Since 18 November 2024, the value of Lloyds Banking Group (LSE:LLOY) shares has risen 12%. This means a £5,000 investment made three months ago would now be worth £5,600.
Although this is a better performance than the FTSE 100 as a whole (up 7.9%), it still lags behind the other four banks in the index, with HSBC leading the way (up 36%). However, with the possible exception of NatWest Group, they have a more global reach.
Lloyds earns nearly all of its revenue in the UK. And with the economy struggling to grow at the moment — and disposable incomes coming under pressure — it faces a difficult environment in which to try and increase its revenue and earnings.
A simple business model
Like all banks, Lloyds charges interest on the amounts it lends, and pays interest on customer deposits. The gap between the two is known as the net interest margin.
Although both rates tend to move in line with decisions made by the Bank of England, banks are generally able to charge more for loans. Higher interest rates are, therefore, better for income.
After reaching a post-pandemic high — in August 2023 — of 5.25%, the base rate’s been cut three times since, to 4.5%. It’s now at the same level as it was in October 2008, just before the global financial crisis.
But although good for income, higher rates also mean an increased risk of customers defaulting on their loans. Banks are required to make a quarterly assessment as to the likelihood (and value) of any bad debts. If the position’s getting worse, an impairment charge (cost) is booked in the accounts. Otherwise, a credit (income) is recorded.
However, Lloyds appears to have its loan book under control. For the seven quarters ended 30 September 2024, it’s recorded a £581m increase in its impairment charge. This might sound like a lot but, over the same period, its net income has been £30.67bn.
A dark cloud looms overhead
But the investigation by the Financial Conduct Authority (FCA) into the alleged misselling of car finance remains a potential problem. And it makes me wonder whether the recent increase in the bank’s share price is justified.
Tomorrow (20 February), the bank releases its 2024 results. It’ll be interesting to see whether it increases the amount it’s set aside to cover the potential costs. Presently, it’s forecasting that the ‘scandal’ could cost £450m. I’ve seen one ‘conservative’ estimate suggesting the final bill could be as high as £4.2bn.
Looking at the firm’s balance sheet at 30 September 2024, this doesn’t seem particularly significant. At this date, it had total assets of £901bn, including £59bn of cash. However, based on its current market cap, the £4.2bn cost estimate is equivalent to 6.9p (11%) a share. Ouch!
And the saga could drag on for the rest of the year. The FCA has given motor finance providers until December to issue a final response to complaints.
Until the situation becomes clearer, I’m expecting the share price to be volatile, which is why I don’t want to buy the stock. It’s already close to its 52-week high, which could be a sign that investors may not be anticipating a £4bn+ cost arising from the FCA investigation. And they might be overly optimistic about the prospects for the UK economy.
