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Will a weaker property market hurt the Lloyds share price?

Typical street lined with terraced houses and parked cars
Typical street lined with terraced houses and parked cars

One way to try and invest in the broad economy can be to buy bank shares. Broadly speaking, most banks tend to do well when the economy is flourishing. On the other hand, when the wider economy struggles badly that can often hurt the profitability of the banking business. As the UK’s largest mortgage lender, I think that logic applies to Lloyds (LSE: LLOY). So, with the prospect of Britain’s property market declining in coming years, could the Lloyds share price fall? Or might the shares offer a long-term opportunity for my portfolio?

The Lloyds share price is in retreat

Some investors already appear to be factoring in the risk that a worsening property market could spell trouble for the bank. In the past year, the Lloyds share price has fallen 13%.

One advantage of that for investors is that it has pushed up the dividend yield. If I bought shares in the FTSE 100 financial services giant today, the yield would be 5%. I find that attractive.

However, dividends are never guaranteed. I think a falling share price suggests that some investors fear that a property downturn may hurt profits at Lloyds. In the first nine months of this year, post-tax profits fell 26% compared to the same period last year. They still came in at over £4bn, meaning the Lloyds dividend remains amply covered.

But I see a risk that weaker housing prices combined with higher interest rates could lead to more borrowers defaulting. If that happens it could eat heavily into profits at Lloyds.

Last month the bank said that it is seeing only “very modest evidence of deterioration”. It added that, “the flow of assets into arrears, defaults and write-offs (is) at low levels and below pre-pandemic levels”. That sounds positive to me – if it continues in the coming years.

A possible bargain

It may be that low default levels do continue. After all, lenders like Lloyds are careful about who they accept as customers. On top of that, I see some reasons why the current Lloyds share price could turn out to be a bargain for my portfolio. Although higher interest rates hurt borrowers, they could be a boon for profits at mortgage lenders.

But I am concerned that things could suddenly get worse if incomes are squeezed, interest rates keep climbing, and property markets start to fall all at the same time. That combination of factors has echoes of the 1990s property crash that negatively affected property prices for many years.

Whether that happens is largely outside Lloyds’ control. It can work hard to manage credit quality and indeed is already doing so. But ultimately I think any serious fall in the property market is bound to hurt the largest lender in the market.

I’m not buying

I see some possible reward in buying and holding at the current Lloyds share price.

But I also think there are potentially big risks that Lloyds cannot control. That could be bad for profits and the bank’s valuation. So I am not buying Lloyds shares for my portfolio right now.

The post Will a weaker property market hurt the Lloyds share price? 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. 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