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Could the cheap Lloyds share price be about to explode?

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The Lloyds Banking Group (LSE:LLOY) share price has risen an impressive 11% in 2023. Yet on paper, this FTSE 100 banking share still offers exceptional value.

City analysts reckon company earnings will rise 6% year on year in 2023. That would leave Lloyds shares trading on a price-to-earnings (P/E) ratio of just 6.8 times.

This sort of rating leaves scope for fresh share price gains if full-year results impress tomorrow (Tuesday, 22 February). A retracement from recent one-year highs also provides room for another move higher.

But I’m not prepared to buy Lloyds shares for my own investment portfolio. Here I’ll explain why.

Reduced interest rate support

Rapid interest rate rises have supercharged bank profits for more than a year now. This month, the Bank of England (BoE)hiked its benchmark for the tenth month in a row to 4%.

Higher rates are good for the likes of Lloyds. They raise the difference between what interest rates banks offer savers compared with what they charge borrowers. In the first nine months of 2022, rate increases propelled Lloyds’ net interest margin (NIM) to 2.84% from 2.52% in the same period a year earlier.

The Bank of England is tipped to keep raising rates in the first half of 2023. And so Lloyds has predicted a NIM of above 2.9% this year.

But I believe the bank could face a struggle to hit this NIM target. Policy makers at the BoE (like Huw Pill, deputy governor) have outlined the dangers of hiking too far, casting doubts on the scale of future increases. There could also be sharp cuts later in 2023 to aid the ailing UK economy.

On top of this, intensifying competition from digital and challenger banks could also hamper Lloyds’ NIM ambitions. Lower overheads mean that online-led banks frequently offer more attractive products than established banks.

Consequently, high street operators are having to slash interest charges and provide better savings rates to stop revenues from stalling.

More shocking impairments to come?

A fresh surge in bad loans is another huge danger for Lloyds this year. Total credit impairments sharply accelerated to £668m in the third quarter, a result which in turn caused pre-tax profit to sink 26% to £1.51bn.

Total third-quarter loans accounted for more than half the £1.05bn worth of bad loans the bank recorded in the nine months to September. And I fear that full-year numbers released tomorrow will reveal another worse-than-expected increase in loan provisions.

All of the UK’s banks are under threat from rising impairments as the economy splutters. But Lloyds is perhaps more exposed than most given its particularly high exposure to the buckling mortgage market. The Financial Conduct Authority predicts that 770,000 households are at risk of mortgage default during the next two years.

The verdict

It’s possible that Lloyds’ upcoming financial update will impress the market and push its share price higher. But this doesn’t change my view on the company as an investor. In my opinion, it carries far too much risk to be considered a sensible share to buy today.

The post Could the cheap Lloyds share price be about to explode? appeared first on The Motley Fool UK.

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Royston Wild 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