Lloyds (LSE:LLOY) shares continue to be the most traded equity on the London Stock Exchange, with a daily average volume of over 135 million. Yet, despite this immense popularity, the banking stock continues to struggle to return to pre-pandemic levels.
That may seem odd, considering the recent interest rate hikes by the Bank of England have created a far more favourable lending environment for financial institutions.
So are investors secretly looking at a superb buying opportunity for Britain’s favourite stock? Or is there something else lurking beneath the surface?
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Higher margins, higher uncertainty
The last decade has been challenging for lending businesses to garner meaningful returns on their loan books. However, with interest rates now sitting at 5%, those days appear to be over. And the tailwind is already starting to materialise in Lloyds results.
At the end of 2022, the bank’s net interest margin stood at 2.94%. As of March this year, this figure now stands even higher at 3.22%. And as old loans mature and new loans are written, this upward trend is on track to continue for several quarters and even years to come.
So it should be no surprise that the bank’s underlying net interest income has grown by 20%, reaching £3.5bn, with after-tax profits coming in at £1.6bn versus £1.1bn a year ago.
Subsequently, management announced a £2bn share buyback programme launched in February and on track to be completed by the end of 2023.
Needless to say, this is all very positive news. And with billions being returned to shareholders, management is clearly optimistic for the future. So why then are Lloyds shares still trading at seemingly depressed prices?
The question marks surrounding Lloyds shares
While profits and margins are rising, investors are rightfully getting concerned about the risk of defaults. With the cost of debt jumping so suddenly, previously affordable loans are venturing into unaffordability for some households and businesses. And anyone on a variable rate mortgage has already likely felt the pinch as rates surge.
Lloyds is fully aware of this threat and has been busy estimating its impact with its expected credit loss (ECL) provisions. And as of March, these now stand at roughly £4.9bn. While these losses haven’t actually materialised yet, there’s a good chance of that happening in the eyes of management. And investors could soon see a gaping hole in the income statement as a consequence.
As horrendous as a multi-billion-pound loss sounds, it’s worth pointing out that this represents only around 1% of the bank’s loan book. So while Lloyds shares are likely to take a hit should these loans go bad, the underlying business is expected to remain afloat largely unscathed financially.
The bottom line
With all this in mind, is now the time to buy Lloyds shares? At a P/E ratio of 6, the bank stock certainly looks relatively cheap, considering the reported earnings growth. And while the ECL is concerning, I think investors may be a bit over-pessimistic about its long-term impact.
Therefore, today’s valuation looks like a buying opportunity in my eyes.
