profit margins on lending activity to expand significantly. With more money rolling through the door, most would assume the stock to rise. So why isn’t it?

A small amount of elevated inflation is good for banks. But too much and problems emerge. The drop off in consumer spending in inflationary environments can lead to an economic slowdown. With the revenues of both small and big businesses suffering and the cost of debt rising, borrowing activity begins to suffer. In other words, Lloyds’ wider margins are meaningless if fewer people start taking out loans. And if a recession comes along, then the impact only gets amplified.

Can the Lloyds share price bounce back?

In the short term, the situation seems bleak for Lloyds and its share price. But as a long-term investor, that’s of little consequence to me. And looking at the latest quarterly results, it appears most investors are letting their fear get the better of them.

Over the last three months, total customer loans increased by £3.2bn, half of which originated from new mortgages. That brings the total outstanding loans to £451.8bn. And that indicates both consumers and businesses are still using the bank’s lending services, despite the higher cost.

Meanwhile, margins on lending activity, unsurprisingly, have climbed from 2.49% to 2.68%. When combined with the rise in lending activity, net income for the period came in at £4.1bn – 12% higher than a year ago.

This is brilliant news, despite what the Lloyds share price would suggest. And it seems management agrees because it just raised its full-year guidance for 2022. By the end of the year, net interest margins are expected to continue rising beyond 2.7%, while return on equity will climb above 11%.

Time to buy?

In my opinion, Lloyds looks like a fine addition to my portfolio, especially with its share price trading at a relatively tiny P/E ratio of 5.7. The risk of a recession still poses a potentially severe near-term threat. But given the bank’s financial standing, I doubt it will be disappearing any time soon. That’s why I personally think the risk is worth the reward.

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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group. 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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