The Lloyds Banking Group (LSE:LLOY) share price has lost a whopping 10% of its value since the start of the year. It’s a descent that has driven its valuation through the floor.
Should I consider buying the bank for my portfolio? Well, a price-to-earnings (P/E) ratio of 5.6 times for 2023 is extremely tempting. This is some distance below the FTSE 100 average of 12 times.
Furthermore, this beaten-down UK share also carries a healthy 6.6% dividend yield for this year, well above the 4% average for Footsie shares.
However, some companies trade on rock-bottom valuations for good reason. Here are three reasons why I’m not yet keen to buy Lloyds shares.
1. NIMs falling
The net interest margin (NIM) is a key metric that’s used to gauge a bank’s profitability. It measures the difference between the interest charged borrowers and what is paid to savers.
NIMs have leapt across the industry thanks to a steady flow of interest rate rises. Lloyds has said it expects its own reading to rise above 3.1% in 2023, up from 2.94% last year. But NIMs could fall sharply from next year, dragging bank profitability lower in the process.
Ratings agency Fitch has predicted that “margins will come under growing pressure from rising deposit costs and increasing loan impairment charges“. Especially worrying for Lloyds is Fitch’s assertion that margins on new mortgages are falling “due to strong competition among banks“.
This is a concern as Lloyds is comfortably the UK’s largest home loan provider. Indeed, Lloyds’ NIM dropped to 3.08% in the last quarter from 3.14% during quarter two, suggesting the pressure is already telling.
2. Housing market exposure
That hefty exposure to the homes market also means loan impairments at Lloyds may be especially severe. The Footsie bank set aside another £187m to cover bad loans in the September quarter.
Building society Nationwide saw mortgage arrears rise to 0.38% at the end of September from 0.32% around six months earlier. That’s hardly an eye-popping rise, sure. But with more homeowners due to come off fixed rate deals in the coming months, inflationary pressures persisting and the economy struggling, arrears and defaults for Lloyds might soar.
3. Long-term weakness
I’m not just concerned about upheaval at Lloyds in the short term, either. I believe the firm’s lack of foreign exposure could see it deliver substandard returns compared to other banking giants like Standard Chartered, HSBC, and Santander.
While Lloyds concentrates on the mature British market, a string of other UK banking shares like those mentioned have considerable exposure to underpenetrated, fast-growing territories in Asia, Africa, and Latin America. This gives them significantly more scope to deliver strong profits growth.
In Asia Pacific, for example, regional banking revenues are set to grow by 7% to 8% per year, for example. That’s according to analysts at McKinsey & Co. This is a market opportunity that Lloyds can only dream of.
The verdict
As I say, Lloyds shares look exceptionally cheap on paper. But this reflects the prospect of severe profits trouble in the near term and weak earnings growth thereafter. On balance I’d still rather buy other value stocks.
