Has The European Banking Crisis Made Lloyds Banking Group PLC An Even Better Buy?

What a difference a week makes. Lloyds Banking Group (LSE: LLOY) was a largely blameless victim of the recent share price sell-off but it has rebounded 10% in the last week to hit around 62p at time of writing.

Bargain bank?

I’m glad that it has recovered given that I named the bank my top FTSE 100 stock tip for 2016. Not that I was overly troubled by the slump. We at the Fool are drilled to view a stock market rout as a great chance to load up on our favourite stocks at bargain prices, and this looked like a classic of the type.

The market sell-off was largely triggered by trouble in China and growing fears of a European banking crisis, rather than concerns about the UK banking sector. But that doesn’t mean Lloyds and the other big banks have their hands clean. UK bank stocks fell 20% because they still haven’t fully repaired their balance sheets, and some fear they remain vulnerable to contagion from the continent. Yet with a common equity tier 1 ratio of a solid 13.7% last September, Lloyds is better positioned than most.

One big negative

The global trend towards negative interest rates is a growing concern however. As my Foolish colleague Owain Bennallack recently pointed out, Lloyds has done a decent job of rebuilding its net interest margins over the past few years but would be crushed by negative interest rates.

I don’t think the Bank of England will go negative: it refused to cut rates below 0.5% because of the damage that would do to building society deposits. Negative rates would be a big step and a sign that Bank policymakers have lost the plot, especially if they prove ineffective elsewhere. Deputy governor Sir Jon Cunliffe recently warned the assumption that rates won’t rise until 2019 and might even be cut weren’t backed by economic fundamentals. But the possibility of negative rates certainly adds an extra element of risk for buyers of Lloyds’ shares.

The people’s bank

Repairing the damage of the financial crisis has been a far longer job than anybody could have imagined. Lloyds is still struggling to cast off the shackles of past misdemeanours and further PPI mis-selling provisions can’t be ruled out. Chancellor George Osborne had hoped to be spearheading a people’s flotation at the moment, but that remains on ice with the share price still well below the taxpayer’s break-even price of 73.6p.

Predictions are notoriously difficult, especially about the future of banking stocks, and you shouldn’t wholly rely on forecasts that the stock will yield 5.1% by the end of this year, up from today’s 1.2%. We should know more about the dividend when Lloyds publishes an update on Thursday. Faithful investors are putting their trust in a return to the dividend machine of yesteryear, but the recent sell-off has given scope for share price growth as well.

I still believe Lloyds is a buy for patient investors, but the road ahead remains long and troubled. One day, this should be a low-risk domestic play again, but that’s hard to imagine right now.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.