Lloyds (LSE:LLOY) shares jumped this week as UK inflation data came in softer than expected, delivering much needed respite for the British economy. Despite strong net interest margins, the bank’s shares have tanked since March on growing economic concerns.
Long-term decline?
The shares are down around 31% over the past 10 years. Obviously, if I’d held Lloyds shares for that long, I’d be incredibly disappointed. A £1,000 investment would be worth around £690 today. During this period I would have received dividends, probably just enough to have broken even over the decade.
This raises a question: is Lloyds in long-term decline? Well, the share price drop being even steeper if we look back 20 years suggests so. Lloyds once traded for around 500p, more than 11 times the share price we see today.
Lloyds has been in business for 300 years, and while the bank has faced a number of challenges in recent years, including the financial crisis of 2008, the pandemic and rising interest rates, it’s not right to view it as a company in permanent decline.
After all, there are plenty of positives. Despite no longer having an investment arm, Lloyds remains the UK’s largest mortgage lender. And while its lack of international operations can be seen as a negative, I feel it’s a more simplistic and safe bet today than when Sir António Horta-Osório took charge more than a decade ago.
A turnaround
After the financial crash, we experienced near-zero interest rates for over a decade. The last year has seen this change considerably, and in many respects, it’s represents a huge tailwind.
When interest rates are high, banks can charge higher interest rates on loans and mortgages, leading to increased interest income and improved net interest margins. This boost in profitability can result in higher earnings for banks.
It’s also important to highlight that Lloyds is currently reaping significant benefits from its central bank deposits. Analysts estimate that each 25 basis point interest rate hike translates to an impressive £200m in interest revenue from Bank of England deposits alone.
The issue with higher rates, and this is why the share price kept pushing lower as inflation remained sticky, is that they also put more pressure on the bank’s customers. In turn, when customers default on their loans, banks have to write off this debt. It can get very expensive.
This, combined with concerns about impact of Brexit, is why we’re seeing Lloyds trade at such low multiples right now. Its price-to-earnings is just 6.3.
To date, higher interest rates have more than covered the cost of rising impairment charges. And hopefully, things will continue improving after the latest inflation data suggested we may be near the end of the monetary tightening cycle.
As an existing shareholder, I’m steadily increasing my Lloyds holding whenever I have available funds. I hold a positive outlook for the medium term, anticipating interest rates to eventually moderate to around 2-3%, creating a favourable environment.
The improved profitability during this period could also fuel further ventures, including the Lloyds foray into the homes rental market through Citra Living. While an investment 10 years ago might not have been a profitable one, I believe the next decade holds better prospects for Lloyds.
