Despite the ongoing investigation into motor loans, shares in Lloys Banking Group (LSE:LLOY) are up almost 38% in the last year. That’s clearly a very good result, but it’s worth putting into context.
While 38% is enough to turn £10,000 into £13,800, investors who bought shares in Barclays or NatWest have fared even better. And this is something investors should pay attention to.
Motor loans
There are a couple of reasons Lloyds shares have trailed some of the other UK banks over the last 12 months. But the biggest is the ongoing investigation into motor loans.
The bank has more exposure to the potential liabilities arising from the case than either NatWest or Barclays. And the bank has put aside £1.2bn to cover potential liabilities.
That’s around 10% of the firm’s net interest income from 2024 and two-thirds of the cash it used for dividends. This has been weighing on its financial results and explains the stock performance.
The Supreme Court’s verdict is due in July. And while there’s obviously a big risk here, things could go very well for Lloyds if the verdict is favourable.
Structural hedge
In terms of motor loans, Lloyds is at a clear disadvantage to Barclays or NatWest. But it might be in a better position to cope with a different potential risk.
Interest rates in the UK have been falling and this typically means lower lending margins. Banks, however, typically make fixed-income investments to try and limit the risk of changes in rates.
This is known as structural hedging. When interest rates are high, it can act as a drag on earnings, but when rates start to fall – as they are now – it can provide a boost to net income.
Lloyds goes about it in a more dynamic and less mechanical way than the other UK banks. And this might well prove to be an advantage with rates coming down in the near future.
Valuation
Lloyds shares currently trade at a price-to-book (P/B) ratio of around one. That’s lower than NatWest, but it’s towards the higher end of where the stock has been trading over the last 10 years.
On this basis, the share price doesn’t look unusually cheap. More accurately, it doesn’t look as though investors are particularly pessimistic about the company at the moment.
Given the ongoing motor loan investigation, I find this surprising. I think the outcome is difficult to foresee and this is something that I’m not sure is reflected in the share price.
Investors who bought Lloyds shares 12 months ago have done very well. But despite the stock underperforming some of its rivals, I don’t see an obvious buying opportunity for my own portfolio at the moment.
Investing in banks
I think banks can be terrific investments. But their businesses tend to be more cyclical than average and their share prices fluctuate accordingly.
With Lloyds specifically, buying the stock ahead of the upcoming Supreme Court verdict looks hugely risky. And I prefer to avoid uncertainty as much as possible with my investing.
A positive outcome for the company could give the stock a big boost. But investors considering buying shares at the moment should at least be aware of the potential for things to go wrong.
