Lloyds (LSE:LLOY) shares have been pushing down again in recent years. But we shouldn’t worry. After all, as billionaire investor Warren Buffett tells us, falling stocks present an opportunity.
This time, the downward movement followed the bank‘s half-year results. The high street giant reported another surge in profits, but missed expectations. Moreover, investors were surprised by the magnitude of the company’s provision for bad debts.
So are we looking at a buying opportunity?
Debt provisions
During the first quarter, Lloyds saw a modest increase in its provisions for bad loans, totalling £243m, which came in lower than the expectations of many. However, the half-yearly report revealed a significant jump of 76% year-on-year, with the bank setting aside £662m for potential bad loans.
Amid an environment marked by heightened market sensitivity, investors interpreted this move as an indication of the bank’s caution concerning the coming months. For some time, investors have been worried that higher interest rates would lead to higher levels of default among borrowers.
Certainly, this is a valid point of concern. However, considering the rigorous stress testing that banks undergo and the substantial positive momentum driven by increased net interest incomes, it’s possible that this concern might be somewhat exaggerated.
Contradictory narratives
Numerous discussions concerning Lloyds and the banking sector have centred on the notion that the tailwind associated with higher interest rates is coming to an end. In other words, interest margins are no longer growing.
However, this standpoint is inherently dubious and self-contradictory.
As interest rates have progressively climbed, apprehension has mounted among investors that the favourable impact of interest rates might be countered by charges attributed to bad debt impairments.
In other words, the Bank of England’s base rate has long passed the optimal point for banks. If the BoE had stopped hiking rates at 3% — a beneficial level for banks — I’m entirely confident that the Lloyds share price would be much higher today.
To labour the point, as Bloomberg’s Jonathan Ferro often states, higher interest rates are good for banks, until they’re not.
The tailwind
Moderating interest rates should prove positive for Lloyds and its peers, for the reasons stated above. But this may benefit Lloyds the most as its operations are almost entirely focused on lending. It doesn’t have an investment arm.
There’s also hedging to consider. Banks borrow short term and lend long term. In other words, savers will likely see their interest rates fall quicker than borrowers will.
After all, if I take out a five-year fixed mortgage at 6% today, Lloyds will continue to benefit — unless I default, which I shouldn’t — from higher interest rates today for the next five years.
In conclusion, there’s a reason the average share price target on Lloyds represents a 40-50% uplift from the actual price. It’s a stock I’m continuing to top up on.
