Lloyds Bank (LSE: LLOY) shares look cheap at the moment. At the current share price of 57p, Lloyds trades on a forward-looking P/E ratio of 7.3, while the prospective dividend yield on offer is a high 6%. By contrast, the median FTSE 100 P/E is 14.1 and the median yield is 4%.
However, before you rush out and buy the shares because they’re cheap, it’s important to stop and consider the risks of investing in the bank. Here are four risks you should know about.
The UK economy
The first risk that comes to mind in relation to Lloyds is its exposure to the UK economy. As a domestically-focused bank and the largest provider of mortgages in the UK, Lloyds is essentially a play on the UK economy and the housing market.
Brexit certainly adds uncertainty here. While UK growth came in at 0.5% in the first quarter, the Bank of England (BoE) recently warned that the economy would flatline in the second quarter and slashed its forecast to zero from a previous estimate of 0.2%. A severe economic contraction or housing market crash as a result of Brexit could see Lloyds’ profits dry up.
UK interest rates
Interest rates are another issue to consider. Last summer, the BoE lifted interest rates to 0.75%. Now, however, with the possibility of a no-deal Brexit increasing, there is talk of an interest rate cut. This would hurt Lloyds, and the banking sector in general, as higher interest rates are better for banks as it enables them to earn a larger spread between the money they borrow and the money they lend out.
Investors also shouldn’t ignore PPI claims. The deadline for PPI claims is 29 August, so hopefully this issue – which has seemingly dragged on forever – will be put to bed soon. However, in the short term, we could see a rush of claims submitted before the deadline. This could hit near-term profits.
The FinTech threat
Finally, don’t forget about the threat of new entrants into the banking sector. New digital banks and innovative FinTech firms are completely overhauling the banking industry right now and if the traditional banks aren’t careful, they could lose customers.
A great example of how digital banks are making life easier for consumers is account opening. If you want to open an account with a traditional bank you often have to visit a branch and speak to an adviser. Then, you’re looking at a seven-day wait for your debit card. However, with new digital banks such as Monzo, you can open an account online within minutes and have access to a digital card immediately.
Lloyds is focusing on becoming more digital. However, it needs to ensure that it continues innovating or it could be at risk of losing customers to new players.
Do Lloyds shares have investment appeal given these risks?
Personally, I do still see appeal. The dividend yield of 6% is attractive, and dividend cover appears to be solid, suggesting a dividend cut is unlikely in the near term. I also think the current valuation reflects the risks. In my view, Lloyds shares remain a solid buy-and-hold income investment.
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Edward Sheldon owns shares in Lloyds Banking Group. The Motley Fool UK has recommended 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.