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2 lessons about Lloyds shares I learnt in 2022

Man putting his card into an ATM machine while his son sits in a stroller beside him.
Image source: Getty Images

I started the year owning a position in leading bank Lloyds (LSE: LLOY). Over the past year, its shares have moved around but, overall, have drifted downwards.

I end the year with no Lloyds shares in my portfolio, although I continue to see the business as attractive.

Indeed, I would be happy to buy into the firm again in future, depending on the bank’s business outlook and its share price. For now though, the risk of growing loan defaults hurting profits is keeping me away from them.

Here are two things I learnt about Lloyds shares this year.

Default risks are growing

On paper, Lloyds looks like a potentially compelling investment. It remains massively profitable and trades on a price-to-earnings ratio of under eight.

It is one of the best-known names in financial services across the UK. It is also the country’s biggest mortgage lender.

But despite all that, Lloyds looked cheap at the start of the year – and still looks cheap. Maybe investors collectively are making a big valuation mistake. But I think it is more likely they are pricing in the risk that a recession might push more borrowers to default on loans, hurting profits at lenders like Lloyds.

What have we learnt about this in 2022? In October, the company said that “the flow of assets into arrears, defaults and write-offs (is) at low levels and below pre-pandemic levels”. That sounds upbeat. But the trend seems to be getting worse. Lloyds noted that observed credit performance has shown evidence of deterioration, albeit at a “very modest” level so far.

The company also noted when explaining its impairment charges for the most recent quarter that it is using an updated outlook. This “includes elevated risks from a higher inflation and interest rate environment”.

In other words, the bank sees growing risks to its profitability compared to the picture at the start of the year. Back then, I expected default risks to grow, potentially keeping Lloyds shares down. But without a crystal ball, I was not sure it would happen. Twelve months has provided more evidence of what a worsening economy means for the banking sector.

Dividend restoration is slow

I know that a company can have healthy profits and cash flows but decide not to pay them out to shareholders. But I still got a nasty surprise this year at the reluctance of Lloyds’ management to restore the dividend at least to where it stood before the pandemic.

In 2018, Lloyds made a post-tax profit of £4.5bn and paid a dividend per share of 3.21p. This year, it made £4.1bn in post-tax profits in the first nine months alone. Yet, despite growing the interim dividend 19%, it remains around a quarter below its pre-pandemic level. I currently expect the full-year picture to be similar.

That is not because of a shortage of spare cash. The company spent £2bn this year buying back its own shares. That could turn out to boost long-term shareholder value if the current valuation of Lloyds shares turns out to be lower than they merit. But it shows management is not prioritising bringing the dividend back to where it stood before the pandemic.

That was one of the reasons I decided to sell my Lloyds shares this year.

The post 2 lessons about Lloyds shares I learnt in 2022 appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group Plc. 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.

Motley Fool UK 2023