Lloyds (LSE:LLOY) shares, like other banking stocks, are cyclical. When times are good, banks tend to do well, reflecting the health of the economy. But when there is an economic downturn, they can suffer as customers struggle to repay debt and loans turn bad.
So with an economic downturn/recession forecast in the UK and elsewhere in the world, could the Lloyds share price tank?
Bad debt and other headwinds
On Thursday, Lloyds said profits for the quarter had fallen on bad loan charges. Pre-tax profit fell 26% to £1.5bn. Net income rose 12% to £13bn on the back of surging interest rates with impairment charges soaring to £668m from a release of £119m a year ago.
Chief executive Charlie Nunn highlighted that the current environment was “challenging for many people.” However, Lloyds also said there had been only “very modest” evidence of customers struggling with repayments to date, with CFO William Chalmers noting that customers were “resilient and [were] adapting well to the cost-of-living increases that we have seen.”
Banks, including Lloyds, are also reeling from the impact of Liz Truss’s catastrophic financial policies which sent markets into turmoil. Following September’s mini-budget, and reactionary interest rate hike, many banks removed products from the market.
One big plus
Banks, including Lloyds, have already put money aside for inflation and recession-related defaults. But the big plus is net interest margins (NIMs) — the difference between savings and lending rates. These have been rising considerably as the Bank of England raised the base rate.
The bank now expects net interest margin to be above 2.9%, up from 2.8%. Chalmers said the bank will be passing about half of rising rates through to savings customers, in line with its competitors. It’s also worth noting that Lloyds is even earning more interest on the money it leaves with the central bank.
Will Lloyds shares tank?
The recession in the UK isn’t anticipated to be too deep, and that’s a positive for banks. Instead, I see bank profits remaining sizeable on the back of higher NIMs. Lloyds’ bad debt provision is considerable, but you’d expect banks to be preparing for the worst, and hoping for the best.
I actually see the Lloyds share price rising back towards 50p as NIMs push revenue higher. There’s also evidence that the macroeconomic environment is improving, especially now Truss is out of office. Natural gas prices, which is one of the core factors behind global inflation, are falling quickly. In fact, UK prices are down 72% since the summer peak. And this should make a huge difference to the state of the British economy.
I already own Lloyds shares but, at 43p, I’d buy more. There are headwinds right now, but the economic forecast is looking a lot better now than it did a month ago. The higher NIM forecast is also extremely positive. There’s also the matter of an attractive 4.7% dividend yield.
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James Fox has positions 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.
Motley Fool UK 2022