Is this a multi-billion-pound reason to buy Lloyds shares?

Lloyds shares have surged in recent months but our writer believes there may well be a major reason to continue buying the stock.

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UK investors may be hesitant to invest in a stock that’s near a five-year high and is rather volatile. However, there are still several tailwinds that will likely help Lloyds (LSE:LLOY) shares push higher throughout the medium term.

So here’s a multi-billion-pound reason why I’d buy more Lloyds shares if it wasn’t for the fact that it’s already one of my largest holdings.

Interest rate sensitivity

Lloyds is among the most interest rate-sensitive of UK banks. That’s because it doesn’t have an investment arm and 68% of loans are UK mortgages.

The UK’s interest rate forecast hinges on the Bank of England’s Monetary Policy Committee (MPC) which meets around every six weeks — eight times a year.

The next MPC meeting’s scheduled for 20 June when policymakers will review economic data and decide whether to adjust rates accordingly.

Markets anticipate that as inflation cools, the MPC may begin reducing rates to support economic growth, balancing this with maintaining financial stability.

The August meeting could see rates fall to 5%. And then to 4.75% in November.

A multi-billion-pound tailwind

Elevated interest rates and a stagnating economy have spelled danger for banks over the last 18 months. While they generate more revenue when rates are higher, it also means customers are under increased pressure.

If customers can’t afford the repayments, and defaults occur, banks incur impairment charges. Lloyds’ worst quarter in recent times for credit impairments was Q3 2022 — £668m.

However, with the economy set to pick up and interest rates due to fall, Lloyds’ analysts think impairment charges will become less burdensome.

As of 31 March, Lloyds’ base case scenario points to £3.5bn in expected credit losses (ECL). That’s an improvement from £3.7bn — stated in December — and £4.4bn on 30 June 2023.

As we can see, during nine months, the ECL position’s improved by £900m. Moving forward, and as interest rates fall, I’d expect this to become a multi-billion-pound improvement.

This ECL metric’s crucial for assessing financial health and risk management, as it reflects the bank’s anticipation of potential future losses based on economic conditions and borrower profiles.

Can things only get better?

Lloyds stock has been held back in over the past five years by a unique mix of factors, including Brexit, the pandemic, interest rates, stagnating UK growth, and low levels of UK investment.

My biggest concerns remain in the very near term. With interest rates still high, impairment charges could remain an issue until rates start to fall — hopefully in August as we mentioned above.

That’s not to mention the things that could prevent interest rates from falling, like surprise inflation prints or a spike in fuel prices.

However, the bank’s operating conditions genuinely appear to be getting better. And it’s broadly considered that falling interest rates will bring a net benefit.

For full disclosure, Lloyds is already among my largest holdings and, due to concentration risk, I’m unlikely to buy more stock soon.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox has positions in Lloyds Banking Group Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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