Lloyds’ share price has declined quickly and violently amid a global equity rout sparked by US growth concerns and a collapse of Japanese equities.
With shares trading around 54p—significantly below recent highs of 60p—investors may have their eyes on the FTSE 100 bank. However, headwinds are building that investors should consider.
Notwithstanding the global equity selloff rocking equity markets, Lloyds shares face several factors limiting income and eroding profit. Some argue that they aren’t fully priced at current levels and that investors may find better value at lower levels.
Lower interest rates
Although Lloyds shares rose steadily on the day after the release of half-year results, the update offered few positives over the coming 12-24 months. The declines in the last few days are more representative of Lloyds’s macro challenges in the short and medium term, which are likley to lead to weaker metrics than those reported last week.
The hammer blow to Lloyds shares came with the Bank of England interest rate cut and the firing of the starting gun on a series of rate decreases, which will ravage Lloyd’s all-important net interest margins (NIM).
Lloyds NIM was down 10% in the first half, and it’s very difficult to see how the bank doesn’t post an equally disappointing NIM for the second half of the year.
Net Interest Margin (NIM) is a key banking profitability metric that measures the income derived from the difference between interest earned on lending activities and that paid out for deposits. Lower interest rates are rarely good for banking NIMs, and this threatens Lloyd’s profitability in the coming periods.
Lloyds is the UK’s largest mortgage provider, and the recent rate cut has already started to affect mortgage rates, signalling lower income for banks across the board.
Rising unemployment
There are a range of economic data points which will present challenges to Lloyds and other UK banks. However, none threatens profitability more than the UK’s rising unemployment rate. Since hitting a low of 3.8% in December 2023, the UK unemployment rate has increased to 4.4%.
There is a strong correlation between the unemployment rate and the UK housing market—one that investors should be acutely aware of. When the unemployment rate increases, defaults and repossessions rise, leading to higher provisions by banks for bad debts. Should Lloyds be forced to make such provisions, it will erode already-pressured income caused by lower interest rates.
You may think the rate cut last week will provide a boost to mortgage holders and the UK housing market. And to some extent, it will. However, if a greater number of people start losing their jobs, saving a couple hundred pounds on a mortgage will be of little consequence if they lose their income entirely. Such a scenario is not guaranteed, but the probability of more people finding themselves in difficult situations is rising.
In addition to provisions for bad debts amid rising default rates, Lloyds investors will be conscious the group is facing potential litigation costs from a car finance probe.
Lloyds share price
With the bank’s headwinds building, some investors will wait for the Lloyds share price to hit 50p before buying, while others will keep their eyes on the low 40s before wading back in.
The Lloyds dividend will provide some compensation for waiting for any capital appreciation. However, the potential yields to be locked in at lower levels may give some reason for pause.