Well, I’ve been buying Lloyds (LSE:LLOY) shares for some time. Obviously, I didn’t manage to buy at the nadir, but pinpointing the turning point is near impossible. And as Warren Buffett says, net buyers benefit when share prices go down.
So, with shares in this lending giant pushing down to 42p, is now the right time to buy? Well unsurprisingly, as I’ve been buying at slightly higher prices, I think so. Here’s why.
How bad will it get?
Lloyds and other banks have fallen amid concerns about a defaults on loans as interest rates rise and the likelihood of a recession grows greater with every rate hike.
Both these factors could contribute to a pretty uncomfortable situations for banks, especially Lloyds which doesn’t have an investment arm — it’s entirely focused on lending to individuals and businesses.
In 2022, Lloyds took an impairment of £1.5bn — the value of bad debt written off by the business. In the first quarter of 2023, this figure was £200m — less than anticipated — but investors are worried that the worst is yet to come as mortgage holders, among other borrowers, struggle with their repayments.
The big question is, ‘how bad will it get’? Right now, that’s almost impossible to answer.
Tailwind continues
We’ve explored the bad side of higher rates, so here’s the good side. It’s higher net interest income. And with interest rates pushing higher, customers will need to pay even more on their loan repayments. Revenue will likely continuing soaring into 2024.
Banks tend to operate by borrowing from savers at short maturities and lending at long maturities. So, in theory, these higher interest rates will continue to delivering more revenue into the long run.
For example, my wife and I are looking to take a mortgage, and we’re looking at fixed rates around 6%-7% for five years. Meanwhile, if I was saving with Lloyds, I’d being earning between 3.25% and 5%. The spread is considerable.
A brighter future
In the near term, there’s clearly some uncertainty. EPS, which came in at a very impressive 2.3p in Q1, will likely fall in the second half of the year.
But, I’m looking beyond that.
Firstly, I’m expecting the dividend to continue growing to 2.7p and 3p in the coming years, from 2.4p last year, despite potential pressure on quarterly earnings this year. The dividend was covered more than three times last year.
And secondly, I’m buying for the medium term when we’ll likely see interest rates moderate. Lenders like Lloyds will thrive with a sweet spot between 2% and 3%. Here, margins remain elevated, but defaults are less likely.
Of course, Lloyds shares could fall further, but the stock is trading at 4.8 times earnings over the past 12 months. That’s very cheap, and the concern might already be priced in. For me, it’s buying opportunity.
