Lloyds (LSE:LLOY) shares continue to trade firmly below 50p. Yet even after recently reporting double-digit earnings growth and pre-tax profits close to £4bn, the banking stock continues to trade below pre-pandemic levels. Is this a buying opportunity, or should investors steer clear? Let’s take a closer look.
Capitalising on higher interest rates
With the Bank of England raising the cost of debt to combat inflation, banks like Lloyds have finally shifted into a more favourable lending environment. With interest rates kept artificially low for over a decade, net interest margins have been pretty tight. But following the recent hikes, the steady stream of newly issued loans is starting to deliver results.
Over the last 12 months, Lloyds’ interest margin has increased from 2.9% to 3.1%. While that may seem like a small difference, it translates into substantial earnings growth thanks to the firm’s £451bn loan book. And subsequently, investors’ return on tangible equity has climbed to a solid 16.6%.
Needless to say, this bodes very well for the lending institution as well as for its shareholders. And with cash flows expanding, management could comfortably increase dividends by 15% versus a year ago.
But these encouraging results do beg the question: why are Lloyds shares not rising?
The problem
Despite the bank’s promising performance, there’s growing uncertainty surrounding its loan book. The number of loans going bad is increasing as borrowers struggle to keep up with rising interest rates.
Management has already had to write off hundreds of millions of pounds worth of uncollectable loans since the start of 2022. And in these latest results, we just saw another £462m worth of impairments added to the pile. Compared to £451bn total issued obligations, these write-offs aren’t financially troublesome for the firm. But it does highlight a concerning trend.
Continued pressure from macroeconomic forces could result in more defaults from Lloyds’ customers. And there are signs of falling demand for financing facilities, with the loan book shrinking. The impact of these effects is currently being offset by interest rate hikes on its healthier customers. But once the fight against inflation is done, earnings growth could grind to a halt.
Time to buy?
Versus current earnings, Lloyds shares are trading at a P/E ratio of roughly 5.6. That suggests the banking stock is cheap. But there’s a chance that this is a value trap if the concern surrounding its bad debt pile proves to be justified.
Personally, I’m not convinced that Lloyds is the best stock to buy today. There are other companies within the FTSE 100 that appear to be performing on a similar level without a shroud of uncertainty looming over their heads. Therefore, I won’t be adding Lloyds shares to my portfolio today.
