Lloyds (LSE:LLOY) shares disappointed me slightly on Wednesday morning. The bank posted flat pre-tax profits of £6.9bn — a considerable figure, but I had expected more.
Despite being a little surprised by the results, I think investors should be diving into Lloyds shares, which are priced at 51p at the time of writing.
Let’s explore why.
Strong results
I thought we’d see Lloyds’ pre-tax profit push upwards year on year. There were several reasons for this, but primarily it’s because I didn’t expect the bank’s impairment charges — £1.5bn — to be as high as they were. These have proven considerably higher than its peers.
However, there were some real positives in the results. The net interest margin (NIM), essentially the difference between lending and saving rates, rose 40 basis points to 2.94% — above forecasts of 2.9% at the end of the year. Lloyds is now targeting more than 3.05% for 2023.
In 2022, net income rose 14% to £18bn, driven by higher rates. It’s important to note that Lloyds has greater interest rate sensitivity than its peers due to its funding composition and the lack of an investment arm. Mortgages are the bank’s bread and butter. So, with that in mind, we can hope to see net interest income grow over the next year.
The bank is now targeting a return on tangible equity of more than 15% by 2026 against a prior aim of greater than 12%.
What makes me want to buy more?
I’m bullish on banks, despite a less than ideal macroeconomic backdrop at the moment. The primary reason for this is higher interest rates.
I’m not expecting higher interest rates to fall away as quickly as some analysts may have originally thought. That’s because inflation is proving stickier than many anticipated and the economy is proving resilient to higher rates.
Moreover, it worth adding that banks employ hedging strategies to smooth out central bank rate rises. And many borrowers will be on fixed rates that were agreed on prior to 2021. Essentially, I believe net interest income still has further to go.
Of course, I have concerns about the state of the UK economy. And this is a very UK-focused bank with mortgages representing a considerable part of the portfolio. That could be seen as a lack of diversification. To some investors, this focus on UK mortgages can also mean Lloyds is a bit boring — but that’s something I like.
Nevertheless, there are some efforts to diversify. Through the brand Citra Living, Lloyds intends to buy 10,000 homes by 2025, and 50,000 homes by 2050, entering the buy-to-let market. It will see additional revenues from strategic initiatives of £700m by 2024, and £1.5bn by 2026, the bank said in its report.
I’m also buying more stock in Lloyds because I’m confident in an improving macroeconomic outlook for the UK. Better trade agreements with Europe and less stringent regulations in the financial sector could also provide a handsome boost for Lloyds going forward.
