Lloyds Bank (LSE: LLOY) is a stock that divides opinion. On the one hand, there are plenty of investors who believe it offers considerable value at its current share price. After all, it’s trading on a P/E ratio of less than 8 and currently offers a prospective dividend yield of 6%. The shares are also around 80% lower than they were at the start of 2007, pre-Global Financial Crisis. On the other hand, some investors believe Lloyds should be left alone, arguing that the investment case for it is highly risky.
Personally, I’m cautiously optimistic on the outlook and I own the stock in my dividend portfolio. That said, today I want to focus on the risks of owning Lloyds shares. These are the key risks you should know about.
The first thing you need to understand about Lloyds is that it’s essentially a proxy for the UK economy. In other words, it’s a business that is likely to perform well when the UK economy is doing the same, yet could suffer if the economy takes a downturn. This is because it is a domestically-focused bank. Whereas other banks such as HSBC have international operations, Lloyds is a pureplay on the UK.
As such, if Brexit was to have a negative impact on the UK economy and the country went into a recession, Lloyds could certainly be affected. A recession could result in job losses, which in turn, could lead to loan defaults for the bank. A recession might also see people cut back on borrowing and credit card spending, and as a consequence, the firm could have trouble growing its loan portfolio. So, in the event of a recession, its profitability could suffer.
The next major risk to consider is claims related to the mis-selling of payment protection insurance (PPI). This is an issue that refuses to go away, and in August, the bank announced that it was setting aside another £550m to cover the cost of claims, taking the total set aside to a staggering £19.2bn.
Investors should be aware that the deadline to make a PPI claim is 29 August 2019. If there’s a rush of last-minute claims right before the deadline, Lloyds’ near-term profits could be hit.
Finally, another major risk to be aware of is the threat of financial technology (fintech) firms. Fintech has made significant progress in recent years, and there are now many amazing products and services available that make life easier for consumers. For example, there’s Transferwise, which enables people to transfer money overseas at a fraction of the rate that banks charge. Or there’s Revolut – a digital bank that enables consumers to hold, exchange and transfer money without fees in 24 different currencies.
Lloyds and every other ‘traditional’ bank need to ensure that they’re not asleep at the wheel here. Otherwise, fintech firms will steal market share. To stave off the threat of fintech, Lloyds need to innovate.
So, they are the three main risks I see for it right now. All three have the potential to impact the share price and the dividend. Having said that, I’m happy to hold the stock for now, despite the risks. In my view, the low valuation and high yield present an attractive risk/reward opportunity.
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Edward Sheldon owns shares in Lloyds Banking Group. The Motley Fool UK has recommended HSBC Holdings and Lloyds Banking Group. 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.