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Is the Lloyds share price heading to 40p?

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Over the past 12 months, the Lloyds (LSE: LLOY) share price has come under heavy selling pressure. Shares in the bank are down around 12% since the beginning of October last year, underperforming the FTSE 100 by about 7%, excluding dividends paid to investors.

There are a handful of reasons why investors have been turning their backs on the bank in 2019. Most of these are external. For its part, Lloyds has continued to grow, cut costs and return cash to investors.

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However, the market is focusing on these external factors facing the business, which are likely to hit profitability. It would appear most investors are trying to get out before this happens.

External factors

The most significant risk facing the Lloyds share price is Brexit. We don’t know what will happen if the UK leaves the European Union without a deal at the end of this month, but all forecasts suggest the economy will suffer.

For Lloyds, which is one of the largest banks in the UK and the largest mortgage lender by volume, this is particularly troubling. If people lose their jobs they can’t pay their mortgages, and the bank will have to write down the value of its loan portfolio as a result. Falling home prices will only compound the problem. 

Further, policymakers at the Bank of England have said it’s likely they will reduce interest rates in a no-deal scenario. Banks rely on high-interest rates to make money. If the base rate falls further, the rates of interest Lloyds can charge customers will have to fall as well. 

Then there’s the competition in the banking sector to consider. New ring-fencing rules, which force banks with more than £25bn in assets to separate their investment and retail arms, have had the unintended result of flooding the market with capital. Banks are now fighting each other for more customers, and a price war is on. Several financial institutions have already warned this year the price war is impacting their profit margins.

For the time being, Lloyds seems to be coping well. In its results for the first half of 2019, the bank told the market its net interest margin remained “resilient” at 2.9%.

Weathering the storm

There’s no ignoring the fact all of the above are issues could significantly impact Lloyds’s profitability over the next few quarters. However in my opinion, the bank is exceptionally well-positioned to weather the storm and could come out stronger on the other side.

The group earned a return on tangible equity — a measure of bank profitability — of 11.5% during the first quarter, whereas most of its peers struggled to achieve a return of 10%.

At the same time, Lloyds’s capital ratio hit 14.6% at the end of June, above management’s minimum of 12.5%. The bank’s costs have also come down substantially over the past 12 months. The cost:income ratio was 45.9% at the end of June, down from 47.7% in the prior-year period. This should help the group’s profitability if earnings come under pressure due to rising loan losses.

Overall, while Lloyds is facing headwinds, I think the group is well-placed to manage these issues. As a result, if the stock does fall much further, I reckon this could be a buying opportunity for savvy value investors to snap up a bargain.

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Rupert Hargreaves owns no share mentioned. 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.

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