3 reasons why Lloyds shares could plummet!

Lloyds shares look like one of the FTSE 100’s best bargains right now. But scratch a little deeper and the bank looks like a potential trap, according to Royston Wild.

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Lloyds Banking Group (LSE:LLOY) shares have soared in value after a slow start to the year. At 55.9p per share, the FTSE 100 bank is now 17% more expensive than it was on New Year’s Day.

By comparison, the broader Footsie has risen a more modest 6%. But I’m not tempted to buy the bank today. I actually believe that a sharp share price correction could be coming down the line.

Here are three reasons why I think the Lloyds share price could crash.

Soaring impairments

The economic outlook for the UK in the short-to-medium term remains bleak. Major economic bodies expect GDP to expand around 1% over the next couple of years. Structural issues like high public debt, trade barriers, and labour shortages mean growth could remain weak beyond the near term, too.

Cyclical shares like Lloyds will likely struggle to grow revenues in this climate. But this is not the only danger. Tough economic conditions mean credit impairments could also keep swelling, even if interest rates fall.

On the plus side, Lloyds’ bad loans dropped to £70m in quarter one from £246m a year earlier. Yet the bank isn’t out of the woods. And its huge exposure to the mortgage market in particular means the number could suddenly surge again.

This is because mortgage rates will rise for 3m households between now and 2026, according to the Bank of England (BoE). Of this number, 400,000 will be paying 50% more than they currently do, the bank says.

As I say, Lloyds is especially immune to this threat. It provides around a fifth of all home loans in the UK.

Margins mashed

Lloyds’ chance to grow earnings will be made all the more difficult should — as the market expects — interest rates likely begin declining from late summer/early autumn.

Banks make the lion’s share of their profits by setting loan interest at a higher rate than what they offer to savers. This is known as the net interest margin (NIM), and it is hugely sensitive to the BoE’s lending benchmark.

Lloyds’ margins are falling even before the BoE has started cutting rates. In quarter one, its NIM fell 27 basis points to 2.95%. And so net interest income slumped 12%, to £3.1bn.

Ambitious rivals

Margin declines could be even more severe going forwards, and not just because of interest rate cuts. Growing competition from digital and challenger banks is also heaping pressure on the NIMs of established banks.

Thankfully for Lloyds, it has exceptional brand strength and a large (if declining) presence on the high street. It therefore stands a better chance of maintaining and growing its customer base than many other banks.

However, the threat from new entrants is still severe. And the landscape could get even more difficult if, as expected, they boost their financial firepower by floating shares. Monzo, Revolut, and Oaknorth are all tipped to launch IPOs sooner rather than later.

Here’s what I’m doing

On paper, Lloyds shares still look cheap despite recent gains. They trade on a forward price-to-earnings (P/E) ratio of just 8.6 times.

However, I think the risks of owning the bank outweigh the potential benefits. So I’m buying other low-cost FTSE 100 shares right now.

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.

Royston Wild has no position in any of the shares mentioned. 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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